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Tuesday, February 11th, 2020 | by

The Pros and Cons of Selling to a DSO

What is a self-respecting professional practice broker to say about the invasion of the dental industry by this no-longer-new business model? DSOs have taken a significant and growing percentage of the dental services industry, as detailed below. And while we all know the DSOs success has been punctured with controversy, significant clinical ethical lapses, and outright failure, one might also observe that taken as a whole, solo practitioners have had their share of the same. One might compare and debate the matters of degree, but in the final analysis it would be an academic exercise alone, because the model is here to stay.

Our industry is not a parallel to medicine. Physicians eschew the nightmare of insurance billings and astronomical technology costs difficult economies of scale and want rather to spend their time with patient care alone. On the other hand, solo practice and small group practice are perfectly viable business models in dental obviously and will remain so for the predictable future. The significantly higher incomes to solo dental practice owners versus employed dentists will ensure that DSOs won’t take over the industry. That said, the business of dentistry has gotten more intimidating these last twenty years or so, and a significant number of dentists young and old are choosing employment as opposed to ownership as a quality of life choice. Fifty percent or more of our graduating classes now are women as well, and they have been choosing for the most part to raise children first before stepping into ownership. This has allowed the DSO business model to be viable business model.

Of course, there is no stopping business progress that wants to happen. Perhaps the best we can do, then, is equip ourselves to address the concerns of our clients, and young dentists stepping into practice where we can, such that they can make informed choices of direction, and end up with transition and career results that best serve them.

A few words about DSOs

DSOs actually go by a number of different names: Dental Service Organizations, Dental Management Organizations, Dental Support Organizations, and variations on the theme. They provide practice management services which include marketing, employment and human resources, billing, accounting, regulatory compliance, lease negotiation, purchasing services, information technology, and negotiation of higher fees with PPOs.

Obviously, the American Dental Association and a few others have taken note of the phenomenon and commissioned a few studies. The statistics are telling. The California Dental Association recently reviewed1 the ADA’s proposed classifications and reported on the ADA statistics, and stated as follows:

The ADA’s Health Policy Resources Center released a research brief, A Proposed Classification of Dental Group Practices. The brief acknowledges that dentistry is a profession in transition with a growing number of large, multi-site group practices with changing character and structure. According to the ADA, group practices currently represent 5 percent of practices nationwide and are expected to grow to 20 percent by 2020.

A 2012 “Distribution of Dentists” survey supports the trend, revealing that the proportion of dentists who own practices dropped from 91 percent in 1991 to 84.8 percent in 2012, and the proportion of solo practitioners dropped during that same time period from 67 percent to 57.5 percent.

The ADA’s Health Policy Resource Center identified six basic types of group practices that indicate two or more dentists are somehow affiliated with each other. CDA plans to utilize the classification system in future communications with members to help in better understanding the dynamics of various practice models.

The classifications are as follows:

Dentist Owned and Operated Group Practice

An aggregation of a variable number and/or type of dentists in a single practice that may be located at single or multiple sites completely owned and operated by dentists, usually organized as a partnership or professional corporation.

Dental Management Organization Affiliated Group Practice

A group practice that has contracted with a dental management organization to conduct all of the business activities of the practice that do not involve the statutory practice of dentistry, sometimes including the ownership of the physical assets of the practice. There are several types of dental management organizations and there can be significant variations in the nature of the agreements between the dentist and the dental management organization. An example is Pacific Dental Services.

Insurer-Provider Group Practice

A group practice that is part of an organization that both ensures the health care of an enrolled population and also provides their health care services. An example is Kaiser Permanente Northwest.

Not-for-Profit Group Practice

A group practice that is operated by a charitable, educational or quasi-governmental organization that often focuses on providing treatment for disadvantaged populations or training health care professionals. An example is Apple Tree Dental.

Government Agency Group Practice

A group practice that is part of a government agency. It is organized and managed completely by the agency. All dentists are government employees or contractors and operate according to agency policies.

Hybrid Group Practice

A group practice that does not clearly fit into any of the above categories and can exhibit some characteristics of several of them.

