Money Matters Investment & Finance Using equity and debt
Using equity and debt
Wednesday, 01 June 2005
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dollarsign_TN.jpgMany of you are in sole practices, partnerships, family companies and the like. Irrespective of your chosen business structure, your ability to build wealth is tied to the fundamentals of your practice.

Most wealth management articles focus on investment of personal income. As a medical professional you've invested heavily in education, experience and your approach to patient care. This "personal equity" commands a salary, whether an employee or paid by your own practice. But a GP's first opportunity is to effectively use your financial resources to build value in your practice. One of the most important factors is to get the balance right between equity and debt.

Equity can take many forms, for example your:

  • Goodwill value, which is largely a reflection of your reputation in the area.
  • Owned medical premises, which can be sold.
  • Practice assets, including staff.

The equity value should outweigh the cash injected to start, acquire or build a practice.

Your equity is a precious commodity. Much of your initial capital will be consumed by various expenses but, as the practice grows and generates positive cash flows, equity should start to increase. While equity growth is good, alone it may not be the optimal way to build wealth. Under Australia's tax system, the "opportunity cost" of leaving equity in the business is not deductible. "Opportunity cost" is the benefit you forgo if the money is not used more efficiently elsewhere.

This is where debt comes in. The benefit of debt is that the tax system (usually) allows deductions for the interest cost when used to create (taxable) income - effectively favouring debt over equity. This "favouritism" makes the concept of "leverage" more attractive. Leverage is adding debt to your equity, thus increasing the amount available for investment. You use other peoples' money to accelerate growth - and some of the cost is offset by our tax system.

Prudent use of debt allows practitioners to make investments such as acquiring a practice, updating clinical equipment or providing better patient facilities. As with any investment, the earlier you start, the more you can take advantage of reinvesting your proceeds in additional opportunities.  Time is a critical factor - making your money and practice work harder for longer builds your wealth.

By taking on debt, you are taking an obligation to pay the lender; increasing your risk as well as your potential reward. Should the investment return less than you expect, then losses may be magnified.

Perhaps, surprisingly, your and the lender's interests are very much aligned. A lender assesses if you can meet the repayments - and so should you. Here is a quick ‘health check' based on what a lender wants to know. It's worth your while thinking like them!

  • Can you service the debt?
  • Will the investment opportunity earn the return you expect?
  • What is your or other practitioners' experience in the practice area?
  • What if something should go wrong? What options do you have?
  • Is the ‘investment' really in income-producing assets or lifestyle?

By getting the investment and business basics right, you can leverage your equity to grow your wealth in the practice and diversify into other income and growth assets.

Brad Potter is Medfin's state manager in Western Australia.