How does a line of credit work for a dental practice?

How money moves through a practice

A general or specialty practice gets paid in four ways, and each moves at a different speed. The patient's share is collected at the chair, by card or cash. Insurance claims, most of them from dental PPO plans, are submitted after the visit and paid in weeks, at the contracted fee rather than the practice's full fee. Some patients use a third-party financing company, which pays the practice up front and keeps a discount. And some treatment, orthodontics above all, is paid on an in-house plan collected month by month while the treatment runs.

The costs run on a steadier clock. Hygienists, assistants and front-office staff are paid every other week whether the schedule was full or not. Dental labs bill monthly for crowns, bridges and appliances. The owner dentist is usually paid last, through a salary or draws.

Put together, a healthy practice has a short cash cycle and little money tied up in receivables. That is why a practice's cash needs come in bursts rather than as a permanent gap: a slow January after patients rushed to use their insurance benefits before the year-end reset, a summer of vacations, a new associate whose PPO credentialing is still pending so their production cannot be billed under the plans yet, or a large lab bill in a month when collections dipped. A line of credit is built for exactly those.

Why a practice's line is usually not a borrowing base

An asset-based line lends a percentage of receivables that meet the lender's rules, recalculated as they change. That fits a distributor, whose customers are businesses owing large invoices. It fits a dental practice poorly, as the table shows.

Most of the balance is owed by consumers, whose balances are small, many and costly to collect. An insurance aging report overstates what will be collected until contractual write-downs are posted, so a lender cannot tell the real balance without reconciling it. The general rules are in eligible vs ineligible receivables.

So banks, and in particular banks with a dedicated healthcare practice group, lend to dentists on cash flow. The line is sized to what the practice earns, not to a pool of collateral, and is monitored through annual financial statements and tax returns rather than weekly reports. The trade-offs between the two models are in asset-based vs cash-flow lines.

How a bank sizes and secures the line

The bank starts from the practice's earnings: collections, less operating costs, with the owner's compensation normalized to what an associate would cost to do the same work. It then assumes the line is fully drawn and asks whether the practice can still carry every payment it owes. Conventional banks commonly look for debt service coverage of at least 1.25x. For an owner-operated practice, the test is usually global: the dentist's personal obligations, such as a home mortgage and student loans, are added to the practice's, and the owner's personal income is added to the practice's cash flow. Explained further in global cash flow.

As a worked example in plain numbers: a practice producing cash flow of 600 a year, after a market salary for the dentist, that already pays 380 a year on its acquisition loan and equipment leases has 220 of room before any line. At a 1.25x test it can carry total payments of 480, so the bank has roughly 100 of annual payment capacity left for the line's interest and any required paydown. The line's size follows from that, not from receivables.

Security is simple and broad. The bank files a blanket lien over the practice's assets. Equipment already financed by a lessor or equipment lender stays pledged to that lender first, so the bank's claim on the chairs, imaging and milling units sits behind theirs. The owner dentist, and any other owner of a meaningful stake, signs a personal guarantee. Because the practice's value walks out the door if the dentist cannot work, many banks also require life and disability insurance assigned to them.

Two SBA routes sit beside the conventional line. SBA Express loans, which can be structured as revolving lines, go up to $500,000 with a 50% guaranty, which can help a bank say yes to a newer practice. SBA's CAPLines program has a working capital line as well. Both carry the SBA rule that every owner of 20% or more personally guarantees the loan. The comparison is in CAPLines vs a conventional line.

What the line is for, and what it is not for

A common problem in practice files is not a weak practice. It is a line doing a job that belongs to a term loan. A balance that never falls tells the bank the practice has a permanent shortfall, and that is how lines get cut at renewal.

For those last three, see financing a dental practice acquisition, SBA lending to dental practices, and refinancing cash advances for dental practices.

If the balance on a practice's line has not come down in a year, the practice needs a term loan, and the time to arrange one is before the renewal, not after.

Covenants and reporting

A practice line comes with far lighter reporting than an asset-based facility. There is normally no weekly borrowing base certificate and no field exam. What the bank does expect:

• Annual financial statements for the practice, and business and personal tax returns once they are filed.
• A personal financial statement from each guarantor, refreshed each year.
• A debt service coverage test, usually measured once a year on the full-year figures, sometimes globally.
• On many bank lines, an annual clean-up: the balance must sit at zero for a stretch of consecutive days each year to prove the line is not permanent capital.
• Deposit accounts at the lending bank, which many banks make a condition of the line.
• Limits on other borrowing, including a prohibition on merchant cash advances, and on distributions if coverage slips.

Many practice lines are also demand or uncommitted lines, which the bank can reduce at any time; see demand vs committed lines. The full catalogue of tests is in the covenants on a line of credit.

Group practices and DSO-affiliated practices

Once a group has several locations, employed dentists and a central business office, its lenders change. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA across a term loan and revolver, and the revolver becomes one part of a larger facility rather than a stand-alone line. Some of these lenders do build a borrowing base from insurance receivables, measured net of contractual write-downs and with aged or repeatedly denied claims excluded; healthcare lenders often age claims from the date of service rather than the invoice date. They also decide case by case whether a very large insurer is held to the single-customer cap that commonly limits one account to 20% to 25% of eligible receivables.

Structure matters more here too. In many states only a licensed dentist may own a dental practice, so a group often runs through a management company that contracts with dentist-owned practices for a management fee. The lender usually lends to the management company, and its collateral is the management company's contracts and fee receivables rather than the clinical practices' own accounts. The lender reads those agreements closely, above all what happens if a practice owner leaves.

What trips dental practices up

• Collections trailing production. Lenders read the production and collections reports side by side. A widening gap, from write-offs, denials or patient balances left uncollected, reads as a practice that is busier than it is profitable.
• Personal expenses in the practice's books. Cars, travel and family payroll are common. They can be added back only with support.
• The associate who leaves. A practice that depends on a second producing dentist should expect questions about their contract, non-solicitation terms and what happens to collections if they go.
• Stacked cash advances. A merchant cash advance taken to cover a slow stretch usually breaks the line's covenants and makes renewal harder.
• Student debt left out. An owner who leaves personal debts off the personal financial statement will have them found on the credit report, and the global coverage will be recalculated without their input.
• Applying too late. A line is easiest to get before the practice needs it; arranged after a bad quarter, it is sized for that quarter.

The documents a lender reads for a practice line follow Transparent's line of credit checklist: the balance sheet, the P&L and a year-to-date P&L through last month-end, an AR aging by payer with days outstanding, the AP aging, and a debt schedule that shows existing liens, with bank statements and two to three years of business tax returns where available. For a practice, add the production and collections reports by provider. Transparent works with 235 lenders in its book of 1,800+ that write asset-based lending and lines, and prepares the file so a bank can read it the first time.