Tread carefully when someone offers you a loan. Make sure you can comfortably afford it before you sign.
Here's the situation: My clients, a husband-and-wife team, own a nice veterinary practice in a fairly large city. Both are full-time practicing veterinarians and have two young children. The couple rents a 3,000-square-foot facility and gross about $1 million annually. They have a strong desire to build their own veterinary hospital and had some plans drawn up by an architect for a beautiful, state-of-the-art, 6,000-square-foot facility. It was about this time that my company was called in to help improve the practice's efficiency and profitability. They told us about this new building almost as an aside.
The cost of the new building, along with rolling in existing debt, was going to be about $4 million. When we asked how they were going to finance this project, they said their loan had already been approved. When we reviewed the loan documents, we found that the finance company had put together $4 million with three separate 25-year SBA loans with an interest rate of prime plus 2 percentage points adjusted quarterly. I was amazed. How were they ever going to pay off this loan, and why would anyone loan them this kind of money under these circumstances?
Naturally, these were the questions I asked the practice owners. They assured me that the finance company told them that the practice could afford the debt and that everything would work out just fine. The finance company representatives had even flown out to visit their practice and pitch the loan to reassure the practice owners that this was a good deal for them. Yet when the practice owners spoke with their accountant about the loan, the accountant confessed to being skeptical as well. I suggested we set up a conference call to discuss financing with the practice owners, the accountant, the finance company, and me.
call, I was seething. The call started off cordially enough, but then I asked the finance company representative how he could lend $4 million to practice owners who were only generating $1 million. He told me that the loan-to-value ratio was not what he would like it to be, but it was within acceptable parameters for his company.
I interrupted him and said, "Wait a minute—do you mean to tell me that you feel it is fiscally responsible to make a $4 million loan to people whose practice is only generating $1 million dollars a year, who have two young children, and who still have school loans to pay off? And with a loan over 25 years at prime plus two points that adjusts quarterly?"
He hesitated and said "yes." I then asked him if he personally would take out a 25-year loan at prime plus 2 percent with a quarterly adjustment and, after another hesitation, he answered "yes." He went on to tell me that he feels the U.S. economy will be like China's and that interest rates would stay low.
"I think your crystal ball is better than mine," I said. "I'm just not willing to gamble on that speculation." I knew if rates went up by one point, the owners' payments could increase by more than $29,000 a year.
Just because someone is willing to loan you money doesn't mean you should take it. You always need to do your due diligence and make sure the loan is the right choice for you. You might wonder why a finance company would make such a loan. Well, few veterinarians will default on loans. Most veterinarians are kind, honest, and responsible.
I think the husband-and-wife team would have worked as long and as hard as necessary to pay back the loan, sacrificing themselves and their family in the process. If the practice were to default on the loan, the loan was backed by the SBA so the financial institution would get their money.
Always do your research before financing a large project. Ask your accountant to prepare pro forma statements for you for a look at your current income and expenses and projections into the future. These numbers show you how much revenue you'll need to generate to afford that new building or piece of equipment.
If you know you need to generate $2.5 million to afford that new building, you have a set goal in mind and can hopefully develop a plan to achieve it. The cost of a professionally done pro forma may be $4,000 to $5,000, but considering the stakes, this will be money well spent.
Get a practice valuation from a competent and trusted source. You need to look at your practice's potential and growth areas. Pick someone who has nothing to gain or lose if the project falls through.
By the end of that conference call, the practice owners decided to look into scaling down their project. I suggested they could build 3,000 square feet now with the intent of adding another 3,000 when the practice could afford it. The finance company representative also agreed that this might be a good idea. The accountant suggested that we look into a fixed rate loan, considering the fact that interest rates haven't been this low in a long time—and may not stay that way forever.
The final decision, of course, is always in the practice owners' hands. The lure of a new veterinary hospital is strong, but now that their decision is a more informed one, I'm confident these young veterinarians will be successful both personally and professionally.
Mark Opperman, CVPM, owns veterinary consulting firm VMC Inc. in Evergreen, Colo.