The two most common methods for a dentist to enter ownership are to buy an established practice or to set up a brand new office. Financing is almost always required, and in today’s competitive market there are many financial institutions vying for your business.
My company recently entered the equipment leasing market and we are now expanding into a full-service lender for dentists. In researching current lending offerings, I have discovered that many banks, leasing companies and other institutions offer a wide array of financial services. A dental practice has proven to be one of the most creditworthy small business enterprises (SBE) and accordingly, the dentist’s choice of possible lenders is always increasing.
Fixed versus Floating Interest Rate
When your income is secure, as in a well-established practice, some dentists are prepared to risk increasing interest rates and will therefore choose the variable rate option when borrowing money. Variable rate debt usually yields a lower initial rate, but it’s possible that the prospect of rising rates will increase the total amount of interest paid over the term of the debt. In today’s strong Canadian economy, I predict that the pending rise in interest rates will cause more dentists to choose a fixed interest rate contract and the comfort that a fixed monthly payment offers.
Variable rates can be confusing when the lender sends its regular notices of interest rate changes, together with an adjustment in monthly payments, and this may not suit your business and personal budget. My advice is to choose the interest rate mechanism – fixed or floating – that suits your comfort level rather than focusing solely upon the interest rate itself. Your accountant is an ideal source of advice in this matter.
Lease versus Loan
For years, accountants have debated the benefits of leasing versus buying, because the tax treatment of each is different. Leasing usually yields a faster “write-off” as the total monthly lease payments are 100 percent deductible. Buying usually involves borrowing money at an agreed upon term and interest rate. This allows for the deduction of interest and, when combined with the prescribed amount of depreciation and amortization deducted from your practice income, is also attractive. Both a lease and a purchase can be equally tax effective depending upon your circumstances. Dental equipment is commonly leased and all the major Canadian dental dealers have arrangements with leasing companies to facilitate a quick processing of your equipment purchases. Some dental dealers receive a referral fee from the leasing company in return for this service, a practice that may occasionally increase the interest rate you might otherwise pay had you dealt directly with the leasing company. Other dealers simply prepare the lease contracts as a courtesy. If you decide to lease, ask your equipment supplier what its arrangements are with the leasing company – before you sign.
Buying a Practice
The most common financing for the purchase of an established practice is the term loan. Many institutions will not lease the value of goodwill – they often prefer the security of a loan, sometimes backed by a mortgage on your home or a spousal guarantee of the debt. While this can achieve a lower interest rate, most dentists I know would prefer to have business debts separate from their personal assets and spousal income. When examining your financing proposal, be certain to consider the long-term effects of using additional security simply to obtain a lower interest rate.
Setting up a New Practice
Leasing companies excel in this field, as they prefer to lease new equipment. The used equipment that is found in an established practice is not as appealing in the very rare event of a default on the lease. Leasing companies use a pricing model known as the “irate factor” that easily helps calculates your monthly payment. Unfortunately, rate factors do not identify the true, effective interest rate inherent in the leasing contract. Ask your leasing company what the interest rate will be, once the lease has commenced, and be careful not to rely solely upon the “interim” rate that is often changed during the project’s build-out phase. Interim rates are typically prime plus one percent, but they usually increase once the term of the lease begins.
Many companies are now offering flexible financing to dentists, both term lenders and banks, who also provide deposit accounts, lines of credit (for accounts receivable) and other services such as debit and credit card processing machines. Term lenders are usually more flexible and banks have been known to ask for additional security in many transactions. Leasing companies do not normally ask for additional security but usually offer a predictable fixed versus a floating interest rate.
Choose the financing source that suits your budget and your tolerance for changes in rates. Always consult with your accountant before signing any loan, lease or instrument of debt.
By Timothy A. Brown