What’s Up With All This DSO Chatter and What Does It Mean?
If you’ve been even a casual user of Facebook, you’ve seen a ton of threads and conversations about DSO’s. I was raised watching my dad and his partner try to create a “DSO” back in the late 1970’s and 1980’s so I was living inside of one before most reading this were even born. I’ve also spent the last few months learning as much as I could from some of the sharpest minds in the DSO world including brokers, CEOs, private equity partners and even those who have joined the organizations.
So many of you have reached out to me to ask questions or offer insight and it’s clear that there is a lot of mystery, misinformation and emotion associated with the idea of DSOs in orthodontics.
Today, I want to help you better understand the world of ortho DSOs and to help separate fact from fiction and emotion from truth. NOTE: I have zero financial interest in any DSO at the time of this writing (who knows what will happen in the future and you may view this years from now).
This is meant as a very broad, 30,000 foot overview and not a deep dive, but if you ever have questions, simply message me and I’m always happy to help. Also, if you feel I’ve misstated something or have it wrong, please also message me because I’m always happy to learn and edit.
What is a DSO?
According to Wikipedia: “Dental Service Organizations, known in the industry as “Dental Support Organizations” or abbreviated to DSOs, are independent business support centers that contract with dental practices in the United States. They provide business management and support to dental practices, including non-clinical operations.” There are other non-DSO groups, but for general purposes, while I recognize there are significant differences in different group types on many levels, I will often just refer to “group” or “DSO”. No disrespect or ignorance intended.
Essentially, the group buys your practice, pays you money for that interest and then support you in some manner. It varies between different groups and the amount of support you get can range from virtually nothing but some guidance all the way to day to day support with things like HR, A/R, A/P, etc. A nice side effect of being purchased by many is that you and your team get benefits like health insurance, retirement plans, etc.
You become an employee of the company that purchase you and your salary (if you’re full time) can range from $280,000-$350,000/year (more on this later). Your actual take home income can vary depending on specific bonuses based on production, a distribution (if you haven’t been fully purchased and own a percentage of your company) or a referral bonus for those whom you refer (and whose deal closes). Every company is different, and the details vary. But note that when they buy you, your compensation could change dramatically from where you were when you were 100% owner of your business.
Who really owns your practice after the sale?
There are a few different models out there, but they essentially boil down to the idea that you will either be wholly owned by a private equity (PE) group (or family office) or in joint ownership with the PE group. (NOTE: While there are huge differences with family offices and PE, for the sake of this discussion they will be used interchangeably as “PE”.) There are models that are 100% group owned by dentists or orthodontists with no PE money, but for the sake of this discussion, I am not including them because they are less common and play by a whole different set of rules that I won’t go into at this time. But they work with a management team to help manage the direction of the group and purchase new practices to grow the equity of the group.
If you’re owned 100% by PE, it means that they gave you money to own your practice, plain and simple. If you’re a partner, they’ve given you money to take a majority share of your practice. Why a majority share? Well, think of it like this: If you were buying a business and throwing a ton of money into it, you wouldn’t want to buy a minority share (less than 50%) where you wouldn’t be able to have a say in what happens because that would be foolish. No different here.
What will change about my practice?
The older, original model of these companies was to buy you and systematize what you do. Branding, supplies, HR, call centers, etc. were often coordinated so that your previous practice was now a part of the collective. Your name changed, the supplies changed and your practice did things the company’s way.
Today, the overwhelming majority of companies know that it was YOU and your style that made your practice successful, so it would be foolish to change that. They let “you be you” and to your patients and the overwhelming majority of your team, literally zero changes (known as an invisible DSO). It’s life as usual, but in the end, you must answer to the company if you don’t meet certain profit goals (usually a 5-10% growth year over year model). As long as you continue to do well by your patients and practice and don’t check out after a big payday, all will generally be good.
None of the orthodontic only groups (as far as I know) will have anything to do with you reducing quality of care or taking shortcuts when it comes to treating patients or reducing what you pay your team. On the contrary, some will promote your best team members to larger positions with increased responsibility and better pay, and discussions I’ve had with these teams members would indicate a lot of happiness with the new roles (but not necessarily so much love with the constant calls with the management team).
And as you’ll see below, it’s in your (and everyone else in the group) to do the best you can, so you get more money later.
So, what about this “payday”?
