Access to capital, one of the greatest challenges for an ASC, has become more difficult with the recent meltdown of the banking industry. Having a good banking relationship is very important, but banks have become more jittery about lending money for new projects. While banks are still lending money for medical projects (not the case in many other industries), they are now requiring physicians and other investors to have more skin in the game.
Bank financing for construction
Before the meltdown, it was not uncommon for banks to loan 75-80 percent against the appraised value of the building. Now, in many cases, the loan will be for 70-75 percent of the cost of construction, which is substantially less money.
For example, a facility with a total cost of $3 million may have an appraised value of around $4 million on an income-capitalized appraisal. The old 75 percent loan-to-value ratio provided 100 percent of financing construction costs, with the cost of land as the equity. But the new 75 percent loan-to-cost ratio only provides financing of $2.25 million. Therefore, an investor needs to be found to cover the remaining $750,000.
Real estate partnerships
Since many physicians aren't comfortable investing significant sums of cash, an outside investor is usually needed, such as a real estate entrepreneur who invests in the real estate partnership of the ASC. These entrepreneurs understand market values and appreciate the returns medical ventures can provide.
The real estate partnership leases the building to the ASC operating entity at a fair market lease rate for ASCs. Banks prefer owner-occupied buildings but they will accept an arrangement with an investor group having a 70-80 percent ownership in the real estate, while the ASC owners have the rest.
However, banks require personal guarantees, which has become a big hurdle for physicians. Only a few years ago, ASCs were able to get limited guarantees, with owners guaranteeing the loan and the lease at 100-150 percent of their ownership interest. In other words, an owner of 10 percent of the real estate and ASC operating entity guarantees 15 percent of the loans and the leases, while a 20-percent owner would be responsible for 25 percent of the ASC loans and leases. In today's market, however, banks have been requiring unlimited guarantees on owners within the real estate venture and the ASC operating entity, a practice known as joint and several liability.
Banks now will finance the real estate on a 20-year amortization, whereas before they offered a 25-year amortization, but the term of the loan would be set at 5 to 10 years and in many cases would depend on the length of the lease with the ASC operating entity. This means payments are calculated on a 20-year amortization but the unpaid principle is due after 5 or 10 years, at which point the usual course is to refinance the debt.
ASC capital, equipment and operating loans
While the ASC can lease the building from the real estate partnership, the operation will need capital to buy equipment and cover start-up costs until it breaks even. This money comes from the initial capital from the owners of the ASC operating entity, an equipment loan and a line of credit from the bank.
It helps to have more physicians to pay these costs, but more physicians do not necessarily mean higher profitability. Instead, they mean higher staff costs, requiring more loans, and a wider mix of cases that can make the ASC less efficient and therefore more costly. For economic reasons, it's better to have a single-specialty center with just a few physicians that have large volumes of surgical patients. Even just two orthopedic surgeons can support an ASC.
Equipment costs
The cost of equipment depends on the specialty mix and the number of ORs. The minimum cost for each OR is roughly $250,000, but endoscopic equipment, high-tech or high resolution displays and electronics tend to cost more, and surgeons' special preferences add to the price tag. The cost of equipment per OR runs the gamut from $200,000 to $1 million in a state-of-the-art neuro-spine facility.
Start-up costs
The ASC needs to have enough funds to cover at least three to six months of operating costs, until it is accredited or certified, and even then volume may still be too low to break even. Insurance contracts usually are negotiated after certification or accreditation.
Choose a management company with experience negotiating contracts in the market. This is especially important with neuro-spine and orthopedics ASCs, where high implant costs can harm profitability. If the health insurance company will not agree to carve-outs, the ASC can use companies that have national contacts, such as Access Medical.
The ASC will have to operate on lines of credit or partners' capital for as long as six months. If the money runs out, going back to the bank and asking for more may not be an option. Banks frown on another round of lending, so it's important get the cost right the first time. An accurate estimate of start-up expenses can be attained through extensive modeling, covering factors such as insurance market characteristics and procedure volume. Physicians tend to overestimate the volume they can deliver in the ASC, so a certain percentage usually needs to be taken off their estimate.
More advice
To keep the amount of the loan and capital low, it's not advisable to hire a full complement of staff. In any case, they won't all be needed because volume will be low in the first few months. Use per-diem RNs who have flexible schedules.
Money needed for operating costs depends on how big the operation is. An ASC with one to two ORs needs at least $250,000 in capital and a line of credit of $400,000-$500,000, which will be used until the operation reaches a break-even point. On the other hand, an ASC with three to four ORs requires $600,000-$800,000 of capital and a line of credit equal to that amount. However, these projections are worse-case scenarios and are estimates only.
Finally, subscription agreements are essential to provide protection from a disgruntled investor. The subscription agreement establishes the terms of the sale and requires the investor to make binding representations to the ASC.
