What you need to know about commitment letters!
by Barry F. Levin, Esq. and Philip M. Bogart, Esq.
While a dentist may spend countless hours researching his or her options before purchasing new dental equipment, that same dentist may decide upon a bank loan in a matter of minutes! A practice loan is one of the most significant transactions a dentist makes during his or her entire career as an owner of a dental practice. Proper planning and scrutiny is vital.
Still, many dentists don’t even consider the terms of their financing until there is a problem.
Upon completion of all of the applications and forms mandated by the lender (and its underwriter), the lender will typically issue a commitment letter if the loan is approved.i The commitment letter, in essence, is an offer by the bank to make a loan to the dentist. The offer might include:
the amount of loan type of loan (e.g., term loan, line of credit)interest rate term of loan (i.e., when is it due?)payment terms (e.g., monthly interest payments; monthly principal payments; or balloon payment at the end of the term)collateral requirementsnsurance requirements (e.g., life insurance for the principal?)required guarantorsclosing conditionsprepayment rights and feesother covenants (e.g., financial reporting requirements) A very common misconception is that loan documents are nonnegotiable. While that may be true in some respects, a borrower still has leverage
before signing the
commitment letter. As a result, the dentist should carefully review the commitment letter. It always surprises us when we see our highly educated, professional clients fail to read their entire commitment letters. Even when they do read the letters, sometimes the scope of review is limited to the loan amount and the interest rate. Never simply “sign on the dotted line.” Remember, there is no such thing as “standard” documents. Moreover, shop around! Banks love dentists — they are great credit risks! The bank’s first offer may not be the final offer — especially if a competing bank is offering better terms. Find out what rates are being offered by other banks. The banker may have a certain amount of leeway in establishing the interest rate and payment terms. While not a comprehensive listing, the following terms should be considered when reviewing the commitment letter:
• Type of Loan. Banks offer various types of loans. For acquisition financing, a fixed long-term loan would be appropriate, while a short-term line of credit may be fitting for the temporary working capital needs of a practice. Lenders also are willing to make equipment loans.
• Tax Structure. It is advisable to work with a tax advisor to ensure that the loan is appropriately structured.
• Amount of Loan. Is the loan large enough? If the loan covers the acquisition of a practice, the borrower may still wish to obtain a separate line of credit in order to cover costs in the short run.
• SBA Loans. Some dental practices are eligible for loans under the U.S. Small Business Administration loan program. The banker should be able to guide the dental practice through this process.
• Expiration Dates. The commitment letter will include a deadline for executing and returning the letter to the bank, and an expiration date for the closing of the loan. Ensure that these “drop dead dates” are realistic.
• Cure of Breach.The commitment letter may provide that the entire loan amount will be due upon a breach by the borrower. Frequently, lenders are willing to provide borrowers with a grace period, so that there is no breach until the payment is at least, say, 10 days late. In addition, lenders may also be willing to provide borrowers with a right to prior written notice and an opportunity to cure nonmonetary breaches (e.g., a failure of the borrower to deliver timely financial statements).
• Convenience. Conventional lenders will require the borrower to maintain his or her principal depository accounts with the bank. Consider whether the bank has a local branch in the proximity of the dental office. Keep in mind that location may be less of an issue if the bank allows its customers to make deposits remotely with a check-scanner.
• Lease Term. The commitment letter may include a requirement for the office lease to have a minimum number of years remaining of at least the term of the loan. If necessary, will the landlord agree to extend the lease?
• Prepayment Penalties. The initial commitment letter may have a pre-payment penalty. Try to remove that clause. At the least, banks are frequently agreeable to permitting the borrower to prepay a certain amount per year (e.g., up to $25,000 per year). In addition, the lender may offer a sliding scale, so that the penalty decreases over the life of the loan.
• Fees and Closing Costs. While the initial commitment letter may contain a broad requirement for the borrower to satisfy all closing costs and fees, the lender should be able to provide the borrower with an expected cost range to avoid last-minute “sticker shock.” If the borrower is responsible for legal fees, try to agree upon a range up-front.
• Financial Covenants.Sometimes lenders include financial covenants that require the borrower to maintain a specific cash flow ratio or a net worth ratio during the life of the loan. The borrower should work with his or her accountant and financial advisor to ensure that these ongoing obligations are reasonable, especially in light of any plans to make significant capital acquisitions or otherwise undertake additional debt.
• Financial Reporting. Be mindful of the periodic financial reporting requirements. The lender may require periodic reports and copies of tax returns.
• Spousal Guarantees. Though still a source of confusion for many bankers, except under specific circumstances, federal law does not permit a bank to require a spouse to guaranty a loan.
• Other Benefits. If the lender is offering added “benefits” over and above the loan amount, interest rate and payment terms, make sure those favorable terms are in the commitment letter.For the most part, as a borrower, the money being borrowed is a commodity. As a result, when it comes to the loan terms, cheaper is usually (but not always) better. Remember, if the lender issued a commitment letter to a dental practice, it means that the lender wants that business. The lender has already determined that the dental practice would be a valuable customer. The practice, therefore, is in a position to ensure that the financing arrangement will enable the dental practice to meet its business and financial goals. Upon signing the commitment letter, that leverage is gone. Working with a trusted legal advisor who has experience reviewing and negotiating commitment letters can be a smart investment.
Barry F. Levin is a partner and chair of Saul Ewing LLP’s business and finance department. Philip M. Bogart is a special counsel in the business and finance department in Saul Ewing LLP’s Baltimore office. Messrs. Levin and Bogart regularly represent dentists — and the business entities in which clinicians practice — in all aspects of the dental practice structure through and including the structuring, negotiation, documentation, and implementation of associateships or employee arrangements, partnership arrangements, acquisitions, and sales and mergers of mature practices. They are also co-chairs of Saul Ewing's Dental Transitions Practice. Visit the website at www.saul.com.
