DSO Acquisitions

Transcript performed by A.I. Please excuse the typos.
00:00
typically for practices with revenue of two million or more, ideally EBITDA of 500,000 or more, that’s where you see the higher multiples, that’s where you see the six, the seven, the eight, the nine X multiples. Oftentimes what we see is a DSO will dangle the carrot of a sexy EBITDA multiple. They’re gonna try to convince you your EBITDA’s lower than it is so that they can buy low. The devil is in the details.

00:26
This is Dental All-Stars, where we bring you the best in dentistry on marketing, management and training.

00:35
Welcome to Dental All-Stars. I’m Alex Nottingham, founder and CEO of All-Stars Dental Academy. And with me is Brennan Munakrief, the CEO of McLaren and Associates, a practice transitions company. And we’re talking about DSO acquisitions. Welcome, Brennan. Thank you. Good to see you, Alex. Yeah. So this is part two of our first part. We talked about practice valuations. want to detail about that.

01:03
specifically for private valuations and how private practitioners are selling their practices and private practices are buying their practices. And then we had time where we talking about, now let’s talk about DSOs. And that’s a whole nother space or discussion. So I wanted to dedicate this podcast to DSOs, all things DSOs, DSO acquisitions. So tell me why is it, I guess we’ll go right, grow right to it.

01:33
Do I want to go right to it? Yeah, we’ll go right to it because I really like when we spoke about it This was fun about a podcast like what I feel like so on the last podcast Okay, and it’s a really good one. You talk about valuations and it might come up again in our discussion We’re not gonna rehash it because I want you to go back because there’s really good on How do we value a practice and you gave? Multiple methods which I think were really helpful. So let’s not rehash this so I want to go right into it Brandon

02:02
why are so many large practices or practice owners choosing to affiliate with DSO? So let’s start with that. Yeah, absolutely. So just to give a little context as to where we sit in the marketplace, we provide sell-side advisory to large practice owners that are looking to monetize their business, whether they’re looking to sell to a private buyer, as we discussed last time, or looking to go down the DSO private equity route.

02:30
Clients come to us with a myriad of reasons as to why they’re interested in affiliating with the DSO. There’s a few that are toppled lists though. So DSOs typically assign a higher valuation to a practice than private buyers do. DSOs look at valuation through the lens of a multiple of EBITDA. So for instance, let’s take a $2 million top line revenue practice with EBITDA of 500,000.

03:00
In the private buyer world, that practice might trade on a good day for somewhere in the range of 1.6 to 1.8 million. In the DSO world, it’s gonna trade for a multiple of EBITDA, and that multiple of EBITDA could be somewhere in the range of six to seven times EBITDA. So you could be looking at anywhere from three million to three and a half million valuation in the DSO world compared to about half that. Typically for practices with revenue,

03:30
of two million or more, ideally EBITDA of 500,000 or more, that’s where you see the higher multiples, that’s where you see the six, the seven, the eight, the nine X multiples. That makes sense. And I will say, you use the word bifurcation, I think that’s a word of the day for everyone, we’ll look that up, that’s a very good word. Well done with that. So tell me about the, let’s see, I guess we’ll go back to valuation. So how do,

04:00
DSOs evaluate the practice. So like you said in that they’re looking for those and that said earlier there’s a split between private buyers that over 2 million or whatever multiple providers buy for kid yes and and and key man risk which makes a lot of sense that they don’t want to rely on one person the doctor if something fails and you know it or Everybody wants that that that doctor that can be a problem. That’s why often very specialized

04:30
Dentistry cosmetic dentistry can be a problem because it’s very personnel personality driven They’re looking for the bread and butter. It’s a business So so tell me about the valuations of DSOs and maybe how it compares to private practice Yeah, so DSOs look at valuation through the lens of a multiple of EBITDA So even it stands for earnings before interest taxes depreciation and amortization But think of EBITDA as absentee on a profit

04:59
So pretend that you didn’t work chair side in your practice and you had to pay another doctor to do all the dentistry. After you pay the overhead and pay doctors to do the dentistry, how much profit is left over for the absentee owner? Because as a corporate entity that owns a practice, are technically an absentee owner, you’re not drawing a wage. So a lot of what we do is make sure that we’re controlling the narrative regarding EBITDA. So we take revenue.