James Cobb is CEO of Orion Medical Services develops and manages ASCs, overseeing all aspects of a project, from financial feasibility analysis to site management and operational development. Learn more about Orion Medical Services.
Bank financing for construction
Before the meltdown, it was not uncommon for banks to loan 75-80 percent against the appraised value of the building. Now, in many cases, the loan will be for 70-75 percent of the cost of construction, which is substantially less money.
For example, a facility with a total cost of $3 million may have an appraised value of around $4 million on an income-capitalized appraisal. The old 75 percent loan-to-value ratio provided 100 percent of financing construction costs, with the cost of land as the equity. But the new 75 percent loan-to-cost ratio only provides financing of $2.25 million. Therefore, an investor needs to be found to cover the remaining $750,000.
Real estate partnerships
Since many physicians aren't comfortable investing significant sums of cash, an outside investor is usually needed, such as a real estate entrepreneur who invests in the real estate partnership of the ASC. These entrepreneurs understand market values and appreciate the returns medical ventures can provide.
The real estate partnership leases the building to the ASC operating entity at a fair market lease rate for ASCs. Banks prefer owner-occupied buildings but they will accept an arrangement with an investor group having a 70-80 percent ownership in the real estate, while the ASC owners have the rest.
However, banks require personal guarantees, which has become a big hurdle for physicians. Only a few years ago, ASCs were able to get limited guarantees, with owners guaranteeing the loan and the lease at 100-150 percent of their ownership interest. In other words, an owner of 10 percent of the real estate and ASC operating entity guarantees 15 percent of the loans and the leases, while a 20-percent owner would be responsible for 25 percent of the ASC loans and leases. In today's market, however, banks have been requiring unlimited guarantees on owners within the real estate venture and the ASC operating entity, a practice known as joint and several liability.
Banks now will finance the real estate on a 20-year amortization, whereas before they offered a 25-year amortization, but the term of the loan would be set at 5 to 10 years and in many cases would depend on the length of the lease with the ASC operating entity. This means payments are calculated on a 20-year amortization but the unpaid principle is due after 5 or 10 years, at which point the usual course is to refinance the debt.
ASC capital, equipment and operating loans
While the ASC can lease the building from the real estate partnership, the operation will need capital to buy equipment and cover start-up costs until it breaks even. This money comes from the initial capital from the owners of the ASC operating entity, an equipment loan and a line of credit from the bank.
It helps to have more physicians to pay these costs, but more physicians do not necessarily mean higher profitability. Instead, they mean higher staff costs, requiring more loans, and a wider mix of cases that can make the ASC less efficient and therefore more costly. For economic reasons, it's better to have a single-specialty center with just a few physicians that have large volumes of surgical patients. Even just two orthopedic surgeons can support an ASC.
Equipment costs
The cost of equipment depends on the specialty mix and the number of ORs. The minimum cost for each OR is roughly $250,000, but endoscopic equipment, high-tech or high resolution displays and electronics tend to cost more, and surgeons' special preferences add to the price tag. The cost of equipment per OR runs the gamut from $200,000 to $1 million in a state-of-the-art neuro-spine facility.
Start-up costs
The ASC needs to have enough funds to cover at least three to six months of operating costs, until it is accredited or certified, and even then volume may still be too low to break even. Insurance contracts usually are negotiated after certification or accreditation.
Choose a management company with experience negotiating contracts in the market. This is especially important with neuro-spine and orthopedics ASCs, where high implant costs can harm profitability. If the health insurance company will not agree to carve-outs, the ASC can use companies that have national contacts, such as Access Medical.
The ASC will have to operate on lines of credit or partners' capital for as long as six months. If the money runs out, going back to the bank and asking for more may not be an option. Banks frown on another round of lending, so it's important get the cost right the first time. An accurate estimate of start-up expenses can be attained through extensive modeling, covering factors such as insurance market characteristics and procedure volume. Physicians tend to overestimate the volume they can deliver in the ASC, so a certain percentage usually needs to be taken off their estimate.
More advice
To keep the amount of the loan and capital low, it's not advisable to hire a full complement of staff. In any case, they won't all be needed because volume will be low in the first few months. Use per-diem RNs who have flexible schedules.
Money needed for operating costs depends on how big the operation is. An ASC with one to two ORs needs at least $250,000 in capital and a line of credit of $400,000-$500,000, which will be used until the operation reaches a break-even point. On the other hand, an ASC with three to four ORs requires $600,000-$800,000 of capital and a line of credit equal to that amount. However, these projections are worse-case scenarios and are estimates only.
Finally, subscription agreements are essential to provide protection from a disgruntled investor. The subscription agreement establishes the terms of the sale and requires the investor to make binding representations to the ASC.
James Cobb is CEO of Orion Medical Services develops and manages ASCs, overseeing all aspects of a project, from financial feasibility analysis to site management and operational development. Learn more about Orion Medical Services.