Key Takeaways
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Every disallowed dollar of EBITDA during a DSO buyer’s Quality of Earnings review can reduce enterprise value by several dollars, so documented financial preparation can be critical.
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Sellers typically need 3 years of accrual-basis P&Ls, tax returns, a substantiated add-back schedule, A/R aging, payroll registers, provider-level production reports, equipment schedules, and leases ready before diligence begins.
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Cash-to-accrual conversion, tax-to-P&L reconciliation, and cleanup of unsupported 90+ day A/R balances are core steps that help the seller maintain control of the financial story.
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A CPA-led, dental-specific advisor builds the diligence-grade EBITDA analysis that can withstand buyer scrutiny and helps prevent the post-LOI price re-trades described below.
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McLerran & Associates is the dental-only, CPA-led sell-side advisor that prepares and defends the financial package through the buyer’s Quality of Earnings review.
Get a confidential review of your financial package before diligence begins.
Financial Documents DSO Buyers Expect To See
DSO buyers and their diligence teams rely on a standard financial package. Assembling these documents early can remove weeks or months from the overall deal timeline.
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Three years of accrual-basis profit & loss statements with monthly breakdowns and a trailing twelve months (TTM), which is the most recent 12-month period regardless of fiscal year. Monthly P&Ls show whether earnings are steady or whether one strong year is masking two ordinary ones.
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Three years of federal tax returns. The buyer’s lender independently verifies returns through IRS Form 4506, so unexplained differences between tax returns and presented financials become a significant diligence risk that can trigger renegotiation, as noted by LegalClarity’s practice sale guide.
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Adjusted EBITDA add-back schedule. A documented bridge from reported net income to adjusted EBITDA, in which every add-back is tied to source records. An add-back without documentation is among the most common findings in dental QoE reviews and is reliably disallowed.
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Accounts receivable (A/R) aging split into 0–30 / 31–60 / 61–90 / 90+ day buckets and separated by insurance versus patient balances. Buyers analyze the two categories separately because they require distinct recovery workflows, as many revenue-cycle resources explain.
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Payroll registers and quarterly 941 filings. These records let the buyer test compensation, benefits, and expected post-close staffing cost, and they help identify worker misclassification risk.
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Provider-level production and collections reports. These reports separate transferable practice economics from owner-dependent production, which is a key valuation input.
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Equipment schedules and depreciation records including age and maintenance history for major items. Deferred maintenance often becomes a negotiating point.
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Office leases and related contracts. Lease term, assignability, and renewal options are tested by every buyer; a short remaining term or a landlord who must consent to assignment creates diligence risk.
Beyond financials, a serious DSO buyer also evaluates clinical quality, systems and technology, team structure, and day-to-day operations, because those areas become the DSO’s responsibility after closing.
Building an Adjusted EBITDA Add-Back Schedule
An adjusted EBITDA schedule shows how reported net income becomes the buyer-ready earnings figure that supports a DSO offer. The EBITDA build follows a documented sequence: start with reported net income, add back interest, taxes, and depreciation to reach reported EBITDA, then layer in each substantiated adjustment. The table below walks through that bridge for a hypothetical practice, showing how $300,000 of reported net income becomes $500,000 of adjusted EBITDA. All figures are hypothetical and for educational purposes; consult your own advisors for figures specific to your practice.
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Line Item |
Hypothetical Amount |
|---|---|
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Reported Net Income |
$300,000 |
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+ Interest |
$20,000 |
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+ Taxes |
$15,000 |
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+ Depreciation & Amortization |
$45,000 |
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= Reported EBITDA |
$380,000 |
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+ Above-market owner compensation add-back |
$80,000 |
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+ Personal expenses run through the practice |
$30,000 |
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+ One-time / non-recurring fees |
$25,000 |
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− Market-rate replacement cost adjustment (net) |
($15,000) |
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= Adjusted EBITDA |
$500,000 |
Common add-back categories include above-market owner compensation, personal expenses run through the practice such as personal vehicles, club memberships, or family cell phone plans, and one-time or non-recurring fees such as a legal settlement or a major equipment replacement that does not recur. Because many private-company acquisitions are priced as a multiple of EBITDA, every dollar of accepted adjustment can move the purchase price by several dollars, so substantiation becomes central.
