by Jim Hornik

Selecting the right type of lender is critical for borrowers who have limited cash or equity for their practice start-up, acquisition or expansion. A cash-flow-based lender rather than an asset-based lender may be required. Here are their key differences:

Asset-based Lenders: Most, though not all, local banks are asset-based lenders. As "community banks" they make loans to a wide variety of businesses in which they have little expertise. Their main expertise is in understanding the general economy and real estate market in their service area.

Asset-based lenders limit their risk by loaning 75% to 80% of the appraised value of land and buildings. If a borrower defaults on payments, the lender can resell the property and retrieve most or all of the unpaid balance of the loan. They also limit their risk by offering shorter terms and amortize loans over 15-20 years. They may have an option to recall a loan, requiring a balloon payment and refinancing, in 10 years. Because they take less risk, asset-based lenders often charge less interest. However, the benefit of lower interest is reduced by the requirement to pay off the loan in 15-20 years.

The critical issue with asset-based lending is the potential gap between what the borrower needs and the appraised value of the real estate. An asset-based lender will typically require the borrower to contribute 20$ of the appraised value in cash and the lender will contribute 80%. If the amount that the borrower needs to buy or build is more than the appraised value of the real estate, which is often the case, the borrow may need to contribute the different in addition to 20% of the appraised value.

Cash-Flow-Based Lenders: Most lenders who specialize in veterinary practices, though not all, base the amount loaned on projected net income more than on appraised real estate value. Their main expertise is in evaluating the ability of a practice to produce sufficient net income after expenses to make its loan payments.

Cash-flow-based lenders usually expect net income to be a ratio of 1.0 to 1.25 times loan payments. Annual loan payments of $10,000 require net earnings of $10,000 to $12,500 if using these ratios.

The cash-flow-based lender will not limit the amount loaned to a percentage of the appraised real estate value as long as they are convinced that the practice can earn enough to make its loan payments. Therefore, the borrower is less likely to be required to contribute more equity if project cost is more than appraised value.

If the Small Business Administration (SBA) provides loan guarantees to the lender, the equity required may be 10% of the project cost, rather than 20%. The combination of cash-flow-based lending and SBA guarantees provides significant benefits for the veterinarian who has good earnings potential but limited cash.

Cash-flow-based lenders typically charge higher interest rates because they take great risk. However, they may offer longer repayment schedules, which reduces the impact of higher interest rates.

Jim Hornik manages KSA's Business Planning Department, conducting market studies, financial analyses, and lender searches.