The Basics of DSO Lending

As emerging DSOs continue to grow, so does their need for flexible financing options that can keep up with their growth plans.  Once a group reaches over $2 Million in EBITDA, has a legally formed DSO structure, invests in their infrastructure, has a positive track record, and is able to provide sophisticated financial reporting, banks look at these groups in a different lens.  The following are common questions we receive from many growing groups looking for a new lender in the DSO industry.

How does financing work now that I qualify based on the requirements above?

Once you reach this milestone many banks no longer consider you to be a small business.  Some institutions have slightly higher thresholds, but Live Oak considers a DSO to qualify for our lower to middle market solutions once they achieve $2-10 Million in corporate EBITDA.  We understand that as you grow, access to capital is more important than ever if you are looking to continue to scale via an acquisition model.  Buying power is key and the ability to quickly execute on a transaction can make or break winning a deal.  Waiting on a bank to underwrite and close a transaction in 60-90 days no longer works in your favor.  Instead, we deploy a Delayed Draw Term Loan facility- essentially a non-revolving acquisition line based on your 12-month pipeline.  A predetermined amount is decided between the bank and borrower and is available for future acquisitions.  Once a draw request is made the bank and the DSO work together based on the permitted draw requirements put in place prior to closing to complete due diligence.  Draws will typically be advanced within a few short weeks depending on how quickly the DSO can fulfill those requirements.  This not only provides the DSO with the flexibility they are looking for in a financing partner, but it provides scalability as well.  If the DSO operates within the guidelines they agree to in the loan documents, this DDTL can be renewed annually along with a revolving line of credit for capital expenditures like small equipment purchases and working capital.

How does the bank look at my enterprise now versus when I was a sole practice owner?

Leverage is one of the primary indicators a bank uses in enterprise value lending to determine financial health.  In small business lending, debt service coverage usually reigned king and leverage was not as important.  While debt service coverage is still just as important now, leverage, also known as debt to EBITDA, is a hot topic and frequently discussed for mergers and acquisitions.  The lower the leverage, the more willing a bank is willing to lend and the more profitable your company will be.  It is common to see both debt service coverage and leverage covenants as requirements which both the bank and the borrower will use on a quarterly basis to determine if the DSO is compliant with these guidelines.  A typical debt service ratio requirement is 1.25x and leverage can vary from 2.75x to 4.00x, depending on the risk profile.  These covenants are tested both quarterly and when an acquisition is to be made to determine where the enterprise lands post acquisition.  The EBITDA of the permitted acquisition is often included in the calculation.

Will I need to personally guarantee?

Many doctor-led groups are used to providing personal guarantees in the early stages of lending.  While some risks have been mitigated to qualify for a DDTL, it is typically not common to have a non-recourse loan (no PG) until the enterprise has seasoned.  Private equity-backed companies usually do not have PGs due to the amount of equity in the capital stack.  Live Oak looks at each platform as a case-by-case basis.  Usually once an independent group achieves over $5 Million in corporate EBITDA coupled with a determined number of consecutive positive covenant compliance periods, Live Oak will remove the personal guarantees.

What is the interest rate?

While the early practice days included teaser rates from banks below 3%, rate is not as important as you look for flexible growth capital.  Rates are still in your favor but expect them in the 4-6% range.  With the additional risk exposure of a bank lending $20 Million to a single client, they are willing to do so for additional return.  There is also the cost of servicing loans factored into the rate.  Multiple draw requests, quarterly covenant compliance, and other frequent service needs require extra attention.  The good news is this is much cheaper than nontraditional financing options that can exceed 10% and you can continue to scale and grow your enterprise for a larger valuation in the future without giving up equity at an earlier stage.

Should I expect a quality of earnings report to be conducted?

There are many different scopes of quality of earnings, but depending on how your financials are prepared, a third-party report to verify the EBITDA is common.  Banks will usually require audited financials over reviewed once debt exceed $7.5 Million and QofEs can often be waived if this is the case depending on the firm.  If you are currently on reviewed financials, expect a limited scope QofE, sometimes scaled down to just a workbook, to know exactly where EBITDA falls.  This provides you a good gauge of where you stand and gives the bank the confidence in your financials to write you that big check!

Do you have questions that we didn’t cover? Contact us!

Written by Mike Montgomery
Vice President and Founder of the DSO Division of Live Oak Bank 
Email Mike: [email protected]

Watch Mike’s recent podcast appearance on the Group Dentistry Now Show


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