Of course one of the most important steps to start a solo practice is to have the money to do so. No money, no practice! Let me start off this post by saying I have the greatest admiration for Ho Sun. He went into solo practice with absolutely no assets and no income! He had the guts and genius to pull it off. I certainly didn’t; I took the more traditional and conservative route by saving up some cash to begin my practice.
And before you stress out about finding ways to fund your practice startup, keep in mind that in our google group, the same folks who were complaining about high interest loans and not having any money are now trying to find ways to max out their 401k plan.
Even for a business loan, the most important factor is your personal credit score. If you want to buy a office building in five years, your personal credit score will still be more important than any business score. So if you are thinking of taking out a loan, the first thing to do is to check your credit reports for accuracy. That way if there are errors you can dispute them with the credit bureau or the original creditor to get your score higher before applying for credit. Ideally you should be doing this six months or so before you apply for a loan, as sometimes it can take a few months to resolve disputes or errors. Some of the free apps I recommend to check your credit score are: Credit Karma, Experian, and if you have an account with them, Bank of America, Capital One, Citibank, and Discover.
Some quick ways to get your credit score up are to pay off credit cards before your statement closes because the balance even if paid off in full, is reported every month. Another is to hold multiple credit cards, as more accounts being reported as paid every month; additionally more accounts usually means a higher aggregate credit line which decreases your credit utilization ratio.
All banks will probably want a personal guarantee on any loans, so even if your practice doesn’t work and declares bankruptcy you are still on the hook for the money. If there is no guarantee expect the rate to be higher.
One important point for all loans is to see if there is a prepayment penalty. Most practices get positive cash flow by the end of the first year and begin to do well years 2 and 3. So if you have a five or seven year loan, you want the flexibility to be able to pay it off early, particularly if the interest rate is loan shark high, which you will often find on equipment leases.
Here are some ways for someone who has been practicing for a few years to finance their startup:
1. Business loans. Bank of America and Wells Fargo among others have specific doctor’s loans divisions for both startups from scratch as well as purchasing a existing practice. If you are purchasing an existing practice with existing cash flow and need financing, this is probably the route you will take. However I wouldn’t choose to purchase a practice over a startup solely for this reason.
But sometimes for business loans they want to see income statements or wages paid, which is hard to do right out of residency. It is much easier to get a loan if you are already working and want to leave a practice to start your own. Ho Sun discusses his experiences obtaining a business loan on Taking It To The Bank Part 1, also read my post on different ways to go solo.
As your practice cash flow improves and you pay off your loan on time, often you can refinance for a lower interest rate. Many folks on our google groups have paid off their loans early, although if you have a very low interest rate compared to your personal loans or the even the average stock market growth, you may wish to hold out for the full term, as the interest for business loans is tax deductible but it isn’t for personal loans.
2. Home equity. If you have enough equity either from living somewhere and paying the mortgage long enough, or if home prices have went up, you might be eligible for a HELOC- a home equity line of credit, a loan against your house. If interest rates have dropped and you plan on staying put, you could refinance your mortgage to get money out of the house and possibly get a lower interest rate. If you are relocating to another city or another part of town, and can sell your place quickly enough, this is another way to get cash out of your home.
The drawback of this is if your business goes out of business, you lose your home equity and possibly your home. This is extraordinarily unlikely if you read our blog and have good business practices.
As of December 2017, Chase has a 4.5 to 6.9% variable rate and there’s only a $50 applicarion fee and a $50 annual fee, while Bank of America has a intro rate of 3% for twelve months and then a variable 4.8%. Both banks give you a discount having a checking account relationship with them. One big advantage is when you get the credit line approved, you don’t have to start drawing from it immediately, which means that interest won’t accrue immediately.
2018 update: home equity loan interest is no longer deductible under the TJCA (new tax law). For someone in the 33% federal tax bracket this increases the effective rate of a 4.5% loan from 3% after the interest deduction back up to 4.5%.