05:29
minus true overhead expenses after accounting for any non-cash expenses like depreciation and amortization, after accounting for any personal or discretionary expenses that you’re writing off through your business, like your car, meals, travel, things of that nature. Looking at any non-recurring one-time expenses, such as let’s say you bought a cone beam or you renovated your office, we would add back those overhead expenses because they’re non-recurring.

05:57
And then looking at any overhead expenses that would be eliminated via leveraging the DSO’s infrastructure, like accounting or legal compliance consulting, whatever that might be. You gotta first start with an accurate EBITDA calculation and then apply an appropriate more. Oh, so they remove those in their calculation because they’re gonna absorb them. Well, we…

06:23
Remu do, oh, so again, you’re representing dentists and hey, I know what you’re doing. We’re not gonna count that because you already have a legal and accounting department that’s spread and economy’s a scale here. Okay, so you’re able to work the DSO a little bit with respect to that. Absolutely, so EBITDA should be objective, the reality here is very objective. And a lot of the value that we provide to our clients is controlling that narrative regarding EBITDA because every dollar of EBITDA

06:53
is worth six to nine dollars in practice value. Because as I said, you calculate the EBITDA first and then you apply an appropriate multiple to that EBITDA to ultimately arrive at the valuation. The number one way that DSOs are opportunistic is they wanna do a deal in the dark. They don’t want somebody like me at the table. They don’t want you to have a self-advisor. They don’t want your CPA involved. They don’t really want your attorney involved. They want to get to you before we get to you.

07:22
Sure, that they want to control the narrative regarding EBITDA. They want to buy low and sell high. That’s the name of the game. So oftentimes what happens is we’re contacted by a doctor that’s got a letter of intent from a DSO. How did they get a hold of that DSO? Typically what happens is their colleague down the street sold that DSO and then introduced them to the DSO they partnered with. They fail to disclose that they’re going to get a handsome referral fee if you partner with that DSO and your deal ultimately closes.

07:51
but they rave about the experience they’ve had with this DSO. You need to talk to them. And they introduce you to the business development person and you start what you think is a rather casual conversation and it quickly ends up with an offer in hand. Well, we always tell docs, hey, press pause on that conversation. Allow us to do an objective EBIT analysis and gut check the EBIT calculation that the DSO has come up with because that’s what their offer’s predicated on.

08:18
Oftentimes what we see is a DSO will dangle the carrot of a sexy EBITDA multiple. So they’ll say, hey doc, your EBITDA is 400,000. We’re gonna give you a seven times EBITDA multiple. We’re gonna give you a 2.8 million dollar valuation on your business. And 7X, I mean that’s as good as you’re gonna get in the marketplace. So no reason to call Brandon and his team. No reason to shop the deal. And we say, hold on, press pause. Let us do an EBITDA analysis and we find out.

08:46
that EBITDA is actually 600,000, not 400,000. And at a $2.8 million valuation, they’re not even at a five X EBITDA multiple. So they’re opportunistic. They’re gonna try to convince you your EBITDA is lower than it is so that they can buy low. And our job is to hold their feet to the fire, control that narrative regarding EBITDA, and then create a competitive environment. Essentially create a bidding war for your practice to give you…

09:13
as much optionality and perspective as possible, right? You need to date around. You need to understand all the options available in the marketplace to make sure you find the right fit and then leverage that competition to maximize the economic outcome. So, controlling narrative regarding EBITDA is huge, huge benefit that we bring to our clients. I feel like half of our day is spent arguing with DSO buyers about EBITDA on behalf of our clients. Not to mention the devils in the details too.

09:43
After terms of how things vest and what they want from you and so on. So you, you, you, gotta get representation. Uh, you know, I hear they don’t want an attorney and that scares me because, um, it may not be a proper deal because you have a heavyweight versus a lightweight dentists don’t typically know. So always get representation. Um, and obviously you guys are great at that. That’s what we’re talking about it. Okay. So what would you, cause that we kind of round out this podcast while we got so much in.

