Bankrolling your growing medical business in a tough economy.

All companies need capital. Growing companies, and new businesses, invest capital in recruiting and training new staff, developing programs and improving facilities, investing in technology, and marketing and advertising.

When these programs succeed, the business must then fund an increase in accounts receivable and collections. Growing companies need more additional capital than stable companies, which can match working capital needs with revenue.

The current economic climate offers many opportunities for practices to expand, hospitals to merge, and new service and product providers to be created. Health care has been a strong sector of the economy during the recession, and will continue to expand despite contraction in other parts of the economy.

There is a paradox at work. Even as health care companies expand to meet the opportunities, finding capital to support that expansion has become more difficult. While new federal programs are creating opportunities for information technology, practice management, primary care and other clinical services, the business environment is making it harder to take advantage of those opportunities.

As traditional sources of capital, i.e., banks, venture capital, and IPOs (public stock offerings) have become more difficult to obtain, alternative funding has grown. Traditional capital is equity and debt.

Alternative capital can be found in several parts of the business, including asset reduction (accounts receivable, prepaid expenses) or increasing debt by slowing of payables or converting capital assets to capital leases.

Here's a look at some creative sources of equity and debt, and then a review some alternative sources of capital for growing your business.

Equity

Even though the IPO market is effectively dead for now, especially for small companies, growing companies can get access to equity capital through public transactions that have been created to serve this market.

PIPE (private investment in public entity) and private equity investments have reached tens of billions of dollars per year. While public market financing is usually not available to small companies, a relatively new vehicle for financing of small companies has become more commonly used in the past decade.

This is the "reverse merger" or "shell company" acquisition. In this transaction, a non-public company is "acquired" by a public company which has ceased operations, but which maintains a listing on a stock market. Usually the public company is a shell corporation that exists only on paper, but is legally registered as a public company.

The shell is actually purchased by the private company. At the same time, the new company issues a PIPE offering for new shares to private investors. The end result is that the private company has become a public company, with new capital from investors, but without the expense of an initial public offering.

Another way for small companies to raise capital is through a "rights issue." A small Australian public company with a rapidly growing product for diagnosis of pulmonary emboli wanted to enter the North American market. Finding the window of opportunity for a secondary offering or PIPE closed, and not being able to get loans, the company decided to offer its existing shareholders the right to purchase additional stock in a ratio to their current holdings.

This achieves the two ends of raising capital to enter the much larger U.S. marketplace, and avoiding dilution of existing shareholders. Of course those shareholders must be willing to exercise their "rights" and believe that management has a good plan that it can execute effectively. If some shareholders do not exercise their rights to invest, then new shareholders can purchase these shares. This type of transaction can avoid some of the fees associated with PIPE offerings.

Reverse merger (ConMed)

A medical practice, which for many years has provided comprehensive medical care at the local jail, expanded in recent years to offer its services to jail facilities in several nearby counties.

Finding a ready market for its services, it began getting RFP's for contracts in neighboring states. The company improved its services, brought in additional managers and providers, and decided that it would tackle similar opportunities around the country.

Lacking capital for expansion, the company was guided through a reverse merger into a public shell company, and $10 million in additional capital was raised. This funding allowed the company to pursue contracts in the West and Southwest, and to quadruple its revenue in two years.

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PIPE transaction: (Chembio)

A small point-of-care diagnostic company developed a highly sensitive and accurate blood test for the HIV virus. The test was sold successfully in the international market, but the company saw an opportunity to enter the U.S. market for rapid blood testing.

In order to receive FDA approval for the test, the company needed to pass stringent U.S. regulations and manufacturing tests. To raise capital for this plan, the company, which was already publicly traded, sought financing through a PIPE transaction.

Investors buy new stock directly from the company in a block of shares. The stock is usually issued at a small discount to the public market, but is not freely tradable for a limited amount of time, which allows for the discount.

The PIPE market has grown to be a significant multi-billion dollar source of financing for small and medium-sized public companies in the past decade. For the diagnostic company, the PIPE allowed the money to be raised quickly, and the HIV test was approved by the FDA within 12 months.

Partnerships have an additional mechanism for raising capital not available to other corporations. Increased capital needs may arise from expanding offices, recruitment of additional partners, or changes in business conditions.

A capital call from existing partners is one of the simplest and quickest routes to raising the capital base of a group practice. Capital calls should be carefully planned and budgeted, and explained in depth to all partners. A slightly less painful way to bring in capital from partners is to decrease distribution of profits. Again, discussion and adequate time for partners to plan and respond is advisable.

Debt

Traditional debt from banks, finance companies, and receivables factoring has become more difficult to obtain as lenders have tightened their criteria for loans. Debt is also more expensive due to the perception on the part of lenders of increased business risk.

For successful businesses, however, there are some motivated sources of debt financing. Suppliers are now offering financing in order to attract new customers, retain existing customers, and increase sales. Your suppliers are able to set up financing, obtain better rates, and even provide guarantees for capital equipment such as radiology equipment and information technology systems.

Some vendors will even provide construction financing if new equipment requires changes in your building. The large pharma distributors will routinely allow generous terms on pharmaceuticals.