The market-rate replacement-cost adjustment deserves particular attention. The owner’s W-2 compensation is removed, and the loaded cost of a market-rate replacement dentist is added back. The net can be positive or negative depending on prior tax planning. An owner who underpaid themselves relative to market will see a negative adjustment that reduces adjusted EBITDA. Many owners quote an EBITDA figure with no salary built in for their own clinical work, which means the number they present is pre-tax take-home pay rather than a buyer-ready cash flow figure.
Each add-back should be backed by invoices, payroll records, or provider-level production reports. A legitimate add-back that is not supported by documentation becomes a negotiating problem regardless of how valid it is, because buyers rarely accept an add-back on the seller’s representation alone. An add-back schedule that proves wrong a material portion of the time causes the buyer’s accountants to re-test every line already accepted, which compounds the damage.
For a sense of how the bridge works in practice, Raincatcher provides an illustrative worked example for a hypothetical company in which adjusted EBITDA is $1,300,000.
Cash vs. Accrual Accounting for a DSO Offer
Even a well-documented add-back schedule rests on financial statements the buyer will accept. Most dental practices file taxes on a cash basis, recording revenue when payment is received and expenses when bills are paid. Cash-basis financials can conceal deteriorating accounts receivable, delayed insurance collections, denied claims, and weak patient collections because current deposits may relate to work performed months earlier. A DSO buyer prices on accrual-equivalent earnings, so the conversion happens one way or another and the seller chooses whether to shape that story in advance.
The conversion sequence recommended by transaction advisors follows a fixed order of work:
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Fix the periods. Restate every fiscal year shown plus the months in the TTM consistently. Converting only the most recent period can create a basis-change artifact that a buyer may mistake for genuine growth or deterioration.
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Build subledgers. Construct A/R and A/P agings, unbilled work, deferred revenue roll-forwards, payroll calendars, prepaid schedules, and inventory roll-forwards for each period.
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Write the policies down. Document revenue recognition cutoffs, reserve policies, and write-off criteria so the buyer tests the seller’s result rather than replacing the seller’s assumptions with its own.
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Post and reconcile to bank statements and the tax return. The bank is the only record nobody inside the practice can edit. Comparing the ledger to actual bank deposits verifies the foundation under the financials.
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Test cut-off on both sides of each period end. Confirm that revenue and expenses land in the correct period, particularly for insurance claims that span month-end.
Accrual statements will not match a cash-basis tax return, and a buyer expects a reconciliation schedule that starts with income on the return, adds and subtracts each timing difference, and arrives at accrual net income. A cash-to-accrual conversion done after the letter of intent happens on the buyer’s clock and under the buyer’s policies, while the seller is typically bound by exclusivity. Starting before the process begins is the practical way to guide the narrative.
Reconciling Tax Returns to P&Ls Before a DSO Offer
A line-by-line reconciliation of 3 years of tax returns to the corresponding P&Ls can be one of the most important and most overlooked steps in preparing financials for a DSO offer. The reconciliation starts with return income and then adds or subtracts each timing and book-tax difference to arrive at accrual net income.
Gaps between returns and P&Ls create buyer skepticism and slow diligence. As noted in the document checklist, the lender’s Form 4506 verification means every gap between returns and financials must be explainable, and a clean reconciliation trail is how you make it so. A clear bridge also supports the add-back schedule, because the add-backs apply to accrual earnings rather than to the cash figure on the return.
A buyer or valuation professional will discount earnings figures that cannot be traced, so sellers often begin with financial statements that tie to tax returns, bank activity, and practice-management reports, with production, adjustments, and collections reconciling well enough to explain timing and write-offs. Differences among the practice management system, general ledger, bank deposits, and tax returns are not automatically fatal to a deal, but each discrepancy should be explainable and reconciled before closing.
