Introduction

A democratic group offers physicians an equal voice and responsibility for providing high quality medical care and service to the community. However, in democratic groups, physicians have the unique opportunity and burdens of being an entrepreneur since they are faced with the challenges and rewards of running a business. Unfortunately, starting a new group creates expenses that are due before physicians begin to receive payment of their accounts receivable. It may take months to develop the accounts receivable into a stream of income. A hospital offering a new contract to provide emergency services may receive proposals from several competing groups. A large, established group likely would have the capital to support the start-up costs of the contract. Smaller groups of physicians who do not have such capital must finance their project while remaining competitive in the bidding process.

Startup costs were estimated in the ACEP information paper, "Starting a Democratic Emergency Department Group," to be $10,000 per 1000 visits. Initial expenses include such items as administrative costs, recruitment, billing/coding, and compensation. For low-volume contracts, initial costs will be a larger proportion of total costs than at higher-volume contracts because of fixed administrative costs such as lower utilization of physicians at lower volumes. Malpractice costs have risen over the last several years and represent a significant expenditure. As costs vary with geography, demographics, and payer mix, a formal study by a health care consultant or CPA may be helpful to develop realistic revenue and cost projections.

Though the startup costs can be substantial, they should be viewed in the context of the equity that will be produced by the group. The owners of the group are also the owners of the accounts receivable, either as a group or individually. The accounts receivable are an asset that can be used to create cash or they can be used as collateral for loans from commercial lenders and hospitals. Individual ownership of the accounts receivable allows personal decisions to be made about using the accounts receivable as collateral or selling them at a discount "factoring" for immediate cash.

Ideally, physicians would obtain needed financing from "interested parties." A cohesive, efficient group with ties to the community is good for the hospital, the individual physicians, and the community. Given the need for emergency physician services, hospitals may be willing to provide a lump sum subsidy or an advance against accounts receivable to assist with startup costs. A hospital may agree to purchase the accounts receivable from the physician group and/or to do the group's billing. Under such an arrangement, the group may be able to secure an income guarantee from the hospital and thus avoid the need to borrow for startup costs. Also, the physicians may receive direct loans that may be forgiven if specified conditions are met. In addition, some initial physician compensation can be partially or fully deferred in exchange for equity in the new business.

However, a small and/or new physician group may be forced to obtain money from other sources whose interest is monetary. Physicians may be able to obtain venture capital to start a new physician group but in doing so will cede some, if not most, of the decision-making control to their financier. Accounts receivable financing as well as traditional loans may be offered by national, regional, or boutique lending firms. As interest rates, economic conditions and laws vary over time, the costs and relative benefits of different financing methods also will change. The financial services industry is creative and continually evolving. The individual needs of the physicians and the prevailing economic environment will influence the most appropriate method of financing.

Accounts Receivable Financing

Two forms of accounts receivable financing are tied to the billing activities of emergency physician groups, referred to as factoring and lending (with accounts receivables being held as collateral).

Factoring

Factoring involves the sale of accounts receivable to an agent (a "factor") at a discount calculated as a percent of the net expected value of the accounts receivable. By definition, accounts receivable represent invoices that have been submitted to third party payers but have not yet been paid. Generally, invoices sent to "self-pay" patients are not included in the pool of accounts receivable that a factor is willing to fund. Net expected value is the amount of money, often estimated from an audit of prior billing activity (which, of course, is not available to a new group), which the factor expects eventually will be collected from a defined pool of accounts receivable.

Factoring may be of a "non-recourse" or "full-recourse" variety. With non-recourse factoring, the factor purchases the accounts receivable and takes all of the risks of collection. Non-recourse factors often have their own collection operations. With full-recourse factoring, the factor advances funds but does not take a credit risk. If after a pre-defined period, the amount of collections is less than the funds advanced, the factor is entitled to restitution from the physician group. Full-recourse factors often allow the physician group to use the billing and collection operation of their choice.

The discount rate - the source of the factor's profit - is reflected in the amount of money that the factor actually remits to the physician group. For example, if a factor judges the net estimated value of the accounts receivable pool to be $1,000,000, then at a 10% discount rate, the factor would purchase this pool for $900,000. The factor is expecting to collect the full $1,000,000, thus creating a gross profit of $100,000 for the transaction.

