Securing a Loan for Practice Acquisition, Expansion and Merger in Today’s Credit Market

The Credit Crisis, with banks now less willing to lend to one another, has redefined the playing field. Standards are back. Gone are the days of knowing there is a loan out there for almost any credit situation. Gone are the days of ‘NINJA/No Doc’ lending – no income, no job, no assets. It’s kind of amazing such a loan ever existed, really. But no, it has not become impossible to secure a loan. You will just have to shop smart, and put to use the services of an experienced commercial lending advisor.

Today, you will need a FICO (Fair Isaac Corp.) score that qualifies you for Prime or “Conventional” lending underwriting guidelines - and a sizable cash down-payment of 20% or more. Yes, 100% financing is still available, with the seller ‘holding the 2nd” on the amount you would have put down. Given the lending challenges of today, you will find more sellers willing to partake in these types of transactions.

With all the turmoil and uncertainty, traditional banks and lending institutions still can not compare to the plethora of innovative and flexible terms and loan structuring still offered by commercial lenders for those with good FICO scores. But, keep in mind that commercial lending is very different than personal and residential lending, so do not go into a commercial loan application armed with information on current residential rates and fees. You will only be disappointed.

Personal Credit Scores (FICO) of the principals will greatly influence the rates, terms and conditions available. FICO scores will determine whether traditional commercial lending funds are an option, or if a temporary, ‘hard-money’ fix with refinancing down the road might be your best solution for now. Unlike residential real estate lending, which focuses primarily on the borrower's credit, commercial lenders concentrate equally on the physical real estate – specifically, the income produced by the real estate and/or the income produced by the business (practice) housed within. You generally need more cash or equity up front for a commercial loan, as most commercial lenders will cap their LTV (Loan to Value) rates at 75% - 80% these days.

You may face more stringent FICO score requirements with commercial lenders, but they are inherently better suited to provide you the money you need quickly to prevent the loss of an opportunity. Commercial lenders also better understand business, and with the assistance of your commercial lending advisor, who will find you the best deal available, and who will work directly with the lender representative on your behalf, can apply that knowledge directly to the structure of your loan.

Several parameters in your credit file, including length of credit history, number of open accounts and their balances, debt/income ratio, payment history of existing and previous debt, mortgages and other public records are used to produce your individual FICO score. The key to using your score to your advantage is to examine and attend to any potentially damaging information to which your lender will have access. Your personal commercial loan advisor can help you with this process, then research and secure the best loan option available for you.

FICO scores are based on five main categories of credit information. These are, in order of importance:
· Late Payments, Delinquencies and Bankruptcies
· Outstanding Debt
· Length of Credit History
· Recent and Current Applications for Credit (includes all credit inquiries other than your personal ones)
· Type(s) of Credit Currently in Use

The many factors, compiled, determine your FICO score – a 3-digit number (350-850), which places you in one of three categories of risk of default; Prime (conventional), Sub-Prime and Shafted.


Prime/Conventional
With a FICO score of 680 and above, you are a ‘prime’ borrower – the lowest risk, and the highest in demand by lenders. You will have no problem obtaining a substantiated, “conventional” commercial loan. You will have the best rates, terms and loan structuring options available.

“Hard-Money” lenders will love you, and should not be discounted as a viable option for fast, short-term lending. You will need a commercial loan advisor, with connections to legitimate hard-money pools, to help you secure this option.

Sub-Prime
With a FICO score between 560 and 680, you are a ‘sub-prime’ borrower – a slightly higher risk. IF you can secure a commercial loan today, you will pay a significantly higher interest rate. The terms and loan structuring options available to you will be limited by comparison.

Shafted
Prior to the credit crisis, with a FICO score of 560 or below, you were considered a ‘shafted’ borrower. You were considered high-risk and the ability to secure lending was extremely difficult, but not necessarily impossible. Today, you will not secure a commercial loan.

The circumstance(s) that resulted in your low FICO score have no merit in the eyes of potential lenders. Prior to the credit crisis, IF you could secure lending, you needed significant cash down or equity (as much as 40% or more), paid the highest rates and had few if any options regarding terms and structuring.

‘Hard-money’ became a viable option for many in this category, often forcing the principals to spend time cleaning up their credit over a planned period and refinancing for better terms and rates down the line.

That said, “hard-money’ is not a solution for the shafted borrower only. Indeed, hard-money is a viable option in many situations, especially when a fast closing is in order, such as in the case of an opportunity that could be missed due to the slower nature of traditional commercial lending.

Work Your FICO Score. Obtain copies of your credit reports from the three main credit bureaus *(Equifax, Experian and TransUnion). Any other provider of a credit score is a waste of time, free or not. No lender looks at anything but a ‘tri-merge’, compiled of the three aforementioned bureaus.

Determine inaccuracies and challenge them to the creditor and each of the three credit bureaus in writing, certified delivery receipt. Catch up with or pay off existing debt in collection (major and department store credit cards, installment loans, etc.), unless you are challenging them (in writing). Reduce balances on current credit lines, if possible, to less than 30% of the available credit. Make all payments on time without fail, from here on.