The Oral Health Workforce Research Center, affiliate with the School of Public Health at the University at Albany, State of New York University, issued a report in 2017 with the following statistics2, which are telling:

In the period between 2002 and 2012, the number of firms (offices of dentists) with 50 to more than 1,000 employees increased from 284 to 438. The number of establishments (locations) operated by larger firms increased from 2,691 in 2002 to 5,485 in 2012. While the number of very large firms remains small, there was growth in the number of establishments/sites at which these firms operate. In 2002, 3 firms operated with more than 1,000 employees in 788 establishments. By 2012, 11 firms reported more than 1,000 employees working in 3,005 establishments.

We should note that in 2012 our nation was coming off the economic crisis. The Ontario Teacher’s Pension Fund at the end of 2012 purchaser and Heartland Dental for something like 11 x EBITDA. Keep in mind these practices were individually purchased for 3.5 to 4.5 x EBITDA. The stock value on a project overall was stunning to say the least. As they’ve grown, Heartland has changed hands a few more times, and each time with significant stock value increases though not to the degree as the initial. This dynamic has drawn private equity money to the dental industry like moths to the proverbial flame.

Today there are approximately 120 private equity backed DSOs in play in the US. Additionally, there are dental owned relatively small group practices structured as DSO’s in large numbers. Our experience of the dental owned “aggolomerators” as we have called them, is that more of them disintegrate than succeed. Many have had the plan to grow to 50 million or so and then sell to private equity for a one-time large profit. The margins prove so small over the process, however, and the financing and years of work involved prove so difficult, that the owners often discover it isn’t worth the opportunity cost.

The multiple dentist owned four of five practice groups aiming for higher ppo fees hybrid model does seem to have staying power in a number of markets – but that is a business model with a different intent. Those groups are a build and hold play. I received recently from a dentist with a large practice in one of the larger towns in Montana. He mentioned that he was among the last of the true fee for service practices left in town, and he was having a difficult time competing with the practice agglomerator groups. By virtue of the combined size of the group’s patient base, they had negotiated crown fees with Aetna of approximately $950. My client said when he checked into PPOs and called Aetna, the maximum crown fee they agreed to for his practice was $750.

Most DSOs have discovered that they need to purchase only practices with collections of approximately one million per year to hit a viable economy of scale. A practice collecting $700,00 today, for example, run with associates only and no owner-operator, will lose money for the owners. Additionally, DSOs want to purchase only practices in areas where they can readily attract dentists to employ. Most DSOs will not purchase or allow Medicaid work in their model, additionally, which is not to say there are not DSOs who do Medicaid by any means.

So, what are the fundamental issues in play for a seller here? Let’s start by looking at what we might call the “typical” DSO transition proposal. We can look at our transition of Dr. P’s large dental practice, which he was selling in order to retire. Dr. P had a very large office facility in one of the more desirable suburbs of Portland. His collections were approximately $950,000 annual. The facility was about 4,000 s.f., with 10 ops of nice Adec equipment. In our first meeting, Dr. P explained that Gentle Dental needed a larger space and had offered him $1,000,000 even for the practice. At that time in our market practices were typically selling for 75% to 80% of recent annual. I told Dr. P “wos” about that offer and he should take it because I couldn’t get that much. But then he explained the sale was on condition that he stay and work for 27% of production for three years. And of course, Dr. P recognized that million-dollar offer wasn’t really a million dollar offer in that case. I told him to just work another three years and then let me sell the practice and he would be far ahead. He really did want to just retire though and we sold the practice for him that year for something like 85% of collections.

So how does this work, then? Why would anyone sell to a large DSO? How are DSOs today getting around this concern? And given the thin margins on non-dentist owner practices, why is there such an aggressive push by private equity into this area?

Turns out, in the now “typical” DSO model, for the seller, it’s all about the stock. In the Heartland model, they figured out that they could incentivize the large solo practice owner by allowing them to participate in the larger play. We can run through a sale our company recently completed to illustrate how that works.

Again, the practice in this case is in a desirable SW suburb of Portland, Oregon. The office has 9 ops, collected about 3.6 last year and was online to collect 3.9 this year. The closing was in September. Total remuneration to the partners was 3.7 million not counting accounts receivable, and the Sellers are obligated to stay for three to five years. They are compensated approximately 30% of collections, and some of the 3.7 total will be paid out as the associate period completes. And again, one would initially ask, why would they bother with this model given the pay reduction. The answer is that for a dentist approaching the end of their career, the stock incentive aspect actually makes the model make sense. Here’s the play: the partners were allowed to purchase approximately $550,000 in stock. The DSO purchases the practice for approximately four times EBITDA, calculated after paying selling dentist projected wages. When the DSO operations reach one hundred fifty million in total, they will sell for 12 to 13x EBITDA. In this model, if it works, the seller’s $550,000 in stock will become $1,650,000. The documents are written up such that they can let their stock remain through the next turn. That is to say, Heartland for example has turned another couple of times after the initial sale to private equity. While the second turn after continued growth won’t yield a tripling of stock value again, it is nevertheless significant. The $1,650,000 would reasonably be worth well over $2,000,000. The early participators in the Heartland project realized an extraordinary gain.

Is this now a viable model for any owner of a large solo practice? Probably not. But for someone approaching retirement? Very possibly. For a young owner, the time involved with growing a practice and the opportunity cost of selling and being employed for three to five years and then trying it again, in our estimation makes no sense. The opportunity cost on something like this for them would be staggering in almost every market. When we run the numbers, they are far ahead by holding their own practice and staying put for a normal career.

Then too there is that issue the play, after all, is in stock. What if it doesn’t work? Today the variety in professionalism and wherewithal of the various DSO players out there are as varied as any large class of dental school graduates. Who do you partner up with? Be careful. Without the stock play, it’s hard to see the program make sense, in our estimation. And for a DSO that has already changed hands a couple of times, the stock history seen in the initial growth and sale is not going to be repeated.

In our review of practice models, for the enterprising and ambitious dentist, the most lucrative and quality of life in practice model is the model where one dentist owns one large office and employs one or two associates. Of course, to each his own. But certainly, from an income perspective, this is the model that virtually every dentist we have worked with enjoys.

Lastly, there is the question of where does the DSO play end up in the long term? Barring significant changes in insurance dynamics and radical clinical advances, what is predictable is the DSOs will max out exactly at the level allowed by the number of dentists in the marketplace willing to work for them as employees. This stock play during the “corporate rollup,” as they call it, can’t continue long term. This is a unique window of time.

In our Pacific Northwest market, a typical solo practice collecting 1.2 million will run with an overhead of 62%, and net out then over $400,000/yr. There are a very few very highly paid employed dentists who may break the $300,000/year income level, by comparison. A typical associate in the vicinity of the low to mid $200,000’s/yr. The “typical” owner vs “typical” employee incomes are far too disparate for the DSOs to take the majority of the market.

Obviously, an abundance of variables in market dynamics make any predictions difficult in our industry. Given present day constraints, however, it’s hard to see where corporate dentistry will proceed to take the majority of the market. There just isn’t the value there in placing a corporate interest in between the dentist and the patient. Corporate economies of scale have thus far not translated to sufficient benefits or cost savings to the patient. Nor have the incomes of employed dentists approached the incomes of dentist owners. DSO’s will continue to provide quality places of employment for dentists electing for that lifestyle for whatever reason. But overall, as long as the disparity in dentist income holds, it’s hard to see how DSO’s will displace the solo practice model.

Joe Consani, Consani Associates, Ltd. Joe has over 20 years of experience in sales and management and has been brokering dental practices since 1997. He has significant expertise in the valuation and sale of specialty practices and has facilitated numerous specialty practice sales.
www.mydentalbroker.com
866.348.3810
joe@mydentalbroker.com

1 https://iframe.cda.org/news-events/cda-explains-new-ada-classifications-of-dental-group-practices
2 http://www.oralhealthworkforce.org/past-projects/


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