Add services without big debt

Financing an X-ray machine or lab is easier than you think.

By Robert Lowes
Senior Editor

There's always been a strong medical argument for adding an X-ray machine, a reference lab, or some other ancillary service to a physician's practice. Besides being convenient for patients, these services may improve care by getting doctors test or imaging results more quickly.

The financial argument for ancillary services, though, has never been more compelling than it is now. With reimbursement rates from third-party payers continuing to tumble, compensation for many primary care doctors threatens to once again lag behind inflation in 2003. Ancillary income could be the cavalry that comes to the rescue.

But how do you pay for a $75,000 mammography unit or a $150,000 lab? Borrow money from a loan shark? The good news is that, despite all the financial turbulence in medicine, equipment vendors and leasing companies are ready to make deals with doctors, and banks are eager to lend them money. A doctor who does his homework can add an ancillary service without getting his thumbs broken.

"I've never encountered a group that wasn't able to fund what was reasonable for it to do," says Hobie Collins, a consultant with the Medical Group Management Association.

The age-old question: Buy it or lease it?

How long you expect to use a piece of equipment generally determines whether you're better off buying or leasing. If your time frame is longer than five years, buy it, experts say. But if you think you'll need to replace it sooner than that, leasing may make more sense. You don't want to get stuck with equipment that can no longer provide the best quality care—or generate the revenue you hoped for.

Rapid technological change in medicine is increasingly turning doctors into lessees. To be sure, some equipment does still have staying power. A basic X-ray machine, for instance, probably can serve an internist or orthopedist 10 to 20 years. A stress-test treadmill also has a long life span. However, given the trend toward computerization, medical apparatus such as CT and MRI scanners are becoming as short-lived as desktop PCs. "Seventy-eight percent of our products in service are, on average, only five years old," says Robert Filaski, a marketing and sales executive with Siemens Medical Solutions, a diagnostic imaging equipment manufacturer.

Cash-strapped doctors often prefer leasing to buying. They don't have to make a down payment, and monthly payments may be lower. That's because in a lease, the lessee isn't financing the full value of the equipment. It's supposed to be worth something when the lease expires—residual value, they call it.

That said, in the long run leasing costs more than purchasing. "We find it less expensive to buy, in terms of cash out of pocket," says David Middag, administrator of Medical Associates of Central Virginia in Lynchburg, VA. This 29-doctor group outfitted its cardiologists with a nuclear camera and gear for stress tests, echocardiograms, and Holter and arrhythmia monitoring.

One reason buyers come out ahead is that they usually can haggle down the list price, says John Cergnul, administrator of Radiology, a 30-doctor group in South Bend, IN. "Leasing companies rarely negotiate on price," he says.

Another rap against leasing: It's hard to tell if you're being taken to the cleaners. When you borrow to buy equipment, the bank spells out your principal and interest rate. But leases are more convoluted, especially if you're contracting for warranties and service as well as equipment. Plus, the equipment's residual value at the end of the lease—which determines how much is financed—is often unknown until the lease expires. "It's easier to hide a high interest rate in a lease than in a bank loan," says Cergnul.

The 30 percent depreciation bonus that now applies to new equipment in the first year—one of several tax-law changes that Congress enacted in 2002—can give a tax edge to buying. A doctor purchasing a $100,000 X-ray machine, depreciated over five years, can deduct $24,000 in the first year under the tax code's expensing rule. Then he can deduct 30 percent of the remainder, an additional $22,800, under the new law. Finally, he can take the standard depreciation amount on the new remainder—$10,640 more. All in all, he'll lower his taxable revenue by $57,440, far more than what he'd be able to deduct if he leased. The depreciation bonus applies to purchases made through Sept. 10, 2004.

Given the complexity of leases as well as the need to weigh tax considerations, always ask an accountant to perform a buy-vs-lease analysis.

Leasing contracts come in different flavors of risk

If you decide leasing is the best way to equip your ancillary service, you have options galore for crafting a deal that meets your needs.

For everything from forklifts to copiers, you can deal with an all-purpose leasing company. Chances are you can find some in your area, which makes it easier to check out references and settle on a reputable company.

Like medicine, the leasing world has specialists as well as generalists. And specialization has its pluses: A Cleveland-based company called SourceOne Healthcare Technologies, formerly known as Diagnostic Imaging, for instance, not only leases equipment, but also can design an X-ray room, maintain the equipment, replenish supplies, and dispose of hazardous byproducts.

Both generalist and specialist leasing companies are essentially middlemen. Can you go directly to the manufacturer? Yes; major diagnostic equipment makers such as GE Medical Systems, Philips Medical Systems, and Siemens have in-house leasing programs. They, too, offer a wide range of add-on services; they can even help you market a new ancillary service. Manufacturers say that since they make the stuff, they can package timely upgrades into a lease. "We know the 10-year path of technology," says Wayne Canner, a marketing manager at GE Medical Systems.

Whoever writes your lease will offer you several basic deals. In an operating lease, you essentially rent the equipment for a given period—typically three to five years—and either return it at the end or renew the lease. If you're concerned about avoiding equipment obsolescence, this is probably the best way to go.

A variation is the fair-market-value lease, which lets you buy equipment at its residual value—a negotiable figure—when the lease expires. If you and the leasing company instead set the residual value in advance, you've agreed to a fixed-price purchase option. This deal makes sense for a doctor who wants a low monthly payment; if he maximizes the residual value, he minimizes the amount of equipment value he must finance.

There's also a so-called capital lease in which you buy the equipment for $1 at the end, but technically it's not a lease because you're making a purchase. Accordingly, you must depreciate it for tax purposes. While your monthly payments are higher than if you were truly leasing, you may be able to avoid making a down payment, which banks typically expect.