Address delinquent credit. Lenders will consider “recency, frequency and severity” of your late payments, in that order. This is where a written letter of explanation (to the lender) regarding why your payments were late may actually be of benefit – but only if the reasons are, in their view, reasonable. Finally (and this is critical), acquire no further debt of any kind (including co-signing for others or new credit lines or cards) until your loan has been closed/settled. Otherwise, underwriting calculations of debt/income ratios begin again, and you face the potential for delays as well as all new rates, terms and loan structuring.

In the Underwriting Process, commercial lenders take into consideration the income, potential income (this CAN be a viable consideration), personal net worth, various ratio’s including debt/income ratio, and FICO score of each principal. Further, they consider the FICO score and various ratios of the business (practice) itself and the particular type of loan for which the principals are applying. Debts in collection, judgments, bankruptcies, liens, wage attachments and current litigation proceedings of a personal or professional nature are also considered. The reasons behind these circumstances are of no merit in the process. Current litigation (which you must disclose in detail) is a huge issue for many medical and dental professionals seeking loans of any kind, as both the battle and the outcome can greatly affect your current and future financial stability.


The “Four C’s” of Commercial Credit Underwriting

It is an underwriters job to assess your ability to repay (or likelihood of default on) the loan. Thus, lenders scrutinize four areas of the practice’s history and financial condition as well as that of the principals.

Capacity
Capacity is defined as the ability of your practice to meet current financial obligations (think existing credit for the practice and financial status/relationships with vendors, suppliers, etc), and probability of successful repayment of the loan. Commercial lenders will consider the practice’s income, cash-flow (many lenders require a cash flow that is 1.25 times the total cost of the company's total and expected debt), and personal and business credit reports.

Credit (FICO)
Issues of credit require the lender's underwriter (the decision maker) to make a careful judgment about the principals and the business (practice) as a whole. What is comes down to is personal and business credit history, including bankruptcies, foreclosures, etc., and showing the potential lender that yours is a serious business venture. How do you do this? Clean up your credit as much as possible before you apply. Present a detailed, well-written business plan (your commercial lending advisor can supply this for you for a fee, or will know someone who can). Be responsive and efficient with regard to any request for information from your potential lender.

Capital
When thinking about Capital, think “collateral” – the income generated from your practice. It is what you are risking, should you default.

Commercial Lenders will review your personal and business credit reports, as well as your balance sheets to determine your practice capital. In addition to scrutinizing how you manage current and previous credit and the value of your assets, commercial lenders will calculate ratios for your practice and compare them to the ratios of similar practices – all in the name of determining your risk.

Collateral
To reduce your risk assessment, you will have to offer up collateral (pledge assets), which might include real estate, including your primary residence. Know what you are pledging for collateral. Know what it is worth. Don’t assume your broker (who told you your house will not be part of the collateral) is correct. He’s not making the loan. The lender is. The lender and the lender alone stipulates collateral, and it can be different for every borrower based on credit history, current finances and business plan.

Read the fine print of every page at closing, before you sign it. Read your UCC1 form at closing - not when you get home because in commercial lending, unlike residential mortgage lending, you have no right of rescission. Commercial loans are absolutely done deals.

Invest in a well-written business plan. Management analysis by underwriting includes various factors; the experience of the principals in the particular specialty, marketability of your specialty and the business plan. The average range for a professional business plan (prepared to typical bank specifications) is $5,000 to $10,000. Many commercial lending advisors, having come from banking, are able to produce such a plan for you, or you can request it of your practice advisory firm. It is money well spent if your lender requires a business plan.

Key Ratios

· LTV or Loan to Value
o LTV ratio equals the amount of the loan for which you are applying divided by the market (appraised) value of the property. In today’s credit market, expect and LTV cap of 75%, and if you find higher, be very, very thankful.

· Personal Debt Ratio
o The Personal Debt Ratio is a principals’ monthly debt divided by monthly gross income, though commercial underwriters are more interested in the income and expenses of the property and the business housed within.

· The D/E or Debt to Equity Ratio
o This ratio measures the amount of debt your practice has, compared to what has been invested in the practice. The debt should include the loan amount for which you are currently applying. Your equity indicates any invested capital and earnings retained (not distributed) in the practice. Generally, a debt﷓to﷓equity ratio of 1.0 or greater indicates your practice has maximized its’ borrowing capacity.
o The D/E represents the proportions of equity and debt to finance your practice’s assets. It is equal to total liabilities divided by shareholders equity (taken from your business financial statement).

· DSCR or Debt Service Coverage Ratio
o THE DSCR ratio equals net operating income (gross income less expenses) divided by debt service. In short, DSCR refers to the property’s ability to sustain itself from the net income produced by the business (practice) housed within. Most commercial lending underwriters require a minimum DSCR of 1.20x.

When all is said and done, expect to close a commercial loan approximately 30 days or so from the commitment date. The time it takes to get a commitment is mostly up to you. It can be done in a matter of a few days if you supply exactly what’s been asked of you the first time. Expect to hand over a lot of information, and expect to answer a lot of questions about the information you provide. Then expect to answer more. This helps your commercial loan advisor better understand your particular goals, financial situation and to better place your loan with the most prudent lender and loan program available.


* There are three main credit bureaus in the U.S. Each may have slightly different information in your file, so be sure to request a copy of your credit report from each on a regular basis. Carefully review the reports to identify errors and discrepancies. Promptly report them to the bureau and the particular creditor, in writing. By law, the bureaus must respond to your inquiry within 30 days.


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