We Are Experts in DSO Transactions
While McLerran & Associates has grown to become the largest dental practice brokerage firm in Texas from a doctor-to-doctor transaction perspective, we have also emerged as one of the authorities on DSO transactions in the dental industry nationwide. We have spent the past few years building strong working relationships with local, regional, and national DSO buyers and private equity firms and facilitated the sale of over $150 million in dental practices to these types of buyers as a sell-side advisor.
Here are a few examples of transactions that we have recently closed:
|1 Location GD Practice||Annual Revenue of $1.2 Million & EBITDA of $320,000 = Enterprise Value of $1.3 Million|
EBITDA Multiple of 4.22 Times; 113% of Annual Revenue
|2 Location GD Practice||Annual Revenue of $5 Million & EBITDA of $1.8 Million = Enterprise Value of $13.1 Million|
EBITDA Multiple of 7.28 Times; 262% of Annual Revenue
|2 Location Pedo/Ortho Practice||Annual Revenue of $3,200,000 & EBITDA of $520,000 = Enterprise Value of $3.2 Million|
EBITDA Multiple of 6.15 Times; 107% of Revenue
|1 Location GD Practice||Annual Revenue of $3 Million & EBITDA of $550,000 = Enterprise Value of $3 Million|
EBITDA Multiple of 5.45 Times; 100% of Annual Revenue
|2 Location GD Practice||Annual Revenue of $7.1 Million & EBITDA of $1.5 Million = Enterprise Value of $9 Million|
EBITDA Multiple of 6 Times; 127% of Annual Revenue
|2 Location GD Practice||Annual Revenue of $2.8 Million & EBITDA of $750,000 = Enterprise Value of $4.5 Million|
EBITDA Multiple of 6 Times; 161% of Annual Revenue
|4 Location GD Practice||Annual Revenue of $15 Million $ EBITDA of $1.5 Million = Enterprise Value of $16 Million|
EBITDA Multiple of 10.67 Times; 107% of Annual Revenue
At McLerran & Associates, we understand that partnering with or selling to a DSO is an enormous decision for our clients from a professional, personal, emotional, and financial perspective. Therefore, it’s imperative that you refrain from responding to unsolicited offers and attempting to negotiate a deal without proper representation. We represent sellers and serve as advocates for our clients. In doing so, we have spent a great deal of time developing and fine-tuning our process to ensure that our doctors make sound, informed decisions, partner with a DSO that is an ideal fit for their office, and obtain the highest price and most favorable terms/deal structure available in the marketplace.
Here are the steps involved:
- Schedule a confidential, complimentary transition consultation to discuss your practice and get a clear understanding of your personal and professional goals. – What is driving your decision to consider the DSO option? Does selling to or partnering with a DSO make sense for you and your practice? If so, what type of buyer and/or deal structure is best suited to meet your needs?
- Educate you regarding what DSO’s are looking for, the different options and deal structures available in today’s marketplace, and what the practice sale/transition process will look like pre- and post-closing.
- Complete a detailed practice valuation to determine the maximum market value of your practice.
- Present the practice to potential buyers in a professional, confidential, and organized manner and address questions/concerns from potential buyers during the due diligence process.
- Control the narrative surrounding the EBITDA and value of your practice. YOU DON’T WANT YOUR BUYER DICTACTING YOUR PRACTICE VALUE.
- Create a competitive environment among multiple buyers to ensure that our clients receive the highest price and best deal terms available. THIS STEP IS KEY TO PROVIDING YOU WITH MULTIPLE OPTIONS AND MAXIMIZING THE VALUE OF YOUR PRACTICE.
- Help our clients interview potential buyers to identify THE DSO that is the best fit for their practice from a financial, infrastructure, and cultural perspective. NOT ALL DSO’s ARE CREATED EQUAL.
- Negotiate the price and major/minor deal terms within the Letter of Intent and Legal Agreements.
- Walk you through each step of the process.
As a result of engaging McLerran & Associates as their advocate and following the steps outlined above, we are proud to say that our clients have achieved an average increase of 20-30% in their practice valuation and negotiated far better deal terms than they would have been able to obtain by negotiating the sale on their own behalf. We look forward to achieving these same results for you!
