Immediate cash flow advance

Financing growth through cash-flow and asset-value credit facilities

In today's healthcare market, a viable growth strategy for healthcare organizations often involves the acquisition and merging of physician practices, outpatient clinics, laboratories, home healthcare, and other services into a seamless delivery system for both patients and payers. Entities considering such efforts - particularly not-for-profit healthcare organizations - should examine their capital structures closely and explore new ways to finance their growth strategies.

Many healthcare organizations may find it difficult to raise sufficient capital through traditional funding sources, such as tax-exempt bonds or internally generated cash flow, to support aggressive acquisition and expansion strategies. In such instances, they should consider alternative sources of financing that are tied to their cash flow and/or asset values more than their balance sheet and debt-to-equity ratios. Nontraditional lenders that specialize in health care, such as commercial finance companies and specialized industry units of banks that have typically dealt with the for-profit sector, will value the enhanced market position and improved cost efficiencies that a healthcare organization can expect to derive by executing large-scale transformations and, therefore, may be more willing to underwrite such business plans.

One caveat must be noted before discussing these financing alternatives: Nontraditional lenders may face some legal barriers to providing financing directly to not-for-profit organizations. Nonetheless, not-for-profits may still be able to secure financing from many of these capital sources through credit facilities available to their for-profit subsidiaries. What is most important to the lender is the ability to secure itself with the stock and/or assets of the operating entity.

Cash-Flow and Asset-Value Financing

In general, the borrowing base for nontraditional financing will be either cash flow, also termed earnings before interest, taxes, and depreciation and amortization (EBITDA), or asset value (typically accounts receivable and/or equipment). A cash-flow-based credit facility typically offers advances tied to a multiple of cash flow, such as 3 to 4 times the EBITDA for the previous 12 months. Often, the acquired operations' EBITDA for the previous 12 months can be included in the borrowing base.

Asset-based credit facilities typically offer a fixed percentage of financing against eligible assets. For example, loan amounts might be based on 75 to 85 percent of net accounts receivable or 70 to 75 percent of the orderly liquidation value of certain equipment. Again, the borrowing base frequently will allow for the inclusion of eligible assets of acquired operations.

Choosing the Right Financing Option

If an organization has an investment-grade or near-investment-grade credit rating, a cash-flow-based credit facility might be the best choice, especially if the organization's competitive advantage derives more from its service orientation and market position than from its tangible assets. Such organizations often share the following characteristics:

* A significant and defensible market position with strong barriers to the entry of competitors into the market, such as contractual relationships with the leading physician practices;

* Historical financial performance that validates an organization's competitive edge;

* An experienced management team; and

* Diversified service and product offerings, payer mix, and (where applicable) geographic markets.

Lenders are likely to view these types of organizations as well positioned for consolidation and competition and, thus, they will be more likely to offer them more favorable credit terms.

Healthcare organizations in a growth mode but with lower credit ratings may still be able to access needed capital through an asset-based credit facility. This type of loan is particularly well suited for the following uses:

* Working capital;

* Immediate advance against receivables;

* Cash flow to bridge the gap between the typical collection cycle and short-term financial obligations, such as payables; and

* Acquisitions of provider organizations.

While strongly relying on assets to make their financing decisions, lenders offering this type of credit facility also will look at cash flow and other financial performance measures. To qualify for this loan, an organization should be able to demonstrate a meaningful debt service capacity. In addition, its management team should be able to articulate how its acquisition strategy will enhance market position, competitiveness, and financial strength.

Other Considerations

In essence, credit facilities are financial enabling tools that allow organizations to capitalize quickly on opportunities in a fast-changing marketplace. One facility called an acquisition revolver, for example, allows organizations to access funds on an acquisition-by-acquisition basis and repay the loan as cash flow increases. Although carrying an unfunded acquisition line of credit has associated fees, this financing strategy generally is much more cost-effective than borrowing a lump-sum amount (as is usually the case with bonds) that is invested in a low-yielding investment instrument until the funds are needed for the acquisitions.

Using such nontraditional financing methods also gives fast-growing organizations the option of switching credit facilities as they implement their acquisition plans. A provider organization planning to build an integrated network, for example, may have to borrow on its assets to begin acquiring physician practices. As the number of acquisitions reaches an optimal size and significant cash flow is generated as a result, the acquiring organization may then wish to switch to a cash-flow-based credit facility.

As with any business relationship, the choice of a lender ultimately is a matter of mutual trust and confidence. If a lender's acquisition covenants are too restrictive, even the lowest financing rates are too high. A good choice in lenders is one that trusts the acquiring organization's business acumen and allows it to execute its strategy by structuring credit facilities to allow for maximum borrowing capacity, competitive interest rate fees, and flexibility to finance future growth.

David M. Anderson is a senior vice president, corporate finance group, Heller Financial, Inc., Chicago, Illinois.