10:13
in a short period of time, I love it. how would you, these are my last two questions I have for you, and you got this down. So what have you seen as major changes over the past few years of DSOs? I know you mentioned 1.0 versus 2.0, but you can expand about that. And lastly, what would you say the key differences are in selling to a DSO versus private? Great questions. So as far as changes that we’ve seen in the DSO landscape over the past few years, I’ll just kind of give you a quick history lesson on

10:42
the evolution of the consolidation. We talked a little about the evolution from DSO 1.0 to DSO 2.0. Today, I think going the DSO route is a much more legitimate option than it was seven, 10, 15 years ago. So that’s been one marked change. But dentistry was arguably one of the highest verticals that private equity was investing in pre-COVID. Dentistry is recession proof.

11:09
And it’s a highly fragmented marketplace that can benefit from organization, leveraging economies of scale to increase reimbursement rates from payers and decrease pricing from vendors. It’s kind of a perfect fit for the type of industries that private equity invest in. So private equity loved dentistry going into COVID. Dentistry rebounded as fast or faster than any other healthcare vertical practices following COVID.

11:37
Practices were closed for 30 to 90 days, but depending on what state your practice was located in. But when practices reopened, they rebounded super quick. And I think that’s a product of the fact that dentistry is way ahead of the curve when it comes to sterilization and airborne illness. And most dentists have a great level of trust with their patients. So patients came back very quickly post-COVID. So there were a lot of DSOs that were already

12:07
buying practices leading up to COVID, they doubled down and started buying practices at an even faster clip in 21 and 22. There were a lot of private equity firms that were eyeing an investment in dentistry that pulled the trigger immediately post-COVID, bought a platform and started building a DSO. So the number of DSOs doubled overnight post-COVID. And as a result of a huge increase in demand and relatively consistent supply, as far as practice owners looking to monetize their business goes,

12:37
Valuations increased by about 40 to 50 % from 2019 to 2022. So was a great time to be a seller in 21 and 22. I think that’s about as frothy as the market has ever been and ever will be. But come 2023, interest rates doubled almost overnight. And private equity firms use a lot of leverage to fuel the growth of these businesses. So interest rates,

13:07
play havoc with their cash flow and their success rate. Combine that with the fact that many of the DSOs were rather undisciplined in 21 and 22. They were buying every practice they could get their hands on, doing very little diligence. They were not really integrating and operating the businesses that they were acquiring. You combine that with the elevated interest rate environment and some DSOs found themselves in trouble over the past 24 months.

13:36
They were either on their heels, know, operationally or financially. Maybe they weren’t buying practices anymore. There were other DSOs that were built on a very strong foundation that were not behaving irresponsibly in 21 and 22. And they’ve kind of stayed steady Eddie over the past 24 months. And then there’s smaller emerging DSOs that took on private equity capital more recently. They kind of stepped in to fill the void that some of those legacy DSOs that were on the sidelines left in the marketplace.

14:06
But all in, what’s happened is over the past 24 months, recaps were either delayed or muted. A lot of DSOs were focused on kind of getting their shop in order after a crazy level of M &A activity in 21 and 22. And now we’ve seen that valuations have cooled slightly, comparative to where they were in 21 and 22. I would say as a whole, valuations have come down about one turn of EBITDA across the board.

14:35
still operating in an elevated valuation environment comparative to pre-COVID, still a great time to be a seller of a large practice that’s looking to go the DSO route, but the market’s just not as frothy as it was in 21 and 22. Thankfully, we’ve now entered a little bit more favorable macroeconomic climate. We’re in a declining interest rate environment. The capital markets are starting to open back up. We’ve seen multiple recapitalization events.

15:02
in the first quarter of 2025 at good returns on invested capital. And I think you’re gonna see that continue over the next six to 18 months. So it’s been interesting to kind of watch the evolution of the M &A activity in the DSO side of our space. I mean, that’s the sandbox we play in every day. So we’ve been right in the middle of that storm. But the reality is we’re still getting amazing results for our clients that wanna go.