Manufacturers and leasing companies try to make their deals as painless as possible. Let's say you want a mammography unit but don't expect to receive substantial revenue until you've used it for three months. After all, there's lag time between billing and collecting. If you're counting on mammography revenue to make your lease payments, the lessor can waive payments for the first three months. But don't feel too good about that break, notes John Cergnul. "You're just borrowing three months' worth of payments."

Similarly, doctors who worry they won't generate enough revenue with diagnostic imaging equipment to make a standard lease payment often can pay a set amount for each image taken. "It's a way for us to share some of the risk," says Michelle Collins, a marketing program manager for GE Healthcare Financial Services. But while a fee-per-scan contract limits a doctor's downside risk, it limits upside opportunity, too, says Collins. "If test volume is what we'd normally project, or higher, we'll make more money than we would under a standard lease."

What if you lease a machine, then a new improved model comes on the market two years later? To avoid getting locked into yesteryear technology or paying a penalty for breaking a lease, negotiate a contract that lets you switch to a new machine. However, if the replacement is more expensive, your monthly payment will increase.

Bank loans: How to get the best terms

Your smartest move may be buying ancillary service equipment with borrowed money, instead of leasing it. If so, getting the lowest interest rate possible shouldn't be your only goal. You don't want to put up your house as collateral. You'd like to forgo a down payment. And you want to avoid joint and several liability, which means that if you and nine other doctors borrow $350,000 for a CT scanner and then scatter to the four winds, the bank can hold one doctor responsible for the entire loan.

One way to buy is having the manufacturer finance the purchase through a capital lease. Sometimes manufacturers offer better terms than a bank would, but sometimes they don't, especially if you've built a strong relationship with a local bank and polished your credit-worthiness, experts say. So get started currying favor with your bank if you anticipate a big-ticket purchase several years down the line.

"Every year, a doctor should sit down with his banker and review the practice's books," says Joseph White, a CPA with LarsonAllen, a Minneapolis-based accounting and consulting firm. "He can take the office manager along with him. Do this whether you need any money or not. The banker will see you as a serious businessperson.

"If you normally keep your books by the cash method, you ought to consider preparing them according to the accrual method once a year for the sake of your banker. With the accrual method, you count income when you perform a service and expenses when you incur them, as opposed to when you receive payment or pay an invoice. This gives the banker a more accurate picture of the practice's fiscal health. You should also give him an aged accounts receivable report."

Bankers look favorably on groups that retain earnings, says White. In other words, if you have $5 in your pocket, your bank will be inclined to lend you $50 more. However, most groups choose not to retain earnings, partly to avoid paying taxes on money squirreled away. "In a professional corporation, those funds would be taxed at 35 percent, which may be higher than most doctors' individual rates," says White. The next best thing to retaining earnings is for one or more doctors to loan the practice money at a fair interest rate. "That loan looks like equity on the books," says White.

A group of doctors also can perk up their balance sheet by agreeing to a pay cut—10 percent, for example—over five years, says consultant Michael Pulaski in Alpharetta, GA. The goal is to leverage the tithed income as you would an internal loan. "You take the pay-cut agreement to the bank and say, 'Look, this will raise $3 million over five years, so give us a $3 million line of credit,' " says Pulaski. Equipment outlays and depreciation, he adds, will greatly reduce or eliminate the amount of retained earnings subject to taxation each year.

All your moves to win better loan terms will be for naught, though, if you don't give the bank a solid business plan for your proposed ancillary service. That means answering a lot of questions, says Michael Parshall, a consultant with The Health Care Group in Plymouth Meeting, PA. What will be your annual cost once you factor in maintenance, supplies, personnel, and building alterations? How much patient volume do you need to break even? How will you market the service to patients and referring physicians to achieve that volume? Will health plans pay for the new service?

If you're intent on borrowing a large amount, like $500,000, solicit formal bids from your current bank as well as competitors, advises White. Also ask them to bid on everyday banking services such as checking and credit card processing. The reason? Banks may give you a better interest rate if you deposit your money in their vaults. Of course, bidding out a loan this way may lead you to leave your current bank. But then again, why shouldn't it have to earn your business?

Hedge your bet with a turnkey operation

Does investing in an ancillary service strike you as too iffy? You can hedge your bet with a turnkey contract. Here, a company leases—or sells—an apparatus to a doctor and manages the ancillary service, providing an on-site technician, for example, to conduct tests.

Polestar Laboratories in Escondido, CA, sets up turnkey reference labs, charging a few dollars per test in addition to a monthly lease payment. For a lab that 10 or so doctors might want, those payments would come to $2,000 to $3,500 per month, says Polestar president Gus Gardner.

A Franklin, TN-based company called PriCare offers turnkey ancillary services ranging from diagnostic imaging and labs to physical therapy and outpatient surgery. PriCare, a former practice management company, loans doctors working capital to cover start-up costs. Loan payments as well as lease payments for equipment are subtracted from ancillary service revenue. PriCare charges an additional management fee based on any profit generated.

Going the turnkey route is worth considering, says Michael Parshall, a consultant with The Health Care Group in Plymouth Meeting, PA. "You make less money than if you operated the equipment, but you take less of a risk."

Among the other advantages turnkey operators claim to offer: They can buy supplies at a lower price than an individual practice. They have the expertise to comply with Medicare antikickback statutes and CLIA regulations governing labs. Turnkeys operate ancillary services more productively than doctors would. And they relieve doctors of administrative hassles.

Robert Lowes. Add services without big debt.

Medical Economics

2003;7:49.