A/R Aging Cleanup Before a DSO Offer
Accounts receivable aging often becomes one of the first places a buyer’s diligence team looks and one of the most common sources of post-LOI price adjustments.
The aging report should be split between insurance A/R and patient A/R. They require different recovery workflows and are analyzed separately. Insurance A/R over 90 days should be below 20% of total insurance A/R; balances materially above that threshold may indicate claims approaching or exceeding payer timely-filing deadlines, after which no amount of follow-up will generate payment.
To make 90+ day balances defensible in diligence, each balance should be documented with:
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Date of service and payer or patient responsibility
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Claim submission date and current claim status
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Denial reason, appeal history, and expected payment
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Evidence that the balance remains within the payer’s timely-filing window
Unsupported or legally uncollectible balances should be reserved or written off before diligence rather than presented as collectible. When A/R is sold at closing, common discount benchmarks run roughly 90% of balance for current accounts and 80% for 30-to-60-day balances. The discount usually deepens with age: 70% for 60-to-90-day balances, 50% for 90-to-120-day, and 30% or less for anything older than 120 days. Presenting a clean, well-documented aging report, rather than a gross balance the buyer must discount, helps the seller maintain control of the narrative.
What a Quality Of Earnings Review Challenges in a DSO Offer
A buy-side Quality of Earnings (QoE) review is a formal third-party analysis commissioned and paid for by the buyer. It evaluates whether reported earnings are accurate, recurring, and defensible. To do that, it rebuilds earnings from source data instead of accepting the seller’s statements and restates anything that will not repeat under new ownership.
The QoE team’s standard challenge list in a dental DSO transaction typically includes:
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Undocumented add-backs. An add-back that can only be described is worth nothing; an add-back with an invoice attached is worth its face value multiplied by the transaction multiple, with no partial credit.
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Owner compensation normalization. The buyer prices the cost of replacing the owner’s clinical production at market rate. If the seller’s package uses a different replacement-cost assumption, the buyer’s accountants will substitute their own, and the difference flows directly through to enterprise value.
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Tax-to-P&L reconciliation gaps. Unexplained differences between returns and financials cause the buyer to question every other number in the package.
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A/R write-offs. Aged balances presented as collectible but lacking documentation are discounted or written off, which reduces working capital delivered at closing.
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One-time expense classification. An expense described as one-time but appearing in three consecutive years is a red flag, and a family member who actually performs necessary work is not fully add-backable because the buyer must replace that role.
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Worker misclassification. Associates and hygienists paid on 1099s while doing employee work are re-costed as employees in diligence, which adds payroll taxes and benefits to the normalized expense base.
Pre-empting each challenge requires documentation, recurrence analysis across multiple periods, and market support for replacement-cost assumptions, assembled before the buyer’s team arrives so the seller answers questions rather than reacting to them. Sellers who ran their own forensic analysis before the buyer ran theirs, presenting independently verified, pre-normalized EBITDA with every add-back substantiated, are the ones who often avoid post-LOI re-trades.
That pre-emptive work is what McLerran & Associates builds: a CPA-led, diligence-grade EBITDA analysis prepared before the deal goes to market and defended through the buyer’s QoE review. That approach underlies the firm’s roughly 85–90% transaction rate and helps its clients’ agreed values hold. DIY sellers and practices represented by generalist brokers whose numbers were never properly underwritten often face a different outcome, where the buyer’s QoE team sets the narrative and the price follows.
Get your DSO offer financials defended by a CPA-led advisor.
Is Your Practice Ready To Prepare Financials For a DSO Offer?
The questions below mirror what buyers ask at the start of diligence. Straightforward answers highlight where preparation work remains.
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Does the practice generate $1.5 million or more in annual revenue, with collections that can support a meaningful EBITDA multiple?
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Are the books maintained on an accrual basis, or will a conversion be required before the package goes out?
