This article is written by this months guest author: Director of Mergers & Acquisitions at McLerran & Associates (and friend of BWDA) Andrew Kobylski, CFP.
As sell-side advisors, we spend a significant amount of time educating our clients regarding their practice transition options, which often involves weighing the benefits and risks of selling to a private buyer (individual dentist) versus affiliating with a DSO. In this article, we exam the pros and cons of each option.
Selling to a Private Buyer
Over the past 35 years, McLerran & Associates has facilitated the sale of over 1,000 dental practices to private buyers. This traditional method of monetizing and transitioning the ownership of a dental practice has been and will continue to be a viable option for private practice owners, as there are ample qualified young dentists eager to purchase established practices with solid profitability. We typically see the highest level of demand and valuations from a private buyer perspective for practices with the following characteristics:
· General Dentistry and all Dental Specialties
· Located within 60 miles of a Major Metro Area
· Established Practices with a Large Active Patient Base (or referral base)
· Annual Revenue of $800,000+
· Net Cash Flow of $300,000+ (prior to doctor compensation and debt service)
· 4+ Operatories
· Updated Equipment/Technology
Now that we have touched on the factors that are most important to private buyers when evaluating practice acquisition opportunities, let’s dive into the pros and cons of selling your practice to another dentist:
Pros of Selling to a Private Buyer
- 100% Cash at Closing – The seller typically receives 100% cash at closing (no seller notes, earnouts, holdbacks, equity component, etc.).
- Short Term Transition – Most private buyer deals involve a short-term transition whereby the seller provides the buyer with 2-6 weeks of transitional assistance and does not work chairside following closing.
- Simplicity of Deal Structure & Legal Agreements – A private buyer sale is much more simplistic than a DSO affiliation, as the seller typically receives 100% cash at closing and can exit the practice in short order. As a result, the deal structure and legal agreements are straightforward and far less complex than that of a DSO transaction.
- Perception of Minimal Change – Sellers typically have the perception their practice will experience less change with a private buyer transition than a DSO affiliation. However, the opposite is often the case. While we advise buying dentists not to make significant changes to the practice for at least 6-12 months following the sale, private buyers are typically at a different stage of their life/career (compared to selling dentists) and have strong ideas of where they want to take the business, which may conflict with the past trajectory and culture of the business and therefore require significant change to accomplish the new owners’ goals.
Cons of Selling to a Private Buyer
- Lower Practice Valuation – Private buyers typically value practices based upon a percentage of annual revenue (60-100%) and a multiple of net cash flow before owner compensation and debt service (1.5-3.0X), while DSO buyers value practices based solely on a multiple of EBITDA. For example, a practice with annual revenue of $1.5 million, net cash flow of $600,000, and EBITDA of $300,000, will be valued at approximately $1.3 million from a private buyer perspective compared to $1.8 million from a DSO perspective. This valuation gap increases exponentially once annual revenue crosses $2.5 million, and EBITDA reaches $500,000+.
- Difficulty in Finding the Right Buyer – Finding a buyer who is the right fit for your practice can be challenging, as there are many factors that come into play, including demographics, experience, skill set, communication skills, ability to qualify for financing, etc. It’s also important to mention that the private buyer pool tends to shrink when practice revenue reaches $2.0 million and/or the seller’s skill set and production level is difficult to replicate.
- Inability to Continue Working in Your Practice Following the Sale – Private buyers are typically looking to become the primary producer immediately following the sale, leaving little opportunity for the seller to continue working in the practice long-term (especially in practices that are not large enough to support two providers or where there is a personality conflict between the buyer and seller).
Affiliating with a DSO
While private buyers are looking to purchase practices of all shapes and sizes, DSOs have specific criteria they are looking for when it comes to identifying viable acquisition opportunities, which include:
· General Dentistry and all Dental Specialties
· Located within 60 miles of a Major Metro Area
· Annual Revenue of $1.5 million+
· EBITDA of $300,000+
· 5+ Operatories
· Owners and/or Associate Doctors willing and able to continue working chairside for 3-5 years
Assuming your practice meets the above qualifications, it makes sense to evaluate the pros and cons of selling to an individual dentist compared to partnering with a DSO.
Pros of Affiliating with a DSO
- Higher Practice Valuation – Practices that trade for valuations in the range of 80-100% of revenue in a private buyer sale can easily be valued at 150%-300% of revenue in a DSO affiliation. This valuation gap is one of the main reasons large practice owners are choosing to affiliate with a DSO rather than monetize their business in a traditional sale to a private buyer.
- Ability to Continue Working in your Practice Long-Term – DSOs typically require the seller and/or associate doctors to continue working for 3-5 years following closing. While some dentists may see this as an inconvenience, many of our DSO clients want to continue working in their office long-term.
- Wealth Creation Opportunities – Most DSO deal structures involve some sort of equity component, whether it be joint venture equity (retained equity in your own practice), holding company equity (stock in the DSO’s parent company), or a combination of both forms of equity. DSOs are typically valued at a much higher EBITDA multiple than individual practices. Therefore, the value of the equity component has the potential to appreciate significantly in the years following the sale and create a secondary liquidity event with a handsome return on invested capital if and when your DSO partner reaches a recapitalization event (when the current financial sponsor of the DSO sells the company to another investor).
- Operational Support – Many of our DSO clients are tired of dealing with the headaches of managing the business and seeking a DSO affiliation to obtain operational support and a better work/life balance. Most DSOs have significant infrastructure designed to support their partner practices from an administrative perspective, including doctor and staff recruiting, payroll and benefits administration, procurement, bookkeeping/accounting, payables, legal and compliance, marketing, etc.
- Access to Economies of Scale – DSOs can leverage their size to fight some of the headwinds that private practice is facing, including negotiating better reimbursement rates with payors (PPOs) and better pricing with vendors (particularly when it comes to dental supplies, equipment, and benefits).
Cons of Affiliating with a DSO
- More Complex Deal Structure – DSO deal structures are typically far more complex than that of private buyer sales. Most DSO affiliations consist of 51-70% cash at closing with the remainder of the deal being comprised of an equity component, earnout, or combination of the two.
- Requirement to Stay on for 3-5 Years Following Closing – DSOs require the seller and/or associate doctors to commit to working in the business for 3-5 years following closing to preserve the continuity of patient care/relationships, culture, and financial performance of the business. For some doctors, this is an inconvenience, while others consider it to be a benefit.
- Perceived Loss of Autonomy – Many of our DSO clients are concerned about losing their clinical and operational autonomy following closing. The reality is that most DSOs are seeking to partner with great businesses and excellent clinicians, stay out of their way from a clinical perspective, and support them behind the veil from an administrative perspective.
- Risk Associated with Equity Component – As previously mentioned, the vast majority of DSO transactions will involve an equity component. While that equity offers the opportunity for significant appreciation, there is also risk associated with the equity depreciating in value and/or the inability to liquidate the equity should your DSO buyer not be successful in accomplishing their financial goals.
The key to a successful practice transition is to get educated regarding the value of your practice (from both a private buyer and DSO perspective) and understand all the transition options available to you. At McLerran & Associates, we serve as your sell-side advisor and advocate. Our proven practice transition process is designed to provide you with the information, optionality, and leverage necessary to make informed decisions, find the right buyer for your practice, and maximize your outcome at time of sale. If you are considering a sale within the next 5 years, we encourage you to reach out to our team to schedule a confidential Discovery Call to discuss your goals and how we can help you achieve them.
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