A disciplined approach to growth capital

The United States is on the cusp of one of the most dramatic demographic shifts this country has ever seen. Over the next several decades, the number of individuals age 65 and over will increase substantially with U.S. census projections of nearly 84 million seniors by the year 2050. This explosion in the number of older adults is a driving force behind many senior living providers’ planning efforts and growth initiatives.

Organizations that are systematic about their growth also should be highly strategic and disciplined in their approach to growth capital so they will have the resources to grow in a healthy, sustained way. 

Growth = evolution

Organizations seek to grow and evolve for a variety of reasons. First and foremost is the general sentiment that healthy organizations are those who are growing, enhancing services and constantly building upon their existing strengths. A stagnant organization is a dying organization. In order to attract future consumers and talented staff and compete in an increasingly complex line of business, organizations must always be growing and evolving.

There are five main drivers of growth:

1. Mission enhancement is often the board’s moral compass when evaluating growth opportunities, particularly for not-for-profit senior living organizations. How can the organization do more to further cultivate its mission to serve older adults? This may include partnerships with others or expanding into new geographic areas.

2. Service expansion is another very common motivation for growth, particularly in today’s environment where providers are shifting their focus to services beyond their four walls to diversify revenue streams.

3. The senior living sector is going through a consolidation phase to achieve operational leverage and economies of scale, much like the rest of healthcare. The ability to spread overhead costs and benefit from purchasing economies can save organizations significant funds. Additionally, larger organizations are able to benefit from greater negotiating power with other healthcare organizations and payers, which is incredibly important post-healthcare reform.

4. Growth initiatives can also be defensive tactics to ward off competition. Organizations should examine their local market for gaps in services for seniors. While hasty growth initiatives don’t benefit anyone, it is important to be nimble and have governance models that allow providers to move quickly on growth opportunities.

5. Access to capital is another reason for seeking growth. Without a doubt, organizations that have greater scale and an increased ability to spread risk across multiple assets benefit from an enhanced ability to attract capital.

Effective resource planning for growth

Any type of organizational growth, whether it be service expansion, developing a new community or engaging in new partnerships, requires organizational resources. A simple gap analysis that compares available resources to needed resources is a valuable initial exercise. Careful, advanced planning is the key. The critical word is “advanced.” Organizations that have done their due diligence ahead of time are much more able to act on growth opportunities than those that have not.

Below are key questions an organization can use to discuss future growth plans:

• What resources will be needed for growth?
• How do growth initiatives align with mission, vision and values?
• If partners are involved, what alignment criteria does the organization have for those partners?
• Is this a proactive move or a defensive one? Why?
• What is the organization’s risk tolerance? Does this vary across stakeholder groups?
• What is the competitive landscape for the various types of growth?
• Is everyone clear on what we would say “no” to and walk away from?
• How does this growth initiative position the organization for long-term success?

Capital planning for growth

The majority of meaningful growth initiatives, particularly those focused on brick-and-mortar models, require significant funds, are likely to yield greater revenue and will entail a greater capital outlay. So, how should providers prepare to access capital to fund their strategic growth initiatives?

The ability to grow often can be stifled if the organization does not have the appropriate corporate structure. Certain organizational structures are more conducive to accessing capital than others. This largely revolves around managing the risk of growth and borrowing additional capital. For example, if an organization would like to build a new campus or grow through affiliation, the ultimate goal will be for the risks associated with that to be separate from the stabilized organization.

Organizations with more sophisticated corporate structures also generally have an enhanced ability to borrow capital because of the managed risk associated with those structures. Larger organizations with strong metrics can develop new projects or undertake major repositioning initiatives inside their obligated group without a rating impact at a significant interest rate savings—one of the benefits of being a strong system.

A number of growing organizations are also “up-streaming” cash to a parent company, which can be a successful growth strategy. Excess cash can legally be transferred to a corporate entity, and these assets can be used to fund an acquisition of a facility or a home health agency. Providers can also use these funds for pre-construction capital if they are developing a new community. The strongest organizations are disciplined over an extended period of time and have cash assets available to fund such initiatives. Organizations should talk with their legal counsel about the best way to position an organization for growth through a modified corporate structure.

It is also important to think about existing debt and potential constraints with certain lending partners or covenants. Some key questions to ask:

• Is your current lender accommodating when it comes to provisions around additional debt, mergers and acquisitions, entry and exit into the obligated group?
• If you currently have bank debt, what is the maximum exposure that lender is willing to undertake—particularly if they hold your coveted operating account business?
• Does your fixed-rate bank debt have restrictive terms, such as make-whole calls, that might limit your ability to refinance that debt if the bank is not accommodative to growth? Avoid provisions from banks and the institutional markets that limit flexibility by requiring the maintenance of specific debt ratings.

Organizations also should keep operational financial planning tactics in mind, even if not preparing for an immediate financing event.

Margin and cash flow are among the key drivers of an organization’s ability to borrow capital. If an organization’s margins are healthy and cash flow is in a superior range compared to industry standards, lenders will, in turn, be taking on less risk and will be more likely to lend capital.

Occupancy is king, particularly for Life Plan Communities (aka Continuing Care Retirement Communities). Low occupancy, which translates into fewer monthly fees and entry fees, reduces cash flow. Providers are encouraged to not only have a firm commitment to sales and marketing, but to reinvest in the existing physical plant.It is also important for providers to regularly audit their fees and annual rate increases to ensure the organization is effectively charging for its services.

Smart organizations are very astute at managing expenses. There is a delicate balance between limiting expenses and maintaining quality, but it can be done. Even the most sophisticated organizations regularly conduct financial and operational audits to determine where they can cut costs or increase efficiencies. 

Related to cash flow and expenses is the all-important balance sheet. This is arguably one of the biggest drivers of rating and availability of bank financing (loan-to-value). For example, in the case ofeEntry fee LPCs, providers need to determine the appropriate use of entrance fees, such as whether they should be used to pay down debt or should be retained as cash.

Strong senior living organizations use sophisticated data analytics that provide daily guidance on the financial underpinnings of the organization, and they work with strong advisors and consultants. External partners can provide guidance on successful capital growth initiatives because they have the tools to do so. The keys to effective capital planning for growth are discipline, clarity and execution. Discipline helps organizations prepare financially for growth initiatives, clarity reveals the true financial and operational metrics of an organization, and execution allows organizations to form a capital plan committed to growth.

Lisa McCracken is Senior Vice President of Senior Living Research at Ziegler, a privately held investment bank, capital markets, wealth management and alternative investments firm that serves as one of the top 10 lead underwriters by paramount for healthcare/senior living financings in the United States. She can be reached at lmccracken@ziegler.com.