When setting up a physician's practice or when expanding the practice to add a new physician or equipment, it is not unusual for the practice to borrow money from a bank. When doing so, it's important to review not only the term letter setting out the key aspects of the loan, but also the actual debt agreement to understand the rights and obligations imposed by the agreement. Many of the clauses in a debt agreement are standard and are required by the Uniform Commercial Code, but many are customized by the bank you are doing business with and are worth negotiating when possible.
The interest rate, term, collateral, and repayment terms are certainly critical aspects of a debt agreement. Other areas to consider are:
Guarantees. In most cases, banks will require a guarantee from the physicians for corporate debt. However, it is important to understand the amount of the debt that is being guaranteed. In many cases, the debt agreement requires 100% of the debt to be guaranteed by all parties.
The fact that four physicians each guarantee 100% of the loan gives the bank the opportunity to go against one physician for the entire amount of the loan (it does not result in the bank receiving 400%). It is then up to that physician to seek contributions from his or her partners.
When only one physician is guaranteeing the loan, the guarantee could be over 100%. It is important to work with the bank to negotiate lower guarantees and request that the guarantee be dropped a few years into the loan payoff when a good track record of payments has been created.
Collateral. Often when a practice requests debt for a new piece of equipment, the loan document initially submitted shows a lien on all assets of the company (a "blanket lien"). This includes all bank accounts, all patient amounts receivable, and older equipment as well as the new equipment being purchased. Watch for blanket liens, and request they be altered to cover only the asset being financed. It's important for physicians to know that it may be challenging to get a bank to place a lien only on the equipment being purchased. Negotiating could be very important in this situation.
Prepayment penalties. Banks make money on the interest you pay over the term of the loan. In dropping or stable interest rate markets, the interest rate the bank quotes you is based on the bank earning the interest for the entire life of the loan. If you pay off the loan early, the bank won't make as much as anticipated, and their costs to make the loan may not be covered. To make up some of that lost income, banks often have a prepayment penalty; this is usually calculated as a percentage of the amount you paid early. When you are negotiating the loan, make it clear that you do not want a prepayment penalty—for longer loans, these amounts can be significant.
Balloon payment. To make loans at competitive interest rates, banks can insert balloon payment clauses. In periods of increasing interest rates, this allows the bank to incur less risk that they made a loan with a low interest rate for a long period. For example, the loan may have a 3.5% interest rate but have a balloon at the end of 2 years. This would show payments as if the loan would be paid off in 10 years, but at the end of 2 years, the remaining balance would be immediately payable. This allows the bank to renegotiate the interest rate that was applicable at the time of the balloon, thus cutting its risk.
Balloon rates might be worth having, but you, as the borrower, would be gambling on rates staying low or going lower by the end of the term. There is also a risk that the credit-worthiness of the company would not be as good at the end of 2 years.
In general, a balloon payment provides the borrower with lower payments in the early years of the loan. With a new practice or a young physician, generally the first 2-3 years can be very difficult; then the practice hopefully starts to grow and earn significant revenue. After that, it becomes possible to take on larger monthly debt payments. The balloon payment allows the physician to pay a smaller amount in the early years, when the practice may be struggling, and gives them an opportunity to refinance a few years later, when they may be able to make larger monthly payments.
Balloon clauses can be worthwhile, but it is important to understand the risks associated with them.
Acceleration clause. This clause lets the lender declare the entire balance of the note due if you default on the terms of the note, such as missing a payment. If you miss a payment, you can negotiate with the bank to hold off on accelerating the note, but once a loan is accelerated, it is very difficult to get the lender to "unaccelerate" and reinstate your old loan. If you begin having problems in making monthly payments, contact the bank immediately; the bank may be willing to work with you before the loan goes into default.
Attorneys' fees. Creditors often include a provision in a loan agreement awarding attorneys' fees if you default and they have to sue you to get paid. However, make sure the contract also says that you have a right to attorneys' fees if you are sued and you win. The document should provide that any awarding of attorneys' fees should be reasonable, because rates vary among law firms and attorneys. If the loan goes into default, you don't want to find yourself paying top dollar for the bank's attorneys.
It's wise to get an attorney's advice or review when negotiating a loan or signing a loan document. Much of the legal verbiage in a loan agreement may seem standard. However, these terms can be negotiated, depending on the financial strength of the physician. In instances where the bank refuses to negotiate the terms, it's important that the physician understand the exposure that could occur. There are many potentially dangerous provisions, such as personal guarantees, acceleration of loan, and the general terms.