Sometimes factors will fund only 80-90% of the net expected value. If the full net expected value eventually is collected and if the agreement so provides, the factor may remit an additional amount to the physician group, minus an additional fee.

Advantages:

• Rapid availability of cash, often 60-90 days faster than an equivalent amount would be collected through traditional billing.
• Mitigates against the bad debt risk of individual payers (however, the amount funded by the factor always incorporates - where available - the overall, historical bad-debt experience).
• Avoidance of debt.
• Smooth cash flow, avoiding the characteristic dips seen with third-party billing.
• Some factors also offer other value added services such as financial management, managed care negotiating, etc.

Disadvantages:

• More expensive than traditional loans.
• The amount of funds available is limited by the size of the accounts receivable pool.
• Public relations problems, if the non-recourse factor handles billing poorly.
• May diminish the ability of the physician group to secure other financing. (Creates a situation where all accounts receivable are pledged.)
• If the factor enters bankruptcy, further funding may be abruptly discontinued causing immediate disruption of the physician group's cash flow. Recent financial problems with factoring companies received considerable press coverage.

Lending with collateralization of accounts receivable

Certain lenders will advance funds in a more traditional fashion and accept the physician group's accounts receivable as collateral. Under such an arrangement, the physician group members may not be required to further collateralize the loan with personal assets. There are specialty-lending groups that specialize in this type of loan to health care providers. Traditional lenders, such as banks, often avoid this type of arrangement.

Advantages:

• Cash availability.
• Continued ownership of the accounts receivable.

Disadvantages:

• Lenders frequently will advance only 60-70% of the net expected value.
• The amount of funds available is limited by the size of the accounts receivable pool.
• Interest rates are typically in the 15-18% range, higher than rates charged by traditional lenders.

Secured Commercial Loans

Many lenders, including national, regional, and local banks, will lend money that is secured by tangible assets. This security may include real estate, equipment or other tangible assets. Under such arrangements, the physician group members provide personal, tangible assets to collateralize the loan This is a core business for traditional banks as well as savings and loans; it is widely available from many institutions. Typically, a bank will lend an amount up to 80% of the assets offered as collateral.

Advantages:

• Lower interest rates than accounts receivable financing, often paralleling current mortgage rates.
• Immediate lump-sum cash.

Disadvantages:

• Physician's personal assets, including houses, may be required as collateral and could be lost in the event of the group's loan default.
• Does not provide an ongoing stream of cash. It is necessary to budget - with some accuracy - in advance.
• Physician members who have poor credit ratings may not be able to participate, which could lead to dissention in the group.

Unsecured Commercial Loans

Some lenders may be willing to advance funds that are not secured by assets. Individual physician earning power is the implied collateral. Under such an arrangement, the physician borrower(s) may be subject to a credit check and the number of physicians borrowing may limit the total loan size. After approval, 100% of the loan amount is advanced and interest, as well as payments, begin immediately. Loans are generally less than $250,000, although larger amounts - approaching $1,000,000 - are possible.

Advantages:

• Less expensive than accounts receivable financing.
• Physician assets are not used as collateral.

Disadvantages:

• More expensive than a traditional, secured loan from a bank.
• Does not create a stream of cash.
• Physicians with poor credit ratings may not be able to participate.
• In case of default, the lender may attempt to attack physician assets, even if they were not explicitly collateral.

Conclusion

Starting a democratic group may require significant cash infusion. However, that investment should be viewed in context of the equity that will be created by the new group. The accounts receivable have cash value although payers can and often do take months to provide payment. Accounts receivable, therefore, can be utilized to generate immediate cash by factoring at a discount or by collateralizing the loan. The expected value of accounts receivable, physicians’ tangible assets, and physician earning potential can be leveraged to generate cash to fund a new democratic group. The type of financing chosen ultimately depends upon the capital need, personal expenses, and the prevailing economic climate.

Prepared by the Emergency Medicine Practice Subcommittee on Resolution 16(03) - Accounts Receivable

May 2004

Randall B. Case, MD, MBA, FACEP, Chair, Emergency Medicine Practice Committee
Peter B. Koch, MD, Subcommittee Chair
Neal F. Aulick II, MD, FACEP
Greg Lepkowski, MD (EMRA)
Jeffrey D. Bettinger, MD, FACEP, Reimbursement Committee Representative
Mason A. Smith, MD, FACEP, Reimbursement Committee Representative