The Mistake Dentists Make When They Take the First DSO Offer

“Hey Connor! I just got an offer from a DSO for 10x. I really want to take it; they’re taking me out to dinner next week to sign. What do you think?”

Every time a dentist comes to me with that message, I’m asking the same three questions. Who calculated that EBITDA, and how? What’s the split between cash at close and equity? How many years do you have to keep practicing after the deal closes? Most doctors don’t have an answer to any of them, because nobody has told them those are the questions to ask.

For several years before I joined TUSK, I was on the buy side in a business development role at a DSO, and I was the one sending that offer letter. We would put an offer in front of a doctor and then spend months working through diligence and negotiation once they signed to close the deal. Somewhere along the way, the doctor would get tired. Tired of the document requests, tired of doing all of this on top of a full clinical schedule, tired of running a process they had never run before and would only ever run once. Oftentimes they didn’t have proper representation from an attorney with experience negotiating with DSOs either. Eventually they would agree to terms that were not in their best interest, because agreeing was faster than fighting, and they had nothing to compare the offer to. My job was to acquire good practices for as little as we could reasonably pay, and the best way to be the only buyer at the table.

We also knew that the tables could be turned on us. If that doctor hired a broker to run a real process, our offer would likely need to change, because we would be up against four or five other DSOs who wanted the practice as much as we did. I’m on the other side of the table now, representing the doctors, and making sure they’re not settling when it comes to their life’s work.

How DSOs Form Their Offers

Before anyone at that DSO has seen a profit and loss statement, they’re running off benchmarks in your area and what they’ve perceived of your practice from the outside. They’ll give you a call, and it feels like an innocent conversation, but they’re fishing for any details they can use to build that offer. They don’t know what one-time expenses live in the business, or how you’ve been growing your patient base monthly, or much at all about the past 3 years of business. They certainly aren’t going to do the work up front of normalizing your EBITDA.

EBITDA stands for earnings before interest, taxes, depreciation and amortization, and it’s the profit number every DSO places a multiple on to reach a final valuation. Normalizing it means adjusting for any one-time expenses, ensuring all providers and staff are being paid a fair market wage, removing any family on payroll that does not perform an active role in the practice, if you own the real estate and become the landlord then deciding what fair market rent would be, etc. Those adjustments are going to move your EBITDA up and down, and the accuracy with which it’s calculated is very important.

“I’ll give you 15x EBITDA if you let me structure the deal.”

Go back to that text message for a second. A 10x offer sounds like a number worth celebrating, and if that doctor had come to me when I was on the buy side, I would happily have given them 15x, as long as I got to structure the deal.

Cash at close is the first deal term that’s going to be impacted. The headline enterprise value at the top of the offer stays impressive while the wire that hits your account on closing day gets smaller. From there, the equity piece gets heavier, meaning more of your value moves into rollover equity, where you leave a portion of your proceeds invested in the DSO instead of taking it home. That money pays out when the DSO sells itself again, which, depending on where the DSO sits with its current sponsor, could be 2 years or 5 years. The employment term stretches out as well, and the compensation model inside it changes, so five years at a lower collections percentage becomes a real cost that never shows up in the multiple. Then holdbacks, escrow, and the working capital peg all come out of the cash side.

Put it together, and a 15x offer with 55 percent cash at close and a five-year employment term can put less money in your pocket than an 11x offer with 80 percent cash and a three-year term. This is why dentists should never focus exclusively on the multiple.

Why DSOs Don’t Want You To Hire a Broker

Buyers are not villains. They’re allocating capital against a return target with an investment committee to answer to, and their job is to buy well.

When you hire a broker to run a competitive process, a DSO must put up their best offer on the table, because the broker is going to bring better offers from other groups. When there’s nobody else competing for your dental practice, they’ve got more room to set the number wherever they want it, because the doctor has no way of knowing whether what they have is a good offer or not.

The other thing working against a doctor going it alone is information asymmetry, which is a formal way of saying they’ve done this two hundred times and you’re doing it once. A do-it-yourself process costs more than the difference in price, because it takes months of your attention while you’re still running a living, breathing business. If your clinical production is impacted during the negotiation process with the DSO, they’re going to factor that into their offer.

How Five Offers Gives You An Advantage vs. One

The first thing is price discovery. You find out what the market pays for your dental practice instead of what one buyer hoped you would take.

The second is comparability. You’re going to have the opportunity to lay out all the DSO offers for an apples-to-apples comparison:

• What is the total enterprise value of the offer?
• How many years until the platform recaps?
• How many years is the dentists working for the DSO post-close?
• How much of the deal contains JV equity vs. Hold-Co?
• What is the track-record of success for this group?
• What support services does the DSO provide my practice?

That leads to the third thing, which is the ability to walk away. If you’re sitting on one offer, you’re facing a deal-or-no-deal scenario. If you’re negotiating with several groups, you have leverage and don’t have to settle for one group or the other. You have the ability to truly choose the partner that is going to better your practice and maximize the value of your life’s work.

How Multiple Offers Helped Florida Dentist

Dr. F came to us already holding an unsolicited offer from a DSO not knowing whether it was truly “market.” He consulted with us to run a valuation analysis, where we uncovered an opportunity to actually grow his EBITDA, and take him to market with a more attractive asset that we knew multiple buyers would bid on. The DSO that had sent him the unsolicited offer was not too happy, but they ended up coming back to the table when we took him to market months later. We had increased his valuation by 36% just by timing the market and uncovering the EBITDA growth. 5 DSOs bid on his business. The result is he closed with a 78% increase in valuation from his original unsolicited offer.

Read the full story here: Florida Dentist Increases Unsolicited Offer By 78%

You have a DSO offer. What now?

Start by reading carefully and get a second opinion.

Get your EBITDA normalized by someone who does this for a living, and understand what a marketed sales process where multiple buyers bid on your business could yield.

If I could give one piece of advice to a dentist holding an offer, it’s the same advice I would have hated hearing back when I was the one sending them. Never accept the first offer, and always explore your options. You spent a career building this practice. It’s worth finding out what the market will pay for it.