4 key financial considerations when selling to a DSO

For many dentists, selling a practice to a dental service organization (DSO) represents a significant milestone. It can provide financial stability, ease operational burdens, and open new professional opportunities. However, navigating the financial complexities of transitions can be challenging.

Here are four key financial considerations every dentist should keep in mind when contemplating a sale to a DSO. These considerations can also help you identify what type of DSO to partner with and what deal structure is best suited for your goals.

1. Cash at close

The immediate financial benefit of selling your practice is the cash you receive at closing. This lump sum often represents the bulk of your profits and can be pivotal in relieving any outstanding debt you may have accrued.

For many dental entrepreneurs, the emotional and financial burden of debt is substantial. Clearing this debt not only offers financial freedom but also emotional relief, allowing you to focus on what you love -- whether that's continuing to provide excellent clinical care, training new employees, or enjoying a well-earned break.

It's often helpful for dentists to see a projection of how this cash at close will benefit them in the long term. At Professional Transition Strategies, we employ a proprietary return on investment (ROI) calculator during the valuation process to help dentists understand their potential financial outcomes.

This tool provides a detailed projection of the affiliation and number of recapitalization events expected, factoring in state-specific details like taxes, broker fees, and more. It allows us to accurately predict the ROI, which is especially crucial for those with significant debt. If a dentist is looking for substantial cash at close, we can project both their immediate and long-term financial outcomes with great precision.

For dentists nearing the end of their careers who are free from debt, receiving a lump sum at close offers a different kind of relief. It allows them to step back from the day-to-day operations and focus on preparing for retirement with a comfortable financial cushion.

2. Salary

Post-sale, many dentists remain with their practice for a period, typically between three to five years. This time frame aligns with the standard private equity cycle, common across various industries.

However, the tenure can be negotiable, with some DSOs willing to agree to shorter commitments of one to two years for the right opportunity, while others are willing to extend it to five or more years. Either way, it's crucial during the negotiation stage to make sure you'll continue to take home a fair doctor's wage while you continue working.

The dentist's projected compensation is calculated and added to the financials on the prospectus, which is typically 30% of net collections and is specific to the deal structure, though some agreements may offer up to 35% for general practitioners, minus half the lab fees. While the salary is negotiable, it will impact the practice's earnings before interest, taxes, depreciation, and amortization (EBITDA). Nonetheless, if you prioritize a higher salary, it's possible to negotiate this aspect with the DSO.

Another key consideration is that DSOs often provide superior benefits compared to traditional dental practices, including medical insurance and 401(k) matches. These enhanced benefits, historically scarce in the dental industry, add significant value to the salary package.

3. Equity

Equity should be a significant consideration when selling to a DSO. It's essential to understand where your equity resides -- whether at the DSO or practice level -- and the extent of your equity stake in the DSO. This understanding influences the returns you can expect from the sale.

Many entrepreneurial dentists prefer to retain an equity stake, allowing them to continue contributing to the practice's growth and use their practice as an investment vehicle with the potential to create generational wealth far beyond what has traditionally been available in dental practice sales.

Various deal structures offer different equity considerations. Joint ventures and equity rolls are two common options to retain equity:

• Joint venture: In a joint venture deal, the dental practice owner sells a significant portion (typically 60% to 70%) of their practice upfront. They get a large upfront payment and retain a minority stake. The retained equity can appreciate significantly, potentially doubling or tripling over the next five years, yielding substantial long-term profits. This increase in profitability is largely due to the DSO's ability to implement changes and leverage economies of scale. DSOs can lower marketing costs, negotiate better deals with insurance companies, and secure better pricing on supplies and equipment. These efficiencies not only reduce operational costs but also enhance the practice's revenue potential, making it a lucrative investment.
  
  
• Equity roll: An equity roll allows the practice owner to reinvest a portion of their sale proceeds into the DSO as a whole, maintaining an equity stake. Owners can choose how much to roll forward, with potential growth tied to the amount reinvested. The equity roll can grow significantly, often four to five times the initial amount. It's akin to holding stock or mutual funds rather than maintaining direct involvement in the practice. This approach is safer and more diversified than investing in a single practice, similar to owning mutual funds versus owning a riskier individual stock like Apple or Netflix. For example, a doctor could sell their practice for $2.2 million and roll $700,000 into an equity platform, growing five times over five years and turning into $3.5 million. The initial $2.2 million asset was monetized for a total of $5 million over just five years. When negotiating equity, consider your long-term professional and financial goals. An equity stake in a growing DSO can provide substantial returns and offer continued involvement in the practice's success. As mentioned earlier, our proprietary ROI calculator can help dental entrepreneurs gauge potential returns precisely, ensuring they make a well-informed decision.

4. Growth and bonuses

Over time, DSOs have recognized the need for a balanced work-life structure for dentists, fostering a more collaborative environment with incentives for driving growth.

DSOs now offer various growth opportunities within their organization beyond clinical work, providing pathways into executive leadership roles or bonuses based on the group's performance. Opportunities include joining clinical advisory boards and even mentoring or training new dentists who are recent additions to the organization. The collaborative nature of these roles can be professionally rewarding and financially beneficial.

Bonuses can come into play through different deal structures, such as joint ventures or straight buyouts. Additionally, dentists may earn bonuses by recruiting colleagues into the DSO or participating in startup ventures supported by the organization. There is something to be said about working with trusted colleagues who share similar values, which can greatly enhance cohesion and job satisfaction within the DSO.

Bottom line

With the dental industry halfway through the consolidation wave, this has created an extremely competitive environment for DSOs, but these options won't be available for long. Experts project that the dental industry will complete its consolidation within the next five to seven years. This underscores the urgency to consider selling soon, as the current competitive landscape will not last forever. As the industry consolidates, the opportunities for negotiation will become less favorable and potential returns on investment will not be as strong.

Remember, focusing on your end goals is crucial. Whether aiming for financial stability, reduced operational burdens, or new professional and investment opportunities, understanding these key financial considerations and leveraging the expertise of a trusted transition specialist will help you make a well-informed decision that aligns with your long-term goals.

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.