Dental Service Organizations (“DSOs”) come in many different shapes and sizes, but the larger and more established ones typically have a structure that involves non-dentist organizations teaming up with dentists to buy and manage dental practices. Here, the non-dentist organization offers (non-clinical) business and administrative support to the practice. Unlike owner/operator purchaser dentists, DSOs tend to have deeper pockets, an army of professionals on standby and can command deep discounts on sundries and equipment. And, for the right practice, DSOs will offer top dollar.
No doubt, as a selling dentist, you’ve probably been approached by a DSO to sell to them and be part of their team (either as an associate or partner). So, should you dance with DSOs? Let’s find out… Are DSOs the right buyer for my practice? DSOs can be the right buyer for your practice in certain situations, or if your and their interests align.
For starters, unlike owner/operator dentists, DSOs are better able to assess and manage risks. For example, they may have access to staff, associates, specialist dentists, and regional managers across their network to help bring practices to their full potential. They also have relationships with dentists in and around the practice that they buy, so a bad lease doesn’t necessarily scare them (worst case scenario: they can move the practice over to one of their adjacent locations).
Furthermore, while typical owner/operator dentists generally want to cut back on a selling dentist’s presence at the office after they buy (6–12- month associateship terms for the seller are typical), DSOs will want a selling dentist to associate for 2–5 years or more (to help manage the practice and their financial returns).
Finally, when it comes to specialty practices, owner/operator dentists generally don’t offer much beyond hard asset values (nothing for the patient charts) or a 1x multiple of the practice’s historical CASH EARNINGS (more on that below); DSOs, however, are currently offering high prices based on the selling dentist specialist sticking around. Indeed, the sale of specialty practices to DSOs – particularly ortho, endo and paedo practices – are on the rise; DSOs want to establish a presence in key markets to help keep more referrals in-house.
How do DSOs value your practice vs. an owner/operator dentist?
To more fully appreciate how ANYONE values a dental practice in today’s climate, you should read my previous article entitled “Dental Practice $ales: Get the Most When You $ell” (Oral Health Office magazine, January 2021, pp. 54-57).
Now, when it comes to the main difference between how DSOs and owner/operators value your practice, we need to talk about cash earnings (also called “adjusted cash flow” or “adjusted net income” or “earnings before interest, taxes, depreciation, and amortization” or EBITDA for short). Cash earnings tell a buyer roughly how much cash will be available to them when they own your practice. And they use a multiple of that figure to propose a purchase price. Forget everything you’ve heard or read about practices selling for a certain % of billings or collections because it doesn’t hold water: would you pay the same for two practices that each collected $1-million, but one had better cash earnings? I didn’t think so. Now you’ll need to appreciate that there’s generally two ways to calculate cash earnings: one for Owner/Operators and one for DSOs. And keep in mind that these figures are average and don’t factor in everything else discussed in my aforementioned article – all of which can drive a purchase price higher or lower.
Owner/Operator: 3.5x Cash Earnings
An owner/operator dentist who takes over the selling dentist’s presence inherits their cash earnings. This is the amount of cash they can expect to make before paying back any loans, interest on loans, or taxes. The cash earnings equal collections minus business-related cash expenses (e.g. wages and salary, rent, marketing, supplies, repairs and maintenance, bank charges, etc.). The average multiple that tends to be used to come up with a purchase price here is 3.5x cash earnings. At the height of 2019, the multiple used to be around 4x. During COVID19, the multiple dropped to 3x. So, let’s look at a typical general dental practice that collects $1-million and has $400k in cash earnings after business-related expenses (so this number is BEFORE the principal dentist pays themselves, a bank loan, taxes, or write-offs for depreciation or amortization expenses on equipment). Based on a multiple of 3.5x $400k, a buyer will offer the seller $1.4 million
DSOs: 6-7.25x Cash Earnings
DSOs will come up with a cash earnings figure that factors in (deducts as a cash expense) all associate pay. This would be an extra expense, like 40% of the selling dentist’s collections, that owner/ operator purchasers don’t take into account. DSOs may also not include certain expenses (like professional fees) or may have lower anticipated expenses (like sundries) than an owner/operator purchaser. DSO’s cash earnings figure will be lower and different. The average multiple that tends to be used to come up with a purchase price here is 7x cash earnings. At the height of 2019, the multiple used to be around 7.5x. During COVID-19, the multiple dropped to 5x, but then came back up. Right now, depending on the particular DSO and the practice they’re looking at, the multiple that they use could range from 6 to 7.25x cash earnings.