The world of finance is pretty big and it would take a lot more room than I have here to help you fully understand the whole world of what happens. But know that the goal of most of these private equity companies is to take a company, grow it and then sell it for a profit, usually in a total of less than 5 years. So, for the sake of this discussion, they want to collect like-minded groups of orthodontists’ EBITDA (more about this below) help manage the group properly and when it grows to a certain size in a certain time, sell it to a larger PE group and give back the profits to the PE company, the management team, the pension fund (or whoever they are beholden to) and the member doctors. There are DEEP discussions we could have on the stock configurations, but not here. It’s too much.
The goal of many PE firms is to get a 10-14x “multiple” when they sell to the next PE group. They can “go public” if they’re big enough, but that’s a LOOOOOOONNNG term play and not for this discussion. But note that when that happens, they need to be big and can get upwards of a 30+x return. These multiples are what play a role in how this “payday” happens. They are more than happy to compensate you well because they know that they will make the money on the backend if they do a good job.
But again, remember that they need to both grow the amount of EBITDA (by acquiring practices) and the growth of the practices in the group (through marketing, better lab bills, better management, etc).
What’s this “offer” we hear so much about?
So, after a group does it’s due diligence they may give you an “offer” (I’ll explain below why they might not do so). This offer will typically include at least three things: A doctor’s yearly compensation, cash and equity. It can also include things like referral bonuses or earnouts for growth, but let’s focus on the first three.
It’s easier to think about this as if it were like when one rents a shell and wants to do a buildout of an office. There, you have rent, tenant improvement and lenth of lease. A lower ask of rent means that you’ll get lower TI and longer term. Ask for a shorter term and you’ll get a higher rent or lower TI. But you can’t have a best situation in all three. No such thing as lower rent, shorter term and higher TI. Something has to give. The same in your offer. You can ask for a lower compensation for a higher amount of cash or equity or less cash and equity for a higher yearly compensation, but you won’t get a higher compensation and a higher cash and higher equity amount. Understand this.
And it’s the multiple on your practice that plays a huge role. But how does a group figure out what you’re worth?
Think of this is terms of how baseball teams look at talent. When they see an amazing player they want to have on their team, someone who hits home runs, gets on base, is a great fielder and is a good bet to make the team better, they will pay more. Our practices are no different. When a PE firm sees a practice that is profitable, large, well run and has potential for growth, they’re interested. If it’s a low performing practice that they see, one that doesn’t show signs of being a great investment, they’ll generally pass. If it’s in between or shows potential (like a promising rookie baseball player) they might give something in the hope it will grow.
If you’re three years out of school, and practice production is $750k/year, it’s probably not a good time to jump into a DSO, nor will a DSO be that interested. And if you’re late in your career and ready to retire, don’t look at a group as your end game. Why would anyone be interested in buying a company that isn’t built for growth with an owner who just wants to walk away? Probably better to sell to a private doc.
If you do get an offer, it could be in the 4-7x multiple of EBITDA range. That means that your deal will be worth 4-7 times your EBITDA in a combination of cash and equity, aside from your compensation. So, if your EBITDA is $1 million dollars, you could expect an offer in the $4-7 million range.
This offer could include the ability to keep, say, 30% of your offer in equity in the group. (It could be way more, or way less. Every group has its own rules depending on how they are set up, the PE group running them and the time they’ve existed.) So, if you had a $5 million offer, you could keep $1.5 million in the group and take $3.5 million in cash. (I am NOT a tax advisor, so please do not accept anything here as tax advice. It is simply what I understand things to be after talking to a lot of folks. PLEASE talk to your tax professional before any deal.) The $3.5 million you took is taxed at capital gains rates (not income tax) and the $1.5 million has no tax. The current capital gains rate in the US is 20% (many believe it is set to go up considerably in 2021 because of the new administration’s approach to taxes) so some will tell you that 2020 is the year to do a deal. I would suggest that if you think that you want to do a deal soon, that makes sense, but if you’re not ready to do one now, don’t do one simply because of tax reasons. So, you’re $3.5 million becomes $2.8 million and you can do with that whatever you want.
But what about the $1.5 million you left in the group as equity? This is where it gets interesting and the group you chose plays a huge role if equity growth means a lot to you.
Historical trends would suggest that the longer a group has existed and the more times the group has been sold, the lower the multiple they get. So, it’s not unheard of for doctors who have joined a group at its infancy to get 6x return at the first sale and perhaps 2-4x (more or less) at the second sale and 2-3x at the next sale, etc.
Now back to your $1.5 million. If you took your $2.8 million after taxes and your $325,000/year salary and continued to work for 4 or 5 years until the next sale, if your management team did a good job and this was the first sale, you could see that $1.5 becoming $9 million. Is that insane to think about? Not at all. There are many companies in the medical and dental world who have shown that kind of growth. Sure, there are going to be naysayers out there who don’t believe this to be true or bark “No way” but the facts and the history would bear it out as being real.
And once you’ve accepted your deal, you just can’t say a year later “hey, I’d like some more of my cash out”. Once you’ve taken out your cash, you’re in that position until the next sale. So, choose wisely. Don’t forget that you need to pay off any debt your practice has after the deal closes and you DO get to keep all of the cash in the bank accounts on the day of closing the deal, but this is why those fresh out of school with a $700k practice and $300k practice loan don’t stand to make very much in this model. If you’ve been out a while and have a $2.5 million practice with minimal debt, that’s a huge difference.
Let’s say the group did OK and not amazingly, but met certain thresholds for sale. You might see that $1.5 go to $4.5 million. Still A LOT of money. This is where I spoke earlier that you and everyone in your group wants to work at being successful every day and grow your practices as if they were still owned by you. If everyone grows and the group gets great practices, you’ll see a higher multiple. If everyone just does “meh”, you’ll see a lower multiple. If everyone just checks out or the management team doesn’t know what they’re doing, you could be in trouble.
What does trouble look like? Well, just like any business, if nobody wants to buy you, nothing happens. No multiple, no sale, and it just sits there. You keep earning a salary and the management team (hopefully) tries to grow you or the group gets a new management team to turn things around. It’s unlikely that it will simply shut down. DO NOT equate today’s groups with those famous ones that failed in the last 15 years. DIFFERENT model entirely. That’s why you want to be in a group with great docs, great management and a PE firm that has done this before. That’s not to say that a PE firm new to the ortho arena isn’t good, but it’s like an expansion team. No history is just that; no history.
So, choose a DSO based upon their history, the strategy and the doctors in the group. More cash up front may sound like a great idea, but equity in an amazing growing group could change your life down the road. Speak with everyone involved. Find out their mission and their personal history running companies. This will be a big part of what is more than just the cash offer.
So, what happens after that first sale? Generally, not much. The management team may or may not stay on but nobody buys a group with the idea that they will suddenly go and change everything. It would be insanity. Maybe some minor changes here and there, but they want you to keep doing what made you successful. They make the rules about your equity. Some may allow you to take out a lot because they don’t want it diluted and others will want you to leave a ton in. But generally, if you’ve seen good growth, you’ll be able to take home some of that money.
Let’s assume the same scenario as above and you left in $1.5 million. You saw a 4x multiple on the first sale and you now have $6 million in equity. You decide you want to take out another $3 million at this point and leave $3 million in there as equity.
Let‘s keep score for now, 3-5 years into the process. You had a practice worth $1 million that you sold for 5x. You took out $3.5 million at the beginning and another $3 million now. So, you have taken $6.5 million on your $1 million EBITDA practice. You still have $3 million in equity.
3-5 years later, if everyone has done what they should, you should see another 2-4x multiple on your equity which means that you have between $6-12 million. The same rules apply as before and if 6-10 years into the process you’re ready to get out, cash in your chips, take your cash and bye. You’ve cashed out between $12.5-$18.5 million 10 years of less after selling and you’re living your best life. There will be a non-compete like any sale and you won’t be able to just open up down the block but if ortho is what you want to do on your own, find a place you are allowed to do it or travel the world until your non-compete runs out and go for it.
If you want to stay in the game, take out some equity, keep working and wait for the next sale or perhaps watch the company go public and make a bigger multiple.
This isn’t ridiculousness folks. These are not “pie in the sky numbers”. This is happening and has happened many times before in industries far less profitable than orthodontics. It doesn’t mean it’s right for you. It just is what it is no matter how hard someone tries to tell you it isn’t.
Can it fail?
As I mentioned above, absolutely. Nothing is foolproof, and you need to do your homework. Ortho DSO (and DSO-like) groups are expanding and more are popping up every day. It’s the opinion of most impartial experts that most of the groups will be successful because of the nature of most orthodontic practices to be profitable and for the doctors within the groups to be committed to growth and patient care.
Is EBITDA the same as “production”?
No. Simply put, according to Investopedia:
EBITDA=Net Income+Interest+Taxes+D+A Where: D=Depreciation, A=Amortization
So, if you’re practice did $2 million in the last twelve months (LTM is a very important number for evaluation) and you had a net profit of 40% ($800,000) you can add the ITDA back on. But…don’t forget that we need to subtract the cost of having a doctor (you or otherwise) to do the ortho. So, take off $300-$350,000 which is a going rate for a full time orthodontist and coincidentally what you’ll be paid when you work the practice. So, your $2 million practice may have an EBITDA of $550,000 (merely a made-up guesstimate here). At a 5x multiple, that would equate to about $2.75 million.
When should one join a group?
It’s a personal decision and not one to be taken lightly. Once you turn over the keys, there’s no going back.
The factors that play a role include your age, how long you want to practice, the size of your practice, your retirement goals, your growth upside of your practice and much, much more. As I stated before, do not look to them as a salvation to suddenly run your practice or an “exit strategy”. They are buying your practice as an investment and you are a huge part of that investment. Good practice + good doctor=great outcome.
And as far as associates go, there are many models that allow your associates to get a piece of the pie. Again, there’s too much to cover here, but suffice it to say that if you want to do right by your associate, there are paths there.
It’s impossible to sum up all of the possible variables and tell you what’s right for you, but I am always here if you have questions.
Is this bad for orthodontics?
This is the BIG question that is very polarizing.
But there are two questions within that question: Define “bad” and define “orthodontics”. I don’t mean to be trite or petty, but the definition of those two words will play a huge deal in how you see all of this.
If you see orthodontics as a pure, doctor-owned, doctor-run specialty, with zero (I mean ZERO) outside influences, I apologize but those days have been gone for a long time. But, I believe (as many others have so aptly stated before me) that there will always be room for a quality private office, no matter what happens. Will there be pressure to join groups in the future? Absolutely. Does it mean that you have to? Absolutely not.
My opinion is that companies alone can do nothing to change the quality of outcome. As orthodontists, we get to choose quality of care. Yeah, many of us came out of school to work in mixed specialty or GP centered DSOs where ortho was a bolt-on for profitability. In many, the quality really suffered and to my knowledge, none of the ortho only groups to which I am referring have that as their model. I have spoken to many orthodontist who sold to ortho-only groups and I am yet to meet one who said they didn’t get to provide the same quality of care that they did before they sold. But, if you’re the kind of doctor who sees 30 patients/day and are set in your ways about how practice should happen, odds are you’re not a great fit for a DSO anyway.
Is it bad that PE firms own a collection of ortho practices? Not necessarily. As long as they don’t dictate how you treat patients, that’s cool. But, what about new docs coming out of school? What kind of opportunities will still be there for them? Well, most of us came out of school and worked in some sort of group for some period of time. The opportunities will still be there to start a de novo and while buying an established practice will still be an option, I suspect it will diminish over time.
One thing I see is that many of the baby boomer docs refuse to let go right now. Many in their 60’s and 70’s got their practices for next to nothing, came out of school with no loans and got their chance to practice when the group of docs before them stepped away in their 50’s and 60’s having done very well for themselves. Now, after having overseen the largest expansion of the stock market and real estate markets in our country’s history, and having done pretty well for themselves, many baby boomer docs refuse to yield to the next group of orthodontists and when they do, they often ask ridiculously high terms for practices which they often neglected.
These ortho groups are going to change that. In the next decade, when every baby boomer orthodontist is out of the ortho workplace and early entrance into these groups has made many orthodontists financially independent, I believe you will see many orthodontists move on to the next chapters of their lives, leaving more openings.
I see this as neither good nor bad for orthodontics as a profession and I do think that one benefit will be many new grads going into groups and getting steady work, equity and the opportunity to be a part of a group with a ton of other orthodontist who can give them guidance. I don’t think I could have said this even 2 or 3 years ago, but the changes to invisible DSOs and the number of groups starting and the quality of docs in these groups is increasing.
Some will say that you should put the “profession” first, but after almost 30 years in practice, I don’t even know what that means. I owe my team honesty, respect, a good working environment and a paycheck. I owe my patients my absolute best outcomes. I owe my family the best financial security I can offer them. I owe my profession what’s left. Will I ever put my “profession” above my family, my employees or my patients? Never.
We should always treat our peers with dignity and respect, and do right for those around us. If someone wants to leave money on the table to help another doc have a pathway to practice ownership, I say: “Good for you” with not a hint of sarcasm. I mean it. Altruism comes in all flavors and should be applauded.
There will always be naysayers, “funsuckers” if you will, who will shoot down any idea based on emotion and give you tons of reasons to never do something. And there will be those who try to convince you that this idea is the absolute best out there and that their group is the finest in the world.
Always remember that it’s your decision and your responsibility and you will bear the burden. Align your decision with your life plan (I hope you have developed a life plan). Never take anyone’s word to replace your due diligence. But know that I am always here to help you with any questions you ever have and to help you however you see fit. You’ve joined an amazing profession and if you’re honest, treat people with kindness and work hard, you’ll be successful no matter what model of practice you choose.
Much love to all of you!!!