Offers from DSOs contain a wide array of terms, variables, vocabulary, and numbers. There is a “headline number” or “enterprise value” near the top of your letter of intent (LOI), but the reality is that many will never realize that number due to deal structure.
Structure drives the long-term value of a transaction. As I have said many times, “I will happily buy your business for 25x, if you let me structure the deal.” If you took me up on this offer and owned a business with $1M of earnings before interest, taxes, depreciation, and amortization (EBITDA is a proxy for operating free cash flow in your business after normalized owner-doctor compensation), I would offer you $25M (25 x $1M = $25M). As for the structure, I would wire you $1M of cash at closing and then put the remaining $24M in unattainable earnouts, but you could tell all your friends that you got paid 25x for your deal.
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When we take a client to market, we will receive offers from five or more DSOs, and they’ll all be different: different enterprise values, deal structures, equity considerations, postsale employment compensation, all from different leadership teams with differing strategies. The one thing that is always consistent is that there are some dollars that are at risk and others that are not. Below are a handful of deal terms that we have seen over the years along with issues that accompany them.
Cash at close: This is the cash amount that is wired to you at closing.
In some cases, DSOs will include clawbacks where the DSO can come after these dollars if revenue or EBITDA targets are not maintained postclose.
Postsale compensation: How will you be paid as a clinician or manager in the business postclose?
Clinical commissions on what? Collections, net collections, production, collections less a percentage of labs? It all matters as it drives your EBITDA and can impact valuation. This is especially true with orthodontists.
Earnouts: These are dollars only realized when your business achieves certain revenue or EBITDA targets.
Earnouts have become more prevalent in the past 18 months.
Deals are sometimes structured to show huge earnouts that are practically unattainable (20% growth per year for three years) simply to boost the headline “valuation” in LOIs.
This is a key area of negotiation that has a great deal of wiggle room with an experienced advisor.
Equity retained in your business: Sometimes described as sub-DSO equity or joint venture (JV) equity, this is equity retained in your business postclose. Most times this equity allows you to enjoy distributions based on your pro rata share of the retained equity in your business.
Management fees charged by the DSO—these fees range from 0%–20%. Some are capped at a certain dollar amount, while others are not. The one thing they all have in common is that they are paid before any distributions to equity holders.
Equity rolled in the DSO: Some DSOs offer you the opportunity to roll proceeds from the sale into equity in their DSO at the “hold co” level. Many will tell you that these shares are the same as or pari passu to the shares that the private equity guys and leadership in the DSO have; others will not be so fast to tell you where these shares live on their capitalization table. These shares don’t typically come with distributions and can return 1–5x cash-on-cash rolled. That is a huge difference.
Timing: When a PE group invests in a DSO, they expect to grow the business and then exit within a 60-month period. If you roll equity into the DSO at month five, your returns will likely be much higher than if you are investing in month 55. Keep in mind that some DSOs are mismanaged and overlevered and don’t make it to a recap.
If after reading this, you are still good with me structuring your deal, I am happy to pay you 25x your EBITDA today for your business. My guess is that you are smarter than that.
Editor's note: This article appeared in the January 2024 print edition of Dental Economics magazine. Dentists in North America are eligible for a complimentary print subscription. Sign up here.
Kevin Cumbus, MBA, CEO of TUSK Partners, has over a decade of experience in the dental industry. He has valued and sold more than 150 dental practices, managed over $100 million of revenue in a DSO, and is co-owner of a start-up dental practice, Mundo Dentistry. Today, Kevin is the founder of TUSK Partners, which helps dental practice owners sell their practices at the highest possible price with the deal terms they desire.