Many health care organizations have been able to consolidate their buying through group purchasing organizations which provide savings by negotiating, cost reductions from preferred suppliers. Most GPOs have negotiated comprehensive financing agreements that are not available to individual buyers. (1)

Hospitals are relying more and more on their GPOs to research the market and help make decisions about capital purchases. It relieves the hospital or group practice of the burden of maintaining a purchasing department that must evaluate and compare multiple offerings.

Especially in the area of imaging equipment, expertise is required, and changes and customization play a big role in the pricing decision. For an organization to save on salaries as well as purchases is a double savings.

Some GPOs have held "live" events in which manufacturers, in the form of a reverse auction, bid lower to supply multiple facilities with imaging equipment.

Directed loan programs from state and federal governments are available in many areas for specific purposes. These programs are designed to help businesses establish or relocate offices in specific neighborhoods, some may be for training of personnel, job creation or minority employment.

These funds may fit well with the established goals and purpose of the business; however it is usually not a good idea to change the business to fit the purpose of the loan. Loan amounts through these programs are also usually small, less than one million dollars, but come with attractive repayment schedules or interest rates.

Small businesses rely on their good credit established by the reputation and trustworthiness of the managers. A fundamental of good credit is timely payment of bills and other obligations, e.g., mortgages, credit cards, taxes, etc.

Growing businesses need capital to manage the monthly cycle of revenue and expenses. In this case, extension of payment schedules can have a powerful impact on the business. A decision to delay payables should be made with consideration of all the factors involved, including how this may affect relationships with suppliers.

In this scenario, payment schedules can be sped up when cash flow from collections for the new practitioners is established. The converse of stretching out your payables is accelerating your collections, which is always the first place to look for additional working capital.

Using payables

For example, if a group practice is expanding and adding five additional physicians in one year, it may anticipate increased billings of $1.5 million per year. Given collection times averaging 45 days, the practice may need to raise $500,000 in additional capital to support those physicians during their first year.

If the practice has overall billings of $15 million per year, then extending the average of all payables for two weeks will produce the amount needed in additional working capital.

Businesses that own their buildings, have large capital equipment or other-assets may want to consider asset based lending. This can be obtained from local or national lenders, and usually carries an interest rate lower than similar sized non-recourse loans.

Alternative financing

Many small companies are founded with credit card debt, savings, and money borrowed from friends and family. That financing model works when investment requirements are small, usually less than $100,000 and the business founder has an established network to borrow from.

Young entrepreneurs may find startup money more difficult to obtain. Successful businessmen in many communities have formed groups of "angel investors" who are willing to commit more capital to businesses, often in the range of $250,000 to $500,000.

These groups have a local focus, can be found by networking with accountants and lawyers, and can often add value to the new business in addition to capital by providing advice, board members, or business connections.

The non-profit Angel Capital Education Foundation (ACEF) provides educational programs and research for angel investors and helps entrepreneurs as well ACEF maintains a comprehensive database of local angel investor groups on its Web site.

Venture capital, which was a traditional source of funding for startups, has grown into a major industry on its own. Many of these funds focus on mid-market companies or larger. A result has been that venture capital for startups, particularly service businesses, is harder to obtain. Recently a new group of regional venture capital firms has been founded that focus on specific industries.

Regional venture fund

HP Growth Partners based in Dallas, Texas, is an example of a specialized, regional, growth capital investor. Chris Paddison, a founder, says: "We are interested in providing growth capital to North Texas companies that have a proven business or product and are seeking to expand their business.

"Health care is one of our top areas of interest because we see significant unmet needs for products and services often with some information technology component that makes the idea rapidly scaleable. We are seeing some terrific companies in the areas of health care IT, disease specific services, new home health care services and remote monitoring. To date we have invested in a physician decision support engine (www.Safe-Med.com) and look to do more."

When speaking with venture capital firms, it is particularly important to look for strategic investors. Strategic investors are those who bring something extra to the table. They might be large customers or suppliers, technology partners, or marketing partners.

A strategic investor can accelerate the growth of your business, and it will benefit as well. An investor may look for a seat on your board of directors, or in technology companies, on the advisory board.

Government programs designed to encourage changes in medical practice patterns e.g. e-prescribing and promoting the adoption of electronic medical records, may be available. Using capital from these sources may free up capital invested in one part of the business for deployment in another venture. Local development grants are sometimes available to assist in construction, hiring and training of new employees, or providing services in underserved areas.

A program focused on helping businesses owned by women, focused on small business, is "Make Mine a Million." Launched in 2005 by Count Me In for Women's Economic Independence, a not-for-profit provider of resources and business education for women entrepreneurs, Make Mine a Million is a program dedicated to helping post-start-up women-owned businesses reach one million dollars in revenues.

The program concentrates on building business skills and networking for women business owners. The organization runs regional business showcases in which business owners can meet with potential funding sources, share contacts and experience.

In health care, as in all business, creativity, communication, and persistence are keys to finding solutions to tough problems. Financing a growing business, whether it is a medical practice, hospital, device, or pharmaceutical company, can be successful, even in a tough economic environment. Companies that can finance their growth are well-positioned for the future.

References

(1.) Rhea S. GPO guidance playing bigger role in tech purchases. Modern Healthcare, 38(48).: 36-40, Dec. 1, 2008.

(2.) http://www.angelcapitaleducation.org

(3.) http://www.makemineamililion.org

Gary Meller, MD, MBA, FACP, FACPE

Founder and president of Commsense, Inc., a health care business development company, based in Florida.

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