Golden Ticket Or Black Hole? High Valuations From DSOs Can Blind Practice Owners To The High Risk Of Losing Everything
To paraphrase the warning we all see in our cars’ side mirrors, “Numbers in an offer may be larger than they appear.” Those are the cautionary words every dental practice owner should keep top-of-mind when a dental services organization (DSO) makes what appears at first glance to be a generous offer to purchase their practice. Shiny top-line figures such as high practice valuations and purchase prices and promises of substantial returns on equity investments, all fueled by the flood of private equity into the dental industry, can blind practice owners to the significant – and potentially catastrophic – financial risks that come with handing over the keys to a DSO.
That was the harsh lesson learned by a group of dentists who sold their practices to one of the nation’s largest DSOs. As alleged in a recently filed lawsuit, the owners all received equity interests in the DSO in lieu of a portion of the purchase price, as is usually the case in practice acquisitions. As is also common, the DSO they sold their practices to was subsequently acquired by another DSO. The management of that DSO then made decisions that significantly decreased and diluted the value of their ownership interests in the DSO. The dilution of their equity interests decimated the dentists’ retirement and left them with little, if any, recourse.
Undoubtedly, these dentists sold their practices after receiving robust practice valuations and being told that the sale would make them multimillionaires. Instead, they find themselves embroiled in litigation and an existential case of seller’s remorse.
This case underscores the importance of looking behind the attractive numbers thrown around by DSOs to understand what you actually stand to receive when you sell your practice – as well as what you stand to lose.
Taking Equity In a DSO Means Taking Away Any Control Over Your Investment
In the race to expand, some DSOs offer to pay five to nine times practices' earnings before interest, taxes, depreciation, and amortization (EBITDA). These numbers can be extremely attractive compared to the lesser amounts offered by a private purchaser.
But, as noted, many DSOs require that a portion of the purchase price be paid in the form of an equity investment in the DSO. But what exactly are you investing in, and when – if ever – will you see returns on your equity investment?
For example, a selling dentist with a $1M valuation may be required to “rollover” 20% of the purchase price into DSO equity. In effect, that dentist is making a $200,000 investment in the DSO. But what the valuation is of the DSO and whether that is a “good” investment is the big question. The reality is that you are making something of a leap with very little control over your investment and minimal information on the DSO you are investing in.
As happened in the case above, the DSO can dilute your shares, and the DSO can change hands multiple times. This means you could be stuck in a relationship with a company you have never dealt with and that may have priorities and practices that do not align with yours.
The Value of Hold-Backs and Earn-Outs Can Be As Illusory As Equity
Individual purchasers of dental practices typically pay the full purchase price at closing, cashing out the seller with no contingencies. On the other hand, many DSO purchase offers include “hold-back” or “earn-out” provisions in which the DSO retains a portion of the purchase price, typically around 20% until and unless specific targets are met. Receipt of that remainder of the purchase price is usually contingent on either the seller’s future performance or a pre-determined post-closing collection threshold.
In addition to significant tax considerations regarding earn-outs, selling dentists need to understand that these contingent payments may never materialize or that they may need to put considerable time and effort to reach whatever revenue or other thresholds must be met to get their money. For dentists looking to retire in the near future or who want to throttle back the hours they put in, the loss or delay of a significant portion of the sale price and the need to continue working may be a deal-breaker, even when that price is substantially higher (in theory) than what a private buyer would offer.
No Way Out
Dentists who relinquish their practices to DSOs largely put themselves at the mercy of distant corporate decision-makers with whom they have never dealt, as well as economic downturns or shifts in the dental industry landscape that could impact their financial security down the line. Additionally, DSO contracts typically include various terms and conditions that can change over time. These clauses can encompass anything from non-compete agreements to unexpected fee adjustments, further limiting the dentist's ability to make financial decisions in their best interests.
For all of these reasons, dental practice owners who are considering offers from DSOs should proceed with caution and in consultation with experienced counsel who can see the risks, costs, and other potential issues that lie behind high practice valuations and promises of a secure financial future that could prove to be illusory.
If you are a dental professional considering a sale or merger, please contact us at ddslawyers.com at (630) 833-5533 or contact us online to arrange for your complimentary initial consultation.
We focus a substantial part of our practice on providing exceptional legal services for dentists and dental practices, as well as orthodontists, periodontists, endodontists, pediatric dentists, and oral surgeons. We bring unique insights and deep commitment to protecting the interests of dental professionals and their practices and welcome the opportunity to work with you.
Jordan Uditsky, an accomplished businessman and seasoned attorney, combines his experience as a legal counselor and successful entrepreneur to advise dentists and other business owners in the Chicago area. Jordan grew up in a dental family, with his father, grandfather, and sister each owning their own dental practices, and this blend of legal, business, and personal experience provides Jordan with unique insight into his clients’ needs, concerns, and goals.
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