15:31
down that path if they want to go to market today. don’t know why when you said it’s interest-ing, interest, I don’t know, it just popped up in me, it’s all about interest. kind of towards the conclusion, kind of wrapping up this podcast as well as part one, how would you kind of summarize the key differences between selling to a DSO versus a private buyer? So they’re very different, right? When we’re…

16:00
looking at valuation, we always try to educate our clients, hey, here’s what your business is worth if you sold to another clinician in the private buyer world. Here’s what your business is worth if you sell to a DSO, and here are the key differences. So one, obviously, we’ve talked about the difference in valuation, especially as a practice gets larger, there’s a pretty big delta between a private buyer evaluation and a DSO valuation. However, a private buyer deal is relatively simplistic.

16:29
it’s typically 100 % or close to 100 % cash at closing. So the deal structure is very straightforward. DSO transactions have a lot more structure and a lot more nuance. You’re gonna look at getting somewhere in the range of 50 to 70 % of the valuation and cash at close, and then the remainder is going to be some form of equity, whether that’s retained equity in your own business, what we call joint venture equity, or stock in the DSO’s holding company.

16:59
what we call hold co-equity, or a combination of the two. And there may be some type of earn out or seller note or preferred equity component, but the deals have a lot more nuance. So like you said earlier, the devil is in the details. And in a private buyer deal, typically you’re gonna be looking at limited post-closing involvement. You you might stay on for a month, you might stay on for six months, maybe max a year, whereas in the DSO world, they’re looking for a long-term commitment.

17:28
likely a three to five year post-closing commitment. Now that doesn’t mean that you have to continue working chair side full time for five years, it just means that they want you to have a vested interest in the performance of that business for an ongoing basis. So those are the three primary differences, the gap in valuation between each of those worlds, the difference in the structure with the DSO deals being much more structured, much more nuanced, and

17:57
the post-closing commitment is substantial in the DSO world compared to a private buyer sale. So typically if I want out and I don’t want any details, whatever, I might be better out on the private front. And if I’m 2 million or under, then I might get a similar evaluation. Still would be good to work with guys like you, companies like yourself. But as the multiples get higher or as the size gets higher, as the potential opportunity cost gets higher, then the DSOs

18:26
You know are a better front but it’s more it’s a business decision and there’ll be some strings attached Because they are hedging another word we didn’t put in here. They’re hedging their risk Right with respect to what they’re doing. They’re not they’re not gonna go all in they don’t want they want some insurance with respect to that So that makes a lot of sense. I really appreciate Brennan the education just in like if you combine these two podcasts is about an hour, but it’s such a great education So for those that are listening

18:56
If they wanna learn more about you and your company, just tell me a little bit about your company, who do you serve? How does one get in touch with you? Tell me, at what it will cost. We serve dentists and dental specialists all across the country. Our headquarters is, that’s where I live, based in Austin, Texas. We have an office in Atlanta as well as an office in LA. So whatever specialty you’re into, whatever size practice you have, our team can absolutely help you. Whether you wanna go the private buyer route,

19:26
whether you wanna go the DSO route, or you’re simply interested about what is my business worth and what are the strengths and weaknesses and what do need to work on to reverse engineer the goal that you ultimately want to achieve. With every doctor, we start with a 30 minute casual confidential discovery call with me, just to get to know each other and see if it makes sense to do a deep dive, see if it makes sense to quantify your options, quantify what your business is worth. And DOS can reach directly out to me. Normally I say, hey, shoot me a text.

19:56
and we can schedule a time to talk. My cell phone number is 512-660-8505 or you can shoot me an email at brannon, B-R-A-N-N-O-N at dentaltransitions.com. Visit our website, dentaltransitions.com. It’s got a lot of resources and articles, webinars and podcasts just like this. We look at this as an opportunity to educate first, right?

20:25
and get to know you so that you can understand your options, what your business is worth, and what is the next best step for your practice. And then take the conversation from there. You’ll never feel any pressure from us to go one route or the other or sell today or sell five years from now. Doesn’t matter to me. We’re blessed to be busy and I just wanna do what’s in the best interest of your clients and your listeners. Well, Brandon, I appreciate the education. I appreciate the kindness.

20:54
Thank you so much for joining us. And remember to follow us on Apple Podcasts, Spotify, and YouTube. Get the episodes as they are released. Share with your friends. And until next time, go out there and be an All-Star.

21:10
We hope you enjoyed this episode of Dental All-Stars. Visit us online at AllStarDentalAcademy.com