What You Need To Know About DSO’s
What is a DSO?
Wikipedia defines DSO’s as: Dental Service Organizations, also known as “Dental Support Organizations”, as independent business support centers that contract with dental practices in the United States. They provide critical business management and support to dental practices, including non-clinical operations.
In a handful of states (such as Arizona), you are not required to be a dentist to own a dental practice. However, in most states (like Texas), only a dentist can own patient records. Therefore, the legal structure of a DSO is constructed to comply with state regulations by consisting of a doctor entity (owned solely by a dentist) which owns the patient records and another corporate entity (the DSO entity) which owns all of the tangible assets of the practice (equipment, furnishings, marketing collateral, lease, etc.) and ultimately controls the net cash flow (EBITDA) of the practice. Sophisticated DSO’s are designed to leverage their centralized infrastructure (services including accounting/bookkeeping, legal, compliance, marketing, HR, etc.) to support their partner offices from a business/administrative perspective while allowing the doctors to maintain their clinical autonomy.
DSO’s are the fastest growing segment of the dental market and range in size from 1-10 offices (known as “emerging DSO’s”) to over 1,000 offices (Heartland Dental). While emerging DSO’s are often backed by traditional banks or private investors, the growth of larger DSO’s is being fueled by Private Equity. Wikipedia defines Private Equity as: investment funds, generally organized as limited partnerships, that buy and restructure companies that are not publicly traded.
Private Equity is particularly interested in the dental industry for several reasons:
- The dental industry has experienced consistent revenue growth over the past 20 years.
- Dental practices enjoy one of the highest levels of profitability of all niches in the medical space and typically sell for very reasonable multiples of EBITDA compared to other industries.
- The dental industry is highly fragmented, which provides investors with the opportunity to organize the market, optimize practices, and take advantage of the economies of scale previously discussed.
- There are a larger number of practice owners/potential sellers who are looking for liquidity and support from a business perspective.
- Demand for dental services is relatively inelastic in relation to changes in the economy.
Reasons for Selling to a DSO
There must be a compelling reason to consider selling to or partnering with a DSO buyer, as opposed to retaining ownership/control of your office long-term or selling to a private buyer. Here are several reasons why our clients have chosen to sell to or partner with a DSO buyer:
- To receive a substantial premium on the practice purchase price compared to a private buyer (as discussed below)
- To unload some or all of the management burden, thereby having less stress and a better work/life balance
- To take advantage of the economies of scale and support a DSO can offer
- To retire debt-free, and accumulate substantial liquidity/retirement savings
- To fund future growth/expansion
Whatever your reason for entertaining offers from DSO buyers, you need to make sure that you choose the right buyer/partner that will truly enable you to accomplish your goals.
What Types of Practices Are DSO’s Looking For?
While the appetite of DSO buyers varies, and there are many factors that are taken into consideration, most DSO’s are looking for practices with the following characteristics:
- Annual revenue of $1 million +
- Updated facility with 5 + operatories
- Located in an area within 60 miles of a major population center
- Easily accessible or high visibility location (retail or free-standing building)
- Owner doctors (or associate doctors) who are committed to staying on for a minimum of 2-3 years following the sale.
How DSO’s Calculate Practice Value
For the most part, DSO’s determine the value of dental practices based upon a multiple of EBITDA, along with some consideration for the unique characteristics of the practice (location, quality and size of the facility, equipment/technology, patient mix, upside potential, etc.). EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and can be calculated as follows:
Net Income (as it appears on your practice financials)
+ Owner Compensation & Owner Benefits (health insurance, retirement contributions, auto, meals, etc.)
+ Associate Doctor Compensation (excluding wages paid to specialists)
Less Doctor Compensation* (calculated at 30% of doctor collections)
* This compensation structure is based upon a general dentistry practice and will vary for multi-specialty and specialty practices.
A practice with EBITDA in the range of $250,000 to $1 million will typically be valued at 4-5 times EBITDA, while a practice with EBITDA of over $1 million will typically be valued in the range of 5-7 times EBITDA. Large, multi-location practices with EBITDA of $2 million+ could serve as a platform investment for a private equity firm that is entering the dental market or an established DSO that is looking to establish a new presence in a particular geographic area. These practices often command values as high as 7-10 times EBITDA.