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Do 3 years of clean, monthly profit & loss statements exist, and do they reconcile to the corresponding tax returns?
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Is every proposed add-back documented with invoices, payroll records, or provider-level production reports?
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Is the A/R aging current, split by insurance versus patient, and free of unsupported 90+ day balances?
Practices that cannot answer yes to most of these questions are not yet ready for a buyer’s QoE review, and going to market unprepared can be a leading cause of extended timelines, re-traded prices, and deals that fall apart entirely. McLerran & Associates offers a complimentary valuation update for practices that are not yet ready to transact and hosts the McLerran M&A Summit (October 29–30, 2026, Austin; 4 CE credits; complimentary $2,500 practice valuation) as a no-pressure way for owners to get educated before committing to any path. For owners in the $1.5–3 million revenue range who are genuinely weighing both a private-buyer and a DSO path, the Summit is built for that moment of decision.
Conclusion and Next Steps
Preparing financials for a DSO offer functions as a defense exercise. The checklist of 3 years of accrual-basis P&Ls, tax returns, an add-back schedule, A/R aging, payroll registers, provider-level production reports, equipment schedules, and leases represents the starting point. What often determines whether the agreed value holds through diligence is the substantiation behind each number: documented add-backs, a clean accrual conversion, a line-by-line tax-to-P&L reconciliation, and an A/R aging report that can withstand forensic scrutiny.
The practical next steps follow the same order the buyer’s diligence team will use. Start by assembling the document checklist, because every later step depends on having the underlying records in hand. From there, document each add-back with invoices, payroll records, or production reports, since an add-back without that support rarely survives the QoE review. Next, convert the books to accrual and reconcile each period to its tax return, which lets the buyer test your numbers instead of rebuilding them. Clean the A/R aging after that, writing off or reserving unsupported balances so the buyer has little left to discount. Then obtain a CPA-led valuation before the buyer’s QoE team does, so the seller controls the EBITDA narrative before diligence begins and increases the chance that the price holds at closing.
McLerran & Associates has completed roughly 2,000 successful practice sales, closing roughly $2 billion in transaction volume with the transaction rate cited earlier. The firm’s dental-only, CPA-led approach, which builds diligence-grade EBITDA analysis up front and defends it through the buyer’s QoE review, is a central reason its clients transact at that rate while the industry norm sits closer to 35–40%.
For more on the financial documents DSO buyers require, see DSO Due Diligence: Financial Documents Sellers Must Prep. For a broader overview of the preparation process, see How to Prepare Your Financials for a DSO Sale. For guidance on negotiating once the offer is in hand, see How to Negotiate a DSO Offer for Your Dental Practice. For an overview of what the seller keeps after taxes, see DSO Practice Sale Tax Implications: What You Keep.
Schedule a free, confidential discovery call with McLerran & Associates.
Frequently Asked Questions
How Far Back Should My Financials Go for a DSO Offer?
Three full fiscal years of financial statements and tax returns plus current year-to-date results is a standard financial package for a dental practice sale. The 3-year history allows the buyer to test whether earnings are consistent across periods or whether one strong year is carrying two ordinary ones. The most recent period, often presented as a trailing twelve months (TTM), reflects current operating conditions and is typically weighted most heavily in the buyer’s underwriting. Some larger or more complex transactions may request 5 years of financial statements and tax returns, along with 5 years of production and collections data, so maintaining clean records well beyond the minimum can be advisable for practices anticipating a DSO process.
Do I Need Accrual-Basis Financials If My Tax Returns Are Cash-Basis?
Yes. The DSO buyer will recast the numbers on an accrual basis regardless of how the tax returns were filed, because accrual accounting matches revenue to the period in which services were performed rather than when cash was collected. As the cash-versus-accrual section explains, the buyer will recast the numbers regardless, and the key question is whether that happens on your timeline or theirs. A seller-controlled conversion, prepared before the process begins and reconciled to the tax returns, keeps the seller in a stronger position. The tax method does not need to change; most dental practices can maintain cash-basis tax reporting while running accrual-basis management financials for the sale package.
