Buying a practice?
Here’s the low-down on deposit requirements
Jon Drysdale considers the frequently asked question of what size deposit is required when buying a practice
A sufficient deposit is critical to buying a practice. Unlike with residential property purchases there is no minimum size of deposit and no published scale of interest rates linked to deposit levels.
Can you borrow 100% of the purchase price?
While there is no minimum deposit, banks don’t routinely lend 100% on the purchase of dental practice goodwill – that is a myth! Perhaps if you have an existing practice or practices, already with minimal borrowing, or significant alternative security to offer, the deposit might be negated.
Just the deposit may not be enough
If your purchase includes a property, banks will usually lend 100% of its freehold value – you only need a deposit for the loan for the goodwill value. The goodwill value may not be the price you pay. In recent years NHS practices have sold for more than the asking price.
Alternatively, you may agree a purchase price which is the asking price or less. Most banks (not all) will insist you instruct one of their panel of valuers to give an independent valuation. The valuation may be lower than your offer. You could try renegotiating the amount you offered – this is unlikely to go down well with the vendor.
In each of the above cases the bank will usually expect you to make up the difference – in addition to any deposit requirement.
When the deposit is irrelevant
The profit from your new business needs to meet your finance costs and your usual personal expenditure. Banks assess finance costs by reference to the loan repayment amount and by ‘stress testing’ against the possibility of rising interest rates. Below is an example – for a loan against goodwill and a loan against property.
- A £450,000 loan for the dental practice goodwill with repayment over 15 years means annual repayments of £39,136 (Bank of England base rate 0.75% plus 2.95%).
- Increasing the interest rate by 2.75% (to 6.45%) brings the annual repayments to £46,891.
- Further stressing the borrowing by multiplying the repayments by 1.25 results in annual repayments of £58,614.
A. A £150,000 loan for a freehold property repayable over 25 years means annual repayments of £9,060 (Bank of England base rate 0.75% plus 2.80%).
B. Increasing the interest rate by 2.75% (to 6.30%) brings the annual repayments to £11,930.
C. Multiplying the repayments by 1.25 (as above) results in annual repayments of £14,912.
Under maximum stress, the combined annual loan repayments would be £58,614 + £14,912 = £73,527.
The net profit for this practice is £160,000. Deducting approximately £50,000 for tax, the available drawings will be £110,000. Under maximum stress, the prospective owner is left with just £36,473.
- Few dentists could convince a bank this is enough to live on.
- To verify personal expenditure the bank will request 12 months of personal bank statements.
- If prospective owner argues their spouse or partner earns enough to cover living costs, payslips/bank statements would need to prove this.
The practice probably isn’t profitable enough for the bank to lend to the prospective owner or they are seeking to borrow too much.
And now the deposit
I didn’t refer to the deposit in the above example as it is largely irrelevant – banks lend on the ‘serviceability’ of loans rather than the size of deposit. To proceed with the purchase in the example, the prospective owner has two options.
- Try to renegotiate the price to be paid. This is unlikely to go down well with the vendor or their sales agent. It is the purchaser’s responsibility to secure the finance.
- Borrow less or Increase the deposit. Either option will make the figures look more favourable. For example, increasing the deposit by £50,000 reduces the stress-tested finance costs.
If as a prospective purchaser you don’t run the finance cost analysis before making an offer, you may not be able to secure finance. Agreeing to buy a practice and subsequently not coming up with the finance means a sales agent will be cautious about future offers you make.
Other factors that count
A bank doesn’t assess a deal on the finance costs alone. If your case is marginal and you simply don’t have additional cash funds to offer, you will need to support your case in other ways:
- Can you offer the bank security such as equity in a property?
- Can you raise separate finance for your deposit?
- Could you buy with a colleague or friend?
How do we help?
As finance brokers and sales agents, at PFM Dental we see the problems of raising finance from both sides and have worked with many dentists to overcome them. Our chartered (dental) accountancy team is skilled at providing projections for your proposed practice purchase and our legal team will help if you are purchasing a practice from another sales agent.
Attending one of our Buying a Practice Seminars is a great way to find out more about what it takes to buy a practice.