Affiliating with a DSO is one of the most impactful decisions a practice owner will make in his or her career. Therefore, it is imperative that orthodontists get educated about the options available in today’s marketplace and make intentional, pragmatic decisions to ensure their objectives are fulfilled and life after the sale is enjoyable. If done properly, a DSO affiliation can be financially rewarding, unlock significant wealth creation opportunities, and improve both the seller’s quality of life and practice performance. However, significant adverse ramifications can occur if this process is not handled with deliberation and care, including financial hardship, loss of autonomy (both clinically and operationally), and decline in professional fulfillment. In this article, we explore the biggest mistakes orthodontists make when partnering with a DSO.
1. Responding to Unsolicited Offers/Failure to Create Competition
If you own a successful practice, we have no doubt that you have been inundated with direct mail, email blasts, cold calls, etc. from DSOs expressing an interest in purchasing your office. Most established DSOs have built an entire business development team focused exclusively on pursuing acquisition opportunities and courting potential sellers. In addition, many DSOs financially incentivize doctors to refer their colleagues in exchange for substantial referral fees. The goal of these solicitations is simple … to pique your interest and open the door to an initial conversation that eventually leads to you selling your practice without obtaining proper representation or “shopping around”. While a DSO affiliation may be a viable option and an unsolicited offer can seem attractive at first glance, it is important to acknowledge that DSO buyers are not altruistic in their approach. The truth is that DSOs want to buy your practice for the lowest valuation possible, which leads to higher returns for their private equity investors. You would do the same if you were in their shoes. That said, it has been eye-opening to see how much more DSO buyers are willing and able to pay for practices when they are put in a competitive situation and you have an experienced sell-side advisor negotiating on your behalf. Entertaining offers from multiple buyers also provides you with a clear perspective on the various options available and the ability to choose the right DSO for your practice from both an economic and fit perspective. The bottom line: If you fail to create a competitive environment for your practice and respond to an unsolicited offer, you will accept a lower valuation and leave deal terms on the table that you could have cultivated by taking a more thoughtful approach.
2. Selling to the Wrong DSO
We say this time and time again… “If you have met one DSO, you have met one DSO.” The consolidation of the dental industry has accelerated beyond anyone’s expectations in recent years. As a result, there are a multitude of new and established DSOs searching for practice acquisition opportunities, each with their own distinct history, culture, executive team, investors, infrastructure, management style, deal structure, financial outlook, etc. Some buyers have robust infrastructure while others have little to none. Certain buyers have a heavy hand from a managerial perspective while others are more hands-off. Many buyers offer the opportunity for the seller to retain/roll equity and participate in the financial upside of the business post-closing, while others don’t provide any wealth creation opportunities outside of the initial practice valuation. Each practice owner has unique personal and professional goals they want to achieve. Should a DSO affiliation make sense, defining those goals and choosing the right DSO partner who can help achieve them is critically important. As you can imagine, partnering with the wrong DSO can have grave consequences for you and your practice both economically and emotionally. Unfortunately, we hear stories all too often of a doctor who responded to an unsolicited offer and sold to a DSO without exploring their options, only to realize that a DSO sale was either not the right fit for their situation or their post-closing work environment was far from ideal (not to mention the practice likely sold for less than its true market value). All of this is to say … do your homework and evaluate your options so you are ultimately in the position to choose THE DSO that is the best fit for you and your practice.
3. Not Asking the Right Questions
The thought of partnering with a DSO is often met with quite a bit of trepidation from potential sellers, and rightly so. DSOs are sophisticated buyers, there are many options available, deal structures are complicated, and there is a lot on the line. Therefore, it is imperative for sellers to know the right questions to ask before and during the sales process. Here are just a few questions to ask prior to pursuing a DSO affiliation: What are my goals? What are my plans post-sale? What is my EBITDA? What is my practice worth from a DSO perspective? Is a DSO affiliation the right option for me and my practice? Here are several examples of questions to ask when interviewing potential buyers: How long am I required to continue working in the office post-closing? Will you rebrand my practice? Will my culture and team remain intact? Will you change the operating hours, payor mix, practice management software, etc.? What type of centralized services do you offer? How will you support my practice from a managerial and growth perspective?
The questions can get infinitely more complicated when discussing deal structures. For example: Are you purchasing a 100% interest or fractional interest in my office? Is there an equity component to the transaction? If so, am I retaining equity at the practice level (joint venture model) or rolling equity into stock in the DSO’s holding company?
- If doing a joint venture model (retaining equity at the practice level): What is the management fee being charged by the DSO before I receive my prorated share of net income distributions? Can I participate in future re-capitalization events? If so, in what manner? How can I divest myself of my remaining equity down the road?