So again, let’s look at a typical general dental practice that collects $1-million and has $200k in CASH earnings after business-related expenses AND after paying all associates. Based on a multiple of 6x $200k, a DSO could offer $1.2 million. (P.S. for specialty practices, DSOs are currently offering purchase prices based on 5x cash earnings). At 7.25x $200k, a DSO could offer $1.450-million. Keep in mind that the price is sometimes all cash, but could also be in the form of cash AND taking back an ownership interest in the practice (e.g. partner shares that entitle the owner of those shares to a set percentage of dividends each month and also allow them to sell those shares at specific times to specific parties).
How do DSOs Buy your Practice vs. an Owner/Operator Dentist?
An owner/operator dentist will typically have their professional corporation borrow money from the bank and buy the shares of the selling dentist’s dentistry professional corporation. When the transaction is complete, the purchaser’s corporation and the selling dentist’s corporation continue (aka “amalgamate”) into one mega-corporation. This is called a share purchase transaction. There are big tax benefits for a selling dentist to going this route – namely, using the lifetime capital gains exemption to avoid paying a lot of capital gains taxes (for more information about this, read some of the blogs posted on DentistLawyers.ca). Sometimes, the selling dentist will simply sell the assets (e.g.: dental equipment, furniture, fixtures, patient records, leaseholds, supplies, etc.) to the owner/operator dentist. Why would they do this when it’s less tax advantageous? It’s because the selling dentist doesn’t qualify for the capital gains exemption or has liabilities affiliated with their corporation (e.g.: tax issues, debts, lawsuits, etc.) that the purchaser doesn’t want to accept. So what about DSOs? Because DSOs need to comply with dental laws (specifically: prohibitions on non-dentists practicing dentistry or dentists fee-splitting with non-dentists), they may buy practices in a two-day process. Now just keep in mind that we’ve seen a lot of deals where it’s a dual asset sale over a 2-day process. It mostly depends on tax implications to the seller of selling. What follows is a general idea of how some DSOs do their asset (day 1) and share (day 2) purchase and sale transaction.
Day 1: Sale of professional goodwill
First, the dentist partner of the DSO will buy the professional goodwill (ie: patient charts) in an ASSET purchase transaction at the end of Day 1; they will also have the dentist partner engage with the selling dentist as an associate (remember: dentists can only be engaged or employed by other dentists). Now, this first asset purchase results in sale proceeds being put into a selling dentist’s professional corporation. And, because of what happens next, these proceeds will need to be removed from the corporation right after that first sale finishes (typically in the form of capital and non-eligible taxable dividends being paid out to the shareholder(s)).
Day 2: Remaining share sale
At the beginning of day 2, the non-dentist organization will typically purchase the shares of the selling dentist’s dentistry professional corporation (which corporation contains all the other assets except for the professional goodwill). The purchase price for the corporation will naturally be reduced by the amount that was paid for the professional goodwill that occurred the previous day.
The parties need to be mindful about the allocation of the purchase price between the Day 1 and Day 2 transactions as there are important tax ramifications. Overall, this 2 step process may cause the selling dentist to pay more taxes and legal and accounting fees on the sale, so naturally, the deal should be structured in a way to offset this
Financial incentives/obligations after the deal is done
As aforementioned, owner/operator purchasers will generally want the selling dentist to exit after a 6-12-months term (with limited days, lots of time off, and a fixed remuneration) so that they themselves can inherit the cash earnings through their own efforts. DSOs are in a different boat: they will want the selling dentist to stick around for as long as possible. To help reduce their own risks and guarantee financial results, DSOs will offer financial incentives to the selling dentist, such as a higher purchase price, a long-term associateship, higher associateship remuneration if certain targets are met, management bonuses, shares in the DSO that may pay dividends and which can eventually be sold at a hopefully higher price down the road.
Now, with greater potential reward comes greater risks to the selling dentist. As I mentioned at the onset, DSOs are generally better at managing risk than an owner/operator. And to that extent, they may insist on the selling dentist agreeing to things like holdbacks of the purchase price that get released over time when certain things happen or even having to pay back the DSO some amount if certain targets aren’t met (over a period of years). Be sure to consider the pluses and minuses of these financial incentives and obligations.
And yes, DSOs are happy to make you a more clean-cut offer; but with less risk, obviously comes less potential reward. In this article, we talked briefly about whether DSOs are the right buyer for your practice, how they value your practice, how they actually purchase (two-day process) and how they offer financial incentives/obligations to selling dentists. If you want to know more about the ins and outs of stepping onto the floor and taking that DSO’s hand, contact DMC for a free, no-obligation chat.