The reason that DSO’s typically target practices with annual revenue of $1 million+ is because offices with revenue below that threshold typically do not generate a substantial amount of EBITDA. A well run practice with annual revenue of $1 million+ will typically generate EBITDA in the range of 18-22% of revenue.
As an example, a practice with annual revenue of $2 million, would hypothetically generate EBITDA of approx. $480,000. At a multiple of five times EBITDA, the practice would be valued at $2,400,000 (or 120% of revenue), which is a significant premium compared to a valuation of approx. 75% of revenue or $1,500,000 under the traditional private buyer model. The substantial premiums that DSO buyers are paying for highly profitable practices is one of the most prominent factors influencing sellers to consider offers from DSO buyers in lieu of selling to a private buyer.
Structural Elements of a DSO Transaction
While DSO buyers may pay a premium price for quality practices, the enhanced purchase price typically comes with some strings attached. The buyer usually pays 70-85% of the purchase price at closing with the remaining balance being paid in annual installments contingent upon the selling doctor(s) working in the practice for a minimum of 2-3 years post-closing and/or the practice hitting certain revenue or EBITDA benchmarks post-closing. For example, a DSO buyer will purchase a practice with annual revenue of $1.5 million and EBITDA of $300,000 for a purchase price of $1.5 million (100% of revenue). The payment of the purchase price will be structured as $1.2 million payable in cash at closing and the remaining $300,000 paid in three annual installments contingent upon the seller continue working full-time AND the practice maintaining revenue levels consistent with that of the trailing 12 months prior to closing.
Another common structural element of DSO transactions is the requirement of the selling dentist(s) to retain an ownership interest in their individual practice or “roll over” equity into the parent company. An equity retention/rollover structure is typically utilized in transactions involving large, multi-location practices or in a scenario where the selling dentist(s) is a major producer and/or plays a major leadership role in the practice. In this scenario, the buyer typically pays the selling dentist 60-80% of the enterprise value of the practice in cash at closing, and the seller either retains a 20-40% ownership interest in their individual practice or exchanges the remaining equity in their individual practice for a diluted equity position in the DSO’s parent company. In both scenarios, the potential upside for the selling doctor is the ability to participate in future re-capitalization events (when the owner of the DSO sells all or a majority interest in the company to a new investor), whereby the seller has the ability to monetize a portion or all of their remaining equity at a much higher multiple of EBITDA than their original practice valuation. The financial risk for the seller is that if the DSO is unsuccessful in re-capitalizing the business at a significantly higher multiple (if at all), it can leave the seller with a potentially unmarketable asset when he/she is ready to exit the company or retire. Therefore, it is imperative for sellers to understand their personal risk tolerance, and investigate the reputation and current financial performance of the DSO (and that of their underlying investor), the company’s future goals and expectations, and the variables at play when the seller is ready to divest themselves of their remaining equity.
What to Expect During the Transition Process
The transition process in a DSO transaction is markedly different than that of a private buyer transaction. In a DSO transaction, the due diligence process is typically much more extensive than that of a private buyer transaction. The seller should be prepared to provide a DSO buyer with open access to all of their practice information, including their practice financials, bank statements, fee schedules, practice management software, employee information, vendor contracts, etc. Given the amount of information DSO’s require to complete their due diligence, it is often difficult for a distrustful or disorganized seller to make it through the due diligence process with a DSO buyer.
DSO’s are typically required to have a certain level of consistency from transaction to transaction in regards to their deal structure and legal agreements. Therefore, DSO buyers typically require the parties to utilize their legal agreements (Purchase Agreements, Transition Agreement, Employment Agreement, etc.) and will be less flexible in the negotiation of those contracts than private buyers. Given the complexity of these agreements, it’s imperative for sellers to engage the services of an experienced dental practice broker and dental attorney to facilitate the negotiation of the deal points and the legal documents associated with the sale.