What Is an Add-Back, and How Do I Document It?
An add-back is an expense recorded on the practice’s books that a new owner would not incur, or would incur at a different level, after closing. Common examples include above-market owner compensation, personal expenses run through the practice such as a personal vehicle, club memberships, or family cell phone plans, and one-time or non-recurring costs such as a legal settlement or a major equipment replacement that does not repeat. Documentation is what allows an add-back to survive a Quality of Earnings review. Each add-back should be supported by the general ledger entry, the underlying invoice or payroll record, a written explanation of why the cost is personal or non-recurring, and evidence that the buyer will not inherit the cost. An add-back that appears in consecutive years under different descriptions will usually be treated as recurring and disallowed. The IRS substantiation standard, which requires amount, date, place, and character of an expense, is a useful benchmark. A line that would survive a tax examination will generally survive QoE diligence.
What Is a Quality of Earnings Review?
A buy-side Quality of Earnings (QoE) review is a formal third-party analysis commissioned and paid for by the buyer, typically after the letter of intent is signed. It is not an audit and issues no GAAP opinion, but it is a rigorous consulting engagement that rebuilds the seller’s reported earnings from source data, tests every add-back against documentary evidence, converts cash-basis books to accrual, reconciles tax returns to financials, and identifies anything that will not repeat under new ownership. The QoE team’s findings become the buyer’s negotiating list for any post-LOI price adjustment. Because the seller is typically bound by exclusivity during this period, the buyer’s leverage can be at its highest. Sellers who have already performed their own sell-side analysis, documenting every add-back, converting to accrual, and reconciling returns to P&Ls, enter the QoE process with a defensible position rather than reacting to the buyer’s findings.
Why Is 90+ Day A/R Discounted in a DSO Offer?
Collection probability often falls sharply once a dental claim or patient balance reaches 90 days. Insurance claims approaching or exceeding a payer’s timely-filing deadline, which typically runs 90 to 365 days from date of service depending on the carrier, cannot be resubmitted regardless of merit, which makes the balance permanently uncollectible. Patient balances aged beyond 90 days face similarly steep recovery challenges. Buyers discount or write off 90+ day balances that lack documentation of active follow-up, a valid claim status, and a realistic path to collection. Sellers who reserve or write off unsupported balances before diligence, rather than presenting them as collectible, avoid having the buyer impose a larger discount during the QoE process. Splitting the aging report between insurance and patient A/R and providing claim-level evidence for material 90+ balances is now a common standard for a diligence-ready package.
Should a Broker or a CPA Prepare the Financial Package?
A CPA-led, dental-specific advisor is usually the most appropriate choice for preparing the financial package for a DSO offer. A generalist broker typically lacks the underwriting depth to build a diligence-grade EBITDA analysis, substantiate add-backs at the documentation level a QoE team will test, or perform the accrual conversion and tax-to-P&L reconciliation that buyers require. A free or back-of-the-napkin valuation becomes the anchor that determines what the seller walks away with, and a weak analysis often gets re-traded in diligence. The financial package prepared before the deal goes to market forms the foundation on which the entire transaction rests, so it should be built by advisors who understand dental-specific economics, have performed this work across hundreds of transactions, and will defend the numbers through the buyer’s QoE review.
How Long Does the DSO Offer and Diligence Process Typically Take?
McLerran & Associates’ DSO bid process typically runs approximately 45 to 60 days and generally generates around 10 offers. After the letter of intent is signed, formal diligence typically runs roughly 30 to 120 days depending on the buyer and the practice’s readiness, including the buyer’s Quality of Earnings review. Practices with clean, organized financial records, a complete data room, and a pre-built accrual conversion move through diligence significantly faster than those whose accountants must reconstruct records mid-process. Total time from first engagement to closing, including preparation, marketing, diligence, and closing, commonly runs several months to over a year for DSO transactions, with pre-market financial preparation consuming a meaningful portion of that timeline.