- If considering an equity roll structure (investing in the DSO’s holding company stock): What is the price of the stock? When was the last re-capitalization (re-cap) event and when is the next re-cap event expected to occur? What is the projected return on my investment between now and the next re-cap event? Will I have the option to liquidate all or only a portion of my holding company stock at re-cap?
Selling to a DSO is far more complicated than it may seem on the surface. Therefore, it is essential to seek assistance from experienced professionals who know the right questions to ask and can guide you through the process.
4. Failure to Obtain Proper Representation
Failing to obtain proper representation is one of the most common mistakes we see practice owners make when pursuing a DSO sale. With so many DSO buyers looking to acquire practices and soliciting sellers directly, many practice owners feel they can navigate the sales process on their own and save themselves a commission. Unfortunately, that “savings” typically comes at an enormous cost. As we have outlined, the reality is that affiliating with a DSO is both a rewarding and treacherous journey that will have lasting implications for you and your practice. Therefore, the decision to partner with a DSO should not be taken lightly. Engaging an experienced sell-side advisor to serve as your advocate, protect your best interest, and help you navigate the process from start to finish is a fundamental element to achieving a successful result. Once you have accepted an offer, it is also critical to engage a dental attorney who has a significant amount of experience in handling DSO transactions and consult with your accountant to minimize the tax implications associated with the sale. At McLerran & Associates, we have spent a great deal of time developing and fine-tuning our process to ensure that our clients 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 available in the marketplace. Here are the steps involved:
- Evaluate your personal/professional goals and help you decide if a DSO affiliation is a viable option.
- Educate you regarding what DSOs are looking for, the different options and deal structures available, and what the practice sale/transition process will look like pre-and post-closing.
- Complete a detailed practice valuation to determine the EBITDA and market value of your office from a DSO/Private Equity perspective.
- Present the opportunity to potential buyers in a professional, confidential, and organized manner and address questions/concerns during the due diligence process.
- Control the narrative surrounding the EBITDA and value of your practice.
- Create a competitive environment among multiple buyers to ensure that you receive the highest price and best deal terms possible.
- Help you interview potential buyers to identify THE DSO that is the best fit for your office from a financial, infrastructural, and cultural perspective.
- 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 30% in their practice valuation and negotiated far better deal terms than they would have received by attempting to navigate the sale on their own.
5. Falling for a Gimmick
Leading up to and following the pandemic, an enormous amount of capital has been flowing into the dental industry (primarily from private equity investors), resulting in an inordinate level of M&A activity. With private equity entering our marketplace, along with it has come the arrival of many new opportunistic “advisors” looking to get in on the action and the advent of gimmicks designed to take advantage of orthodontists’ lack of knowledge in this arena. Here are a couple of examples:
- Buy-Side Advisors – A buy-side advisor is essentially an outsourced business development person (headhunter) who is paid a fee to introduce potential sellers to a particular DSO. These buy-side advisors often cold call doctors offering to help them with the sale of their practice at no charge, frequently operating under the guise of representing the seller when in fact they represent the buyer. Working with a buy-side advisor is akin to responding to an unsolicited offer and will inevitably ensure that you leave money, deal structure, and optionality (the ability to choose between multiple buyers) on the table.
- Roll-Up Concept – There are currently numerous brokers and dental cooperatives that are pitching sellers on the concept of coupling together individually owned practices with the goal of selling them as a group at a significantly higher EBITDA multiple than each office would fetch on their own. The reality is that private equity firms are comprised of savvy business people who have a responsibility to their investors to make sound decisions and can easily see through the thin veil of illusion created by this type of gimmick. While it is true that multi-location dental groups with substantial EBITDA will sell for higher EBITDA multiples than individual offices, it is important to note that buyers will only pay a premium when the offices are fully integrated and share a common brand, ownership, culture, patient mix, systems, etc. Therefore, trying to convince a DSO/Private Equity buyer to pay a higher EBITDA multiple for a loosely affiliated group of individually owned practices is a far-fetched proposition. Not to mention that this concept requires all owners within the “group” to sell at the same time, to the same buyer, at the same EBITDA multiple, and with the same deal structure. As you can imagine, this is a nearly insurmountable task and will not result in a favorable outcome for the parties involved.
Pursuing a DSO affiliation is a challenging and potentially rewarding endeavor that requires serious deliberation and a disciplined approach to the sales process to ensure that you maximize your return. The exciting news is that there are a multitude of viable options available and dental practice valuations have recently reached an all-time high. Therefore, it is an ideal time for successful practice owners to consider partnering with a DSO. Should you be interested in learning more about the options available in today’s marketplace and the value of your practice from a DSO perspective, we encourage you to reach out to McLerran & Associates to schedule a free, confidential consultation. We look forward to hearing from you!