Should you sell your practice to a start-up or fully operational DSO?

February 19, 2019

Consider the pros and cons of each model before making your final decision.

DSO marketers and owners look for dental practices that can be acquired with the potential sellers ready to join them. The existing DSO organization offers an acquisition by their business with terms and conditions already resolved and reviewed by sophisticated legal and dental business minds.

They typically have a strong capital base, which comes from venture capitalists, investment bankers or sometimes other dentists who have sold their practices but still want to be involved with management and potential growth for the future. The financing and capitalization for this type of DSO is ready to acquire other dental practices. These DSOs have a solid “back room” - administrators and good dental minds of clinicians, who have a lot of experience with the clinical and administrative side of financially strong dental practices. They also have the patience to wait for the DSO to grow financially with profits and from a reputation stand point as well. As stated previously venture capitalists and groups of wealthy business people are primarily the investors. Other entrepreneurial types are those who have contributed capital to the entity and worked to build the business model that the existing DSO uses for the acquisition process as well as the ongoing success that the DSO enjoys.

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Selling a dental practice to a DSO

DSOs look for dentists who want to sell their practices for a variety of reasons. These potential dentists in transition are typically offered an arrangement where they remain with their previously owned practice and work as an associate for compensation from their patient collections in addition to a percentage of the profit after payment of fees for management and other overhead expenses. Most importantly, an experienced management team is already part of the successful organization. Teams of legal, accounting and other advisory members are part of the well-run DSO as well.

The idea that is appealing to the selling dentist is that he or she is involved with the clinical aspects of the practice and all management and financial decisions are made by the DSO buyer, allowing the transitioning dentist to get away from the most hated jobs at the practice (management and administration). The DSO allows the selling dentist the opportunity to transition his or her practice and to continue to earn compensation while slowing down over an agreed amount of time. On some occasions, the ability to own shares in the DSO is available. The selling dentist does not have to worry about the financial strength of the DSO or its employees or administrative staff.

The start-up DSO with limited resources

Another type of DSO is the start-up. This type of format may be for the purpose of financing the acquisitions of dental practices but its capitalization and borrowing capacity is normally weak. This DSO entity often does not have an investment banker, venture capital firm or lender supporting their growth and infrastructure. The initial owners do not want to give up rights that a venture capitalist will demand for the risk they will be undertaking with a start-up. Many times, original owners do not want to extend guarantees in order to be able to obtain the funding that they need. These funds are used for working capital and infrastructure hiring, training and support. This type of DSO does not have experienced management personnel but think they have enough expertise for management and financial decision making within their ranks. These people may be a group of dentists who have recently sold their individual practices.

Challenges to the short- and long-term success of a start-up DSO with limited resources

Start-up expenses are very high for DSOs since there are few who understand what needs to be done. Finding those with the legal and business advisory background to assist the DSO prior to the incorporation start-up date, and on a day-to-day basis, is expensive. The normal operating dentist may be used to reasonable fees from the dental CPA who is employed at the dental practice, but the charges by the dental CPA with experience working with DSOs will certainly scare many of the dentists interested in the start-up. When the attorneys begin, those dentists involved with their own business will really wonder, as they see charges that they never would have seen with their individual practices. The idea of the dentist even having any involvement with an attorney is so rare that the dentist may only have been involved with one upon his or her own transition. These costs are incurred before and during the hiring and acquisition mode. The DSO, without the ability to obtain working capital lines or adequate capitalization, is getting ready for the trial and error aspect of “seat of the pants,” operating procedures with no funds needed to keep chaos from occurring. When dentists are approached for funding, the start-up DSO owners will see a time lag from the “maybe I’m in,” to the actual advancement of the funds to the DSO, if it happens at all. If they find a dentist with a similar mindset for the venture, that dentist may or may not have the capital to invest. Advisors to that dentist should let their client know of the risk.

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Questions a potential DSO investor or dentist should be asking

The financial statements of the start-up DSO are good beginning. Copies should be available to the dentist and to the dentist’s financial advisor to allow him or her to see the financial strength of the enterprise.

What type of equity is it? What are the terms and conditions of the buy in arrangement?

Is there a way out if unhappy?

Who assists with financing if the dentist does not have the money to invest?

A very important question as well regards the content of the resumes of those on the management team of the new DSO. The money for capitalization is important but without those knowledgeable about running this type of enterprise, it most likely will never get started or will have a long road to success.

Likely answers to the above questions

Let’s attack these questions and see what the likely answers are going to be. The start-up DSO probably has no financial statement to review or has a low equity position. Plans to expand and become successful will be long coming. The reason for this is that there is likely no third-party funding included in their ownership position. Without the experienced legal, accounting and advisory team behind them, the contracts and agreements for review are typically vaguely worded. They are often dependent on input from the dentists they are seeking to include as members of their team. Stock acquisition prices are high and difficult to justify. The start-up DSO may have a source for borrowing for the dentist who wants to buy into the DSO enterprise to make it easier to borrow than from a conventional lender. The acquiring dentist should be careful when considering the terms offered by the lender proposed by the DSO. Finally, the internal management, legal and professional team in charge of the DSO during its growth and acquisition period are the ones who will be primarily responsible for the decisions to allow the members a way to sell their interest with liquidity being involved.

Who's the potential buyer of the start-up DSO shares?

The buyer of the start-up DSO is ordinarily a high-producing dentist who may work for someone as an associate. It can also be a solo practitioner who does not like the intransigence of the acquisition and compensation model or the “little fish in the big pond,” concept. Those who are interested in slowing down without responsibilities are not the model for the start-up DSO. Its perspective is that the dentist who wants to be involved, participating in many of the decision making processes and someone who wants the recognition that the smaller DSO affords. Many of the solo practitioners without exit strategies find this model to be very attractive as the seller continues to work, gets paid for the services he or she performs and also receives compensation for the sale of the practice. The investment is made and the potential for future growth and the reward for it is available. The dentist’s decisions and advice are useful to the start-up DSO as it typically can’t afford the high cost of the well funded DSO that has CPAs, consultants and attorneys readily available to it. Especially important and usually missing with the start-up DSO is the management team and administrative staff that is included with the DSO that has had an investment banker or venture capital fund provide its capital and borrowing capacity. The start-up makes use of its acquisition’s personnel and can take the best of the purchases that it has made for its own administrators, clinicians and outside contractors such as the Dental CPAs and the attorneys available from the pool of its acquisitions.

Which is the right approach: start-up or existing DSO?

Of course, the answer to this question is based on the emotional, financial and work input that the potential dental investor is desirous of making. The sale with the continuation of practicing with a great deal of input sounds right for the dentist who wants the exit strategy and does not yet want to stop working. The dentist who is ready to retire fully and does not really want to work very much or at all, will probably look to the existing DSO since it will fulfill the concept of leaving things and “riding off into the sunset.”