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Best Practices for Sellers in the Evolving DSO Marketplace

Co-Authored by Craig Woods
Published in DSO News, January 7, 2019

The tsunami of consolidation activity in the dental services industry has created remarkable financial opportunities for dentists and investors. Primarily, these opportunities play out in the form of Dental Services Organizations formed by entrepreneurial dentists and/or private financial interests through the acquisition of established, profitable practices. Building a DSO through acquisition or selling a practice can be a smooth and rewarding process, or a miserable and disastrous one, depending in large part on your willingness to use best practices.

Four best practices will help to ensure that the purchase or sale process is successful. They are not silver bullets, but can make a critical difference in the smoothness of the process, and potentially the net results. They are:

1. 1. 1. Set your sights (broadly)
      2. Seek expert input (within reason)
      3. Move swiftly (but not recklessly)
      4. Stay involved (without micro-managing)

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BEST PRACTICE #1: SET YOUR SIGHTS (BROADLY)

Setting your sights – or, in other words, establishing your goals – is far more than just determining a purchase price if you are a purchaser, or your sale price if you are the seller. Instead, if you are the dental practice seller, the post-sale goals you should consider are whether you wish to: (1) continue practicing as you did before as an employed dentist of the DSO; (2) be employed in an executive leadership capacity by the DSO; (3) become an investor in the DSO with an equity interest; and (4) accept payment of a portion of the purchase price on an “if-come” basis, depending on financial performance of the practice (called an “earn-out”).

Each of these considerations relates to the selling dentist’s sense of professional gratification, and their present and future financial needs, and they therefore warrant the same careful and mindful approach as do personal financial planning and estate planning. Where a selling dentist lands on each of these issues has a great deal to do with their answers to the following questions:

• • • Do I enjoy the practice of dentistry?
    • Would I enjoy being an employed dentist?
    • Would the likely sale price net of debt, transaction expenses and taxes allow me to give up dentistry?
    • How do I feel about my future partner?
    • Will I succeed as a DSO executive, if that role is offered?
    • Can I afford to defer payment of a portion of the purchase price and make it contingent on the practice’s future financial performance?
    • How much am I willing to defer, if any?
    • Do I have confidence in the DSO to deliver upside potential on my equity interest?
    • How much more money will my family and I need in the future, depending upon my age, savings, lifestyle, obligations and other financial opportunities, etc.?

From the purchaser’s perspective, it is important to first determine the structure of the DSO (if one has not been established already) or restructuring to accommodate growth and to comply with regulatory requirements, including those prohibiting the corporate practice of dentistry and fee splitting. In general terms, a DSO is a legal arrangement established under contracts among a management services entity and practice entities that provides non-clinical administrative support services, including financing and leasing arrangements and non-clinical staff, and accommodates third-party financial investment, DSO equity participation (on the part of selling dentists and other key participants), and the diffusion of financial risk through scale. The DSO must be established in a manner that is regulatory compliant, particularly with regards to the DSO’s governance features relating to management of the non-clinical parts of the business and the equity and compensation arrangements for incoming selling dentists. Such features are critical to the viability of the overall structure and should be considered in light of the DSO’s investor arrangement, leadership requirements and need to attract successful partners.

Therefore, to set your sights (broadly) means, for the selling dentist, to plan for a rewarding future in all relevant respects, while for the DSO it means to plan for appropriate governance and growth.

BEST PRACTICE #2: SEEK EXPERT INPUT (WITHIN REASON)

The proper balance of outside expertise, whether building a DSO or selling a practice, is somewhere between not too much and not too little, depending on your in-house capabilities, size of your operation and complexities of the deal. Expert input on a number of factors is particularly important, primarily to ensure the most favorable financial outcome for buyer and seller. Key factors that usually warrant expert input are:

• • • Dental practice valuation in consideration of national and regional market activity;
    • Tax structuring to achieve optimally efficient tax treatment;
    • Accounting of proceeds, including flow of funds and purchase price allocations; and
    • Regulatory compliance.

Regarding legal input pertaining to the central transactions, whether you are building a DSO or selling your practice, your lawyer should advise you as to the agreements that cover the primary financial aspects of a deal, including the purchase agreement, employment agreements and equity participation agreement (often covered by the DSO’s organizational documents). Together, these agreements will spell out the main financial elements of the deal, including the cash consideration to be paid to seller(s) upon closing and, as may be applicable, the nature and amount of awarded equity participation in the DSO, any earn-out calculations and conditions, the destiny of debt (which might be transferred to or replaced by the DSO, or extinguished), the payment of transaction expenses incurred for advisors upon closing, salaries, bonuses, benefits and perquisites to be paid to selling dentists after closing, and the rights and obligations of selling dentists who become equity participants with respect to their financial exit (contingencies, valuation and timing).

Your lawyer will also advise as to the stages of the deal process, from the letter of intent stage (at which the parties frame in the financial aspects and structure of the deal), through due diligence (during which the seller, especially, provides information about the financial, legal and operational aspects of the practice), and on to the negotiation and execution of definitive agreements, and closing, including the transfer of cash consideration.

BEST PRACTICE #3: MOVE SWIFTLY (BUT NOT RECKLESSLY)

While most parties will choose speed over delay, many imperatives may influence the wished-for timing of a deal (including tax considerations). Indeed, countless dental practice acquisitions have become bogged down for one reason or another, resulting in amplified advisory costs, deal exhaustion and, potentially, loss of the deal as one party or the other moves on, or the funding source becomes disinterested. The reasons for falling into a mire vary widely, but often involve indecision on the part of sellers’ principals (if some are supportive of the transaction and others are, or become, skittish), “over-lawyering” by deal counsel who does not understand the industry or fails to efficiently prioritize and address legal issues, operational disorganization and complexities of the practice, which can complicate and impede the provision of due diligence information, untangling of debt and contribution arrangements, and resolution of third-party entanglements that stand in the way of finalizing a deal.

On the other hand, if the parties move too fast important elements of the deal – like the description and mechanics of the purchase price, long-term responsibilities of the parties, and indemnification obligations – may be given short shrift or be entirely overlooked. Items that seemed straightforward become less so as the deal evolves and additional elements are introduced to the deal structure. Thus, as has been said before – “make haste slowly.” Ensure a proper balance between urgency and diligence to avoid critical mistakes and increase the likelihood for a successful transaction and partnership.

BEST PRACTICE #4: STAY INVOLVED (WITHOUT MICRO-MANAGING)

While seemingly easy in theory, staying involved without micro-managing is harder in practice. Too much involvement from an interested party, and presumed expertise where none exists, can lead to mistakes and wasted time. Too little involvement due to over-delegation, and your own interests will not be represented in the final arrangements. These are truisms whether you are delegating to others within your own operation or to external experts, and they should be made true whether you feel too busy to be adequately involved or too knowledgeable to defer to experts.

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The future of DSOs should be built on good deals for all involved parties, as lawyers would say “to their mutual satisfaction.” These four best practices should help you identify those good deals and increase the likelihood of a successful transaction for all involved.