What To Know When Comparing DSO Acquisitions To Earn Outs

When the owner of a dental practice has been negotiating with numerous buyers and both buyer and seller feel they can’t go any further, an earn out may be attempted to complete the transition. When comparing the parameters of the earn out to an acquisition of a dental practice by a dental service organization (DSO), there are some surprising similarities.

One of the biggest comparisons of all is the fact that the earn out has a list of incentives that must be reached before the earn out is completed and each side to the transaction is happy. These incentives are all about money and how much each party to the transition earns. The earn out sounds just like what it is. Funds are earned based on certain things happening between the buyer and seller of a dental practice.

Here’s an example of an earn out: when the buyer and seller of a dental practice can’t agree upon a price, there is a base amount of the sale price agreed upon which is not what the buyer or the seller wanted. Maybe after months of negotiating, the buyer and seller agree on an amount but add a strategy that if the buyer and seller agree to a schedule of additional gross revenue to be achieved during a 2- to 3-year period after the closing of the first piece of the earn out, the seller receives additional monies based on an agreed upon in advance methodology determined at the initial closing of the earn out.

In this case, the buyer is happy because he or she has reached the gross revenue plateau that was needed to have net earnings that was needed to assist with the financing needed to acquire the dental practice. The seller is happy because he or she received additional payments based on what was thought to be the correct amount of the sale price but not totally accepted by the buyer. The earn out forces both the purchaser and the dentist transitioning his or her practice to each see the advantage of the earn out since there would have been no transition to this buyer without it. Now there is a buyer who paid what the seller wanted and a seller who achieved what he or she wanted because of the provisions of the earn out.

Now we will describe a major comparison between provisions of the earn out with provisions of an acquisition of a dental practice by a DSO.

The DSO and some similarities to the earn out:

In the prior paragraph one can see how the earn out begins with a price that is not necessarily the final price of the transition. The seller and the buyer don’t want the initial amount to be the final price. From a seller’s perspective, the additional amounts that are part of the contract add an incentive to the buyer and the seller. If the buyer reaches the additional gross revenue, he or she will earn additional net income from the DSO. The seller will earn additional income from the extra revenue that is paid to him or her by the buyer having reached the gross revenue goals over the next few years.

The DSO has a similar approach in that an initial amount is set for the base sale price. Then there are incentives set that the solo practitioner could never reach on his or her own. Just like the earn out, if the seller should reach his or her goals, an additional amount would be earned by him or her. The DSO would be happy because if the selling dentist reached the agreed upon incentive goals then it would have enjoyed additional gross revenue and net income.

One of the problems with the comparison of the DSO and the earn out is that the DSO sets the incentives as part of its overall goals for acquiring this dental practice as well as additional dental practices. With the earn out, each dental practice is looked at individually and every one of them has its own purchase price and terms of earn out provisions. The DSO has an overall goal of acquiring many dental practices with as much of a standardized format as possible. The owners, attorneys and others who have substantial input into the master plan designed for the DSO do not have much wiggle room for changes in the basic incentive terms that are being offered to the dental practices that they want to own. Compared to the earn out, a variable offer of compensation may be negotiated with the seller of each dental