3. Prosper and lending club. These are peer to peer lending platforms. Investors finance loans which are diversified among many borrowers. The idea is that investors can make between a 3-11% return. The risk is that a borrower could default on one of these loans, losing principal for the investor. Prosper gives three to five year loans, and the interest rate depends on your credit score, debt to income ratio, and current income.
Recent rates have ranged from 6% for excellent credit to 32% for poor credit for a three year loan. If you want a smaller payment to begin with then consider a five year loan; my understanding is that Prosper doesn’t have a prepayment penalty.
4. Loans or gifts from family and friends. The IRS annual exemption limit for gifts from individual to another is $14,000 per year. If your two parents want to contribute then it could be $28,000 per year. Anything above this amount is subject to the lifetime gift exemption, but my understanding is that the person giving the gift files form 709 to report the amounts the year the gift is given, but is not taxed until the cumulative lifetime amount is $5.49 million.
If your parents, relatives or friends are especially generous, they can make one gift in December and another gift in January of the next year. So if done at the end of a year this would allow two parents to gift you $56,000 within a month. Let me know if they want to adopt me!
If you want to set up a loan, definitely have something in writing, charge at least the IRS Applicable Federal Rate (the current rate for a mortgage should easily exceed this), use a amortization table to calculate the interest and payments, and issue a 1099-INT yearly. The interest payments are deductible for you, and taxable for the person giving you the loan. Here’s Ho Sun’s story on family gifts and loans as a blog post.
If you don’t set up a formal arrangement the IRS may look at the situation as a gift rather than a loan, so my understanding is that the amount would be subject towards the $5.49 million gift tax exemption.
5. Credit cards. In order to play this game you must be able to pay the balance off after the interest free intro period. Either positive cash flow or availability to a line of credit or loan will do the trick. I would recommend establishing this credit line before applying for cards. I would also recommend applying for multiple cards on the same day, before you build any balances, to increase the chances of approval with the highest credit lines. If you open cards later your total credit limit might be too high for a bank to approve more credit limits.
Here are the cards with the longest interest free periods:
Citi simplicity- 21 months
Chase Slate- 21 months
Wells Fargo Platinum- 18 months
Discover Cashback- 14 months
AMEX everyday- 12 months
Note that all of these are personal cards. One huge disadvantage is that any balances will be on your personal report, which will lower your credit score if balances are high. In contrast, if you hold a business card, if you have a $10,000 balance it won’t be reported on your personal credit report, with Capital One being the exception. So probably best to get both types of cards.
If you hold another card from the same company, say a Chase Sapphire card, once the interest free card from the same company (Chase slate) is open, often you can transfer credit lines so you have a higher amount of credit for interest free purchases.
Once the interest free grace period expires, if you are still tight on cash flow but have good enough credit to apply for a different card, do so and transfer the balance.
Many times banks say you have a $25,000 credit limit but the reality is if you begin to carry larger balances they might do a soft pull to find out if you are maxing out accounts at other banks and deny further use of your available credit line. So be careful with this. I don’t have any personal experience with this but doubt you could entirely start your practice with credit card loans. Probably at the most you can have a credit card balance $20 to $40 grand but that’s just a guess.
Interest paid on personal cards for business purposes is tax deductible for your business, but you need to segregate interest from personal purchases vs business purposes. If you choose to go this route the accounting can be a headache so it’s recommended to use one card for business purposes and another for personal expenses.
Keep in mind that if you choose to go this route and charge significant amounts on your card, it will increase your utilization ratio (debt to total credit available) which will make it more difficult to get a loan before you pay off the cards. I cannot emphasize enough to pay off the card before the interest free period is over, or you will be paying extortionist 12-17% interest rates!
6. Equipment loans or lease to buy. The general consensus is to use this as a last resort because the interest rates are higher than a business loan and often you can’t pay it off early.
Next post, I’ll discuss some more ways to finance your solo practice startup.