What to Expect After the Sale
While you may be able to unlock a substantial amount of liquidity and freedom by selling to or partnering with a DSO, it’s important to understand that you are exchanging autonomy/control and a portion of your personal income in return for those benefits. Not all DSO’s are created equal. While some DSO’s take a “hands off” approach and leave your practice’s culture, clinical philosophy, staff, patient/payor mix, operating hours, etc. intact following closing, other DSO’s may take a more intrusive approach and look to substantially change your culture and systems immediately following closing or shortly thereafter. Therefore, it’s vital for you to do your due diligence on your potential DSO buyer/partner. Ask for references from several doctors who have sold or partnered with the DSO, call those doctors to ask questions, and discuss how their experience has been following the sale. Here are a few questions that you may want to ask the DSO and their doctor references:
- Are you partnered with a Private Equity Firm? If so, what is the name of the firm and when did they acquire an ownership interest in the company?
- What are your future plans for the company in regards to growth, re-capitalization events, etc.?
- How will you go about integrating and supporting my practice post-closing? What services does your centralized infrastructure provide (required or elective)?
- What benefits do you offer to your doctors and staff members?
- Do you plan to retain my staff?
- Will you assert any influence on my clinical philosophy or treatment planning?
- Will I have the ability to choose the supplies we purchase and the labs that we utilize?
- Are you planning to change the operating hours of the practice? If so, what are your expectations regarding my work schedule?
- Are you planning to change the practice management software? If so, when?
- Are you planning to change my payor mix (PPO’s, Medicaid, etc.)? If so, how?
Doctor Reference Questions:
- Did the DSO make any significant changes to your practice that caused problems for you or your team?
- Were you able to retain your practice culture and clinical philosophy post-closing?
- Has the performance of your practice improved or declined since the sale?
- Did you meet the requirements of your post-closing holdback/earn-out and were you paid 100% of the total purchase price? If not, why?
- What are your thoughts regarding the DSO’s management team on the corporate and local level?
- What do you like about this DSO? What would you like to change?
- If you were to go back in time, would you have sold your practice to this DSO?
It’s important to mention that the culture of a particular DSO can change over time. If the company has yet to partner with a private equity firm, there could be a shift in the company culture and/or operations following a liquidity event (the sale of a substantial interest in the company to a private equity firm). It’s also pertinent to mention that private equity firms typically re-capitalize their investment (provide a return to their investors) by selling a portion of their stake in the company to another investor (often another private equity firm) every 3-5 years. While liquidity events may be lucrative for selling doctors who retained an ownership interest in their individual office or re-invested/rolled equity into the DSO, each capitalization event can lead to changes in the company’s goals, culture, and operations.
Alternatives to Selling to a DSO
While most experts agree that the consolidation of the dental industry will continue for the foreseeable future, there will always be a place for private practice in the dental space. Patients who value personalized service and high quality dental care will continue to support private practices. However, it’s important to touch on the fact that, in order for the next generation of dentists to experience sustained success, they will need to be more astute from a business perspective and adapt to industry trends and patient needs/wants as they evolve. This may involve several iterations of private practice models, including:
- Group practices where several dentists combine their resources and talents to form large multi-doctor offices that can take advantage of the same economies of scale that DSO’s currently enjoy.
- Multi-specialty offices where all facets of dentistry are performed under one roof.
- High-end, boutique dental offices that focus on providing an unparalleled patient experience to fee-for-service patients who want the best service and dental care available in the marketplace.
While DSO transactions are currently generating a tremendous amount of buzz, doctor-to-doctor transactions are, and will continue to be, the most frequently utilized transition option. The demand for quality practice acquisition opportunities is expected to remain high due to the continuous supply of young dentists who want to control their own destiny and are not interested in working in a “corporate” setting. These transitions take various forms, including walk-away sales (which are still very common), phased transitions (the gradual sale of a practice to an associate), partnerships, and practice mergers.
Regardless of whether you choose to sell your practice to a DSO buyer or are looking to do a doctor-to-doctor transition, DON’T GO AT IT ALONE. It’s critical for you to engage the services of an experienced dental practice broker who can help you evaluate your options, craft a transition strategy to meet your personal and professional goals, and represent your best interests throughout the process.