August 19, 2023

Rolling the Dice – The Risk of Selling to Private Equity Firms (Part 2)

By Spencer Wesley, Realtor®, Dental Practice Broker

In my last blog I highlighted some of the risks dentists face when selling their practices to Dental Service Organizations (DSO). In this blog I’ll provide some context so business owners who’ve been approached by DSOs have a better understanding of the market. To be clear, not all DSOs are the same. For some dentists, selling your practice to a well-run DSO could be a good option. This blog focuses on corporate DSOs financed by private equity firms. If you’re negotiating with an entity that fits that description, I want to make sure you know what you’re getting into and are comfortable with the risks.

Private Equity & DSOs – A Symbiotic Relationship

DSOs got their start in the 1990s as a way to separate the clinical and nonclinical parts of a dental practice. The idea was to have business experts deal with things like negotiating contracts with landlords, managing employees, and purchasing supplies, thereby freeing up dentists to focus on patient care.

Around that same time, Private Equity firms (PE) were gaining popularity in the financial world, attracting more and more investment dollars. Just in the last decade, PE assets grew by more than $4 trillion (that’s trillion with a ‘t’). These are funds in search of good investments, and dental practices became a prime option. In 2017, Bloomberg reported that the overall market for dental services was around $73 billion. A huge market like that is a big draw for PE dollars.

In keeping with the corporate practice of medicine doctrine, most states require a practice to be owned and operated by someone with a dental license. But the DSO model opened up new opportunities for PE firms to buy practices while following the letter, if not the spirit, of the law.

PE Firms Focus on Maximizing Value for Resale

PE investment in DSOs caught the attention of the Academy of General Dentistry (AGD) and in 2013 it appointed a task force to investigate their impact on the industry. The result was a white paper which characterized “corporate dentistry” as practices under the umbrella of DSOs that are owned by PE firms. The report didn’t sugarcoat the fact that PE firms are in it for the money and the executive summary listed the kinds of changes PE firms make in order to turn around and sell a practice at a profit. “The outside equity firm’s interest is in maximizing the enterprise value of the acquisition in order to make it attractive for sale. The management company drives production expectations; controls the vendors used, the quantity of supplies and the equipment used; and may have final approval on hiring decisions,” (see page 4, “Investigative Report on the Corporate Practice of Dentistry,”).

In the years since the AGD whitepaper was published, the flow of PE cash into dental practices has exploded. PE firms need volume and are willing to pay for it. It’s not unusual to see a general dental practice selling for 100% of annual gross revenue. PE firms will buy practices for 100% of gross with the expectation of selling the company for 300% to 400% of gross. In an over-heated market, valuations can become pretty frothy, driving the creation of a bubble.

One thing that could burst the bubble is legislation currently being considered in California, where legislators have raised concerns about the rapid growth of DSOs. California tends to lead the way for legislation like this, which could have a major impact on the broader market.

What Happens When a Practice Gets Resold

The most important point I want to make is this: if you sell your practice to a DSO, when that DSO bundles up your practice with others for resale, the new PE firm might not go along with the original terms of your contract agreement. The new DSO will have its own requirements, which may include extending the length of your contract, increasing productivity requirements, decreasing costs, and may even revisit future payment commitments. Even though changes aren’t supposed to impact treatment plans, they usually do.

In my next blog, I’ll offer some tips for finding out what’s really in a contract agreement before you sign it.

The exponential growth of DSOs is something the industry has never seen before, so there is no reliable trail to follow. The good news is that nobody has more experience with transitioning practices than Engage Ownership Transitioning. If you have questions, give us a call and we’ll get you answers you can trust.