Halfway through the dental consolidation wave, here's what entrepreneurs need to know

The dental industry is undergoing a transformation marked by a consolidation wave that has been steadily gaining momentum. Knowledge is power, and as we find ourselves halfway through this wave, it's imperative for dental practice owners to understand the current landscape and seize the opportunities presented before it’s too late. 

Understanding the consolidation wave

Consolidation within any industry follows a predictable trajectory, and the dental sector is no exception. Drawing from Harvard Business Review's research on consolidation curves, we can ascertain that dentistry is presently at stage two out of four of the consolidation curve. This stage is characterized by significant merger and acquisition activity and the emergence of major players within the industry. Already, a considerable number of high-value practices have been acquired by dental service organizations (DSOs).

At PTS, our expert brokers work with practices on a national level and see how fast things are moving in the consolidation wave. Currently, the dental industry is about 35% consolidated, with our industry experts projecting that it will reach the full 60% to 70% consolidation within the next five years.

Once we reach this point, the majority of practices will be owned by DSOs, marking a fundamental shift in the ownership landscape. The market is expected to stabilize after this period, reducing practice sale values, which is why it's important for dentists to understand their options now.

How DSOs have evolved

The evolution of DSOs has been a defining feature of the consolidation wave. Initially, some DSOs were primarily focused on generating profits, often at the expense of the well-being of their employees and patient care. This approach led to a tarnished reputation, with employees citing unfavorable working cultures, poor compensation, and a lack of benefits.

However, competition within the DSO space has intensified, forcing them to reassess their priorities and shifting to a more doctor-centric approach. This shift entails fostering supportive cultures, offering competitive compensation packages and providing opportunities for professional development. Moreover, many are now doctor-owned or led, ensuring much more emphasis on the well being of their people, clinical care, and ethics. 

There is now over 375 DSOs operating in the U.S., and there is fierce competition to attract quality practices during the consolidation wave. This competition translates into more attractive offers for practice owners, including joint ventures, equity rolls and other lucrative deal structures.

Wealth-building opportunities

One key wealth-building opportunity for dental entrepreneurs lies in equity turns. Equity turns refer to the multiplier effect, or multiple, that private equity firms or DSOs apply to their investments in dental practices. This metric plays a large part in evaluating the potential return on investment for practice owners.

For instance, consider the scenario where a practice is valued at 5.5 times its earnings before interest, taxes, depreciation, and amortization (EBITDA). With no equity turn, the value at the time of sale would be $2.75 million. However, with just one equity turn, the value could increase to $3.25 million -- a significant bump in returns. The more private equity turns available, the more cash dentists can get when selling their practices. 

During the second half of the consolidation wave, practice owners can capitalize on one to two equity turns if they act now, procuring even more lucrative opportunities. However, if they wait too long, it's unlikely they'll be able to benefit from any equity turns.

Maximizing return on investment

Joining a DSO through recapitalization provides access to substantial resources and expertise that can significantly enhance the value of a dental practice, especially during consolidation. These events often involve additional equity investment or debt restructuring, leading to increased financial stability and growth potential for the DSO. As a result, dentists who sell their practices to or join these DSOs stand to benefit from enhanced market positioning, expanded patient reach, and improved operational efficiencies.

Equity arbitrage also plays a pivotal role. DSOs backed by private equity can offer more favorable deals due to their ability to leverage equity from multiple practices. This allows them to overcome traditional debt ceilings faced by private owners, resulting in higher financial returns. By combining equity from various practices, the DSO creates a larger investment vehicle capable of faster growth and increased returns. Dentists transitioning their practices to DSOs can become beneficiaries of this equity arbitrage, maximizing their financial outcomes in the process. 

Why act now?

While DSOs may not be for everyone, time is of the essence for those who want to explore the option. As industry consolidation progresses, valuations are likely to peak before stabilizing. Right now, brokers are able to pull a lot of levers and deal options to get a greater outcome for sellers. But the smaller the market becomes, the more control private equity firms exert on variables like multiples, diminishing returns for practice owners.

Currently, DSOs have to offer more wealth-building opportunities in the competitive landscape. With 375 DSOs competing for the best practices, there are many options and deal structures they're willing to work out with doctors, and an experienced broker can use that to the seller's advantage to develop the best plan. 

Next steps

For dental practice owners considering a transition, there are crucial steps to take, including the following:

1. Get a practice valuation. Understanding the value of your practice is the first step in the transition process. A comprehensive valuation will provide insight into your practice's worth and inform your decision-making.
   
   
2. Partner with a dental practice broker. A seasoned dental practice broker can negotiate more competitive deal structures to ensure you receive the best possible price.
   
   
3. Explore your selling options. Consider the various selling options available, including a joint venture, a sub-DSO, equity rolls, and more. Each option has its own advantages and should be carefully evaluated based on your goals and preferences.

The consolidation wave sweeping through the dental industry presents unprecedented opportunities for practice owners to maximize the value of their businesses. 

Kim McCleskey is a practice transition consultant with Professional Transition Strategies. She has worked in dentistry for 30 years and is a certified professional business coach. She can be reached at [email protected].

The comments and observations expressed herein do not necessarily reflect the opinions of DrBicuspid.com, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.