Financial Pitfalls Of Expansion Projects And How To Avoid Them

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Financial Pitfalls Of Expansion Projects And How To Avoid Them
Or How to plan for a large expansion project
Finance Geeks Copyright: David Catalano, 11/05


Wouldn’t it be nice to have perfect hindsight before you make a big financial move? When we get excited about something, we tend to downplay the potential risks and focus on the benefits. In my experience, acting prior to planning creates $100,000 mistakes all of the time and is the largest reason for many of the common problems in expansion projects.

What if you could actually isolate the risks and then mitigate them before you began your project?

One of my favorite sayings is “intelligence is no substitute for experience”. If you have always been successful at everything you have done, you may be at risk for thinking your success in one area will be applicable in another.

Expansion projects involve the highly specialized areas of design, construction, real estate and banking. All of the people that you will negotiate with during your project do what they do for a living. They spend 2,000 hours per year plying their craft. The probability of you getting the better end of the deal is low.

A Professional, working on your behalf, is far more likely to negotiate a more favorable deal for you. Consider the following case examples of common mistakes created by unwitting dentists as they move through their expansion projects. Then consider the probability of you running into the same traps. Hiring a Professional to take you through the process may be the edge you need to come out on top.

[sidebar]
Economic Concept – The Ego Bias
This common bias is that most people are not willing to assume that the “true probability rate” information applies to them. The typical person assumes “I’m special and those probabilities don’t apply to me”. The Ego has an amazing ability to distort information. Suppose, for example, you were told, based on your lifestyle and age that you had a 32% chance of living another 6 years. Would you accept those odds? Probably not because you are not willing to assume that data applies to you.
[sidebar]

All of the examples are real with the names and subtle details removed to protect the identity of the person.

Case Example #1 – Signing a lease before you create a plan

We have had several clients sign new office leases prior to having a complete financial and project plan in place. The amount of damage this error can do is incredible. The errors tend to build on themselves.

If you are spending a significant amount of money for leasehold improvements, you are likely going to want a long-term lease (10 years with options for 10 more). The property owner is likely to require your personal guarantee for the lease payments. This means that barring bankruptcy, you are not going to get out of making those payments.

Before you sign the lease, make sure you understand the total cost of completing the project and have the capital lined up to fund those costs. The more detailed your plan, the better. Asking the property owner or the Condo developer how much it will cost to convert the existing space to your dental office is not going to get you close to the cost of the project.

If you are leasing space, the closer you get to making two lease payments the higher your anxiety around financing grows. The longer it takes to obtain financing, the less discerning you get. This is how people end up with the wrong type of financing. You eventually get the money, but the terms are onerous or your cash flow is compromised.

We have seen people sign leases that increase their monthly payment 200 - 300 percent prior to knowing the cost of the project or how they were going to finance it. If your rent is going from $2,500 to $8,000, you should understand the costs of your project with a high degree of certainty.

Case Example #2 – False confidence in your local bank

The appraised value of a dental building is usually less that cost of constructing the building. Most local or community banks lend the lower of the appraised value or cost of the project. If you build a new dental office, you will have a GAP between what the bank will lend you and the cost of construction. Add in the cost of technology, equipment, furnishings and you have a large amount of money to borrow over a short period.

It is common for a dentist to know a local banker that promises him “all of the money he needs for his project”. With that statement, they are full of confidence and begin the process of building the Taj Mahal. Banks are highly regulated and have strict lending policies. The days of character based lending are over. If your banker has not issued a commitment letter that you understand, then you should assume that you do not have any money. The bank must understand the project completely. How will you cover the Gap and the additional costs of the project? If you rely on your bank to construct your plan, you have a high probability of having problems.

Case Example #3 –Not leasing enough space to achieve your practice goals

It is common to meet with a dentist that has signed a lease for space that will not accommodate the number of operatories he wants to build. The ratio of square footage to operatories is too small. There are certain regulatory bodies that dictate square footage allotted to the facility and there is no way around it. It is common for someone to lease space intending to build five operatories but after considering the national and local building codes only are able to complete three.

You should never sign a lease for a space without having the space reviewed by an architect that understands dental office design. The cost of this mistake can be huge. It will affect your productivity for the length of your lease. These mistakes can easily add up to $100,000.

Architects must comply with ADA (American Disabilities Act) codes and restrictions. Many dentists perceive that non-public areas do not need to be ADA compliant and that is not the case. Architects must also comply with fire marshal codes that have certain restrictions that can dictate the square footage required to achieve your ideal space. You should know all of the local and national code requirements before you sign a lease.


Case Example #4 – Leasing too much square footage, over-extending yourself

If your current office is too small, you may fall into the over-compensation trap and make your new office too big. Big offices are hard to finance and hard to sell.

You may fall pray to this bias if your waiting room is always full and your business office is too small. Maybe your hygiene department is always booked up too. Humans tend to move in extremes. Be careful that you do not make an extreme change to the size of your office.

Another related blunder is building a facility based on attracting an associate. In my experience, the associate either never comes or does not stay. In general, if you can attract an associate, it may be better to stagger your schedule to accommodate them rather than to create a larger facility. In my experience, you have a higher probability of paying for more operatories than you need, than to profit from the associate during the time you employ him.

Case Example #5 – Know what you are getting before you sign

What is included in the price of your lease or Condo purchase? Are you getting an HVAC system? How about a floor? We had a client that leased space and did not receive either of these items.

You are paying for 2,500 square feet, how many are usable? Column locations are a big issue and must be considered in relation to how the space is laid out. If the column falls in the middle of the tray prep area, it renders the area useless. Architects that don’t understand how you use the space can make this mistake. It will require you to lease or buy more space that you would ordinarily need.

Understand the difference between usable and gross square feet. If you are considering an oddly shaped space, you must understand how your office will be laid out to fit into the space while considering all of the local and national building codes.

Case Example #6 – Know the land before you buy it

An architectural consultation and investigation will help you uncover what your easements and setbacks are. It will also help you understand the access consideration. What are the existing conditions of the site? How will the building be situated on the land? Is the property properly zoned for a medical facility? If not, how long will it take and how much money will it cost. Can you achieve your ideal building on this ground?

It is not unusual to see a dentist buy a piece of land without the appropriate investigation. Land is a liability because it does not produce cash, carries an insurance and tax burden and cannot be easily sold. These are not the qualities of an asset. Being stuck with land that will not work for your project because you thought it was a good deal and had to close fast, may not be the best move on your part.

You have seen six common problems associated with expansion projects. There are many more. A bigger challenge comes when you combine multiple problems. This occurs when one issue creates the next. It can be overwhelming and wear on your confidence. Consider seeking a Professional in each area of your project who will work on your behalf so you can avoid $100,000 mistakes.

I would like to acknowledge the help of Kitt McKillop of T.H.e. Design for her assistance with part of this article. Over the past six years Kitt as worked with hundreds of dentists as an Office Planning Consultant for T.H.e. Design in Austin, TX. See them on the web at www.thedesign.com.

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