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Tuesday, February 11th, 2020 | by

The Advantages and Disadvantages of Selling to a DSO: A Case Study

What are 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 dental practice management and administrative services including marketing, human resources, billing, accounting, regulatory compliance, lease negotiation, and purchasing services.

The DSO Model

The DSO model can fundamentally cause issues for the Seller. Turns out, in the now “typical” DSO model, for the seller, it’s all about the stock.Some questions a seller might ask are:

How does selling to a DSO work?

Why would anyone sell to a large DSO?

Why is there such an aggressive push by private equity into this area?

 

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.

The Number of DSOs Have Increased Since 2002

The Oral Health Workforce Research Center issued a report in 2017 with the following statistics:

Between 2002 and 2012, the number of dental practices with 50-1,000 employees increased from 284 to 438. The number of dental practices operated by larger firms increased from 2,691 in 2002 to 5,485 in 2012.

Advantages of Joining a DSO

DSOs have taken a significant and growing percentage of the dental services industry. While DSOs’ success has been punctured with controversy, including clinical ethical lapses, and outright failure, Solo practitioners have had their share of the same.

Physicians eschew the nightmare of insurance billings and astronomical technology costs with difficult economies of scale and prefer 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 and will remain so for the predictable future. While solo practice owners typically have higher incomes than employed dentists, the dentistry business has become more intimidating over time, and many are choosing DSO’s as a quality of life choice.

Disadvantages of Joining a DSO

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.

Video: The Private Practice/DSO Dilemma

Case Study:

The DSO Transition Proposal

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 income. I told encouraged Dr. P to take the offer, then he explained the sale was on condition that he stay and work for 27% of production for three years. Dr. P recognized that million-dollar offer wasn’t really a million dollar offer in that case. I suggested he continue to work for another three years and then sell the dental practice, however he really wanted to retire. We sold the practice for him that year for about 85% of collections.

We should note that in 2012, the United States was coming off an economic crisis. The Ontario Teacher’s Pension Fund at the end of 2012 purchased 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.

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. Again, the practice in this case is in a desirable SW suburb of Portland, Oregon. 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.

Why They Agreed to the DSO Proposal

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.

 

What if Selling to a DSO Fails?

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.

 

What are the Long-Term Effects of a DSO-owned Practice?

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.

 

The Future of the Dental Industry

Obviously, an abundance of variables in market dynamics make any predictions difficult in the dental industry. Given present day constraints, however, it’s hard to see where corporate dentistry will proceed to take the majority of the market. 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.

Of course, there is no stopping business progress. Perhaps the best we can do is to continue to make informed decisions and find dental transition and career results that are the best fit.

 

Joe Consani 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. Consani Associates, Ltd.

Sources:

1 Everett J. The necessity of accountability and ethics in Dental Service Organizations. Dent Hypotheses 2015;6:159-60

2 http://www.oralhealthworkforce.org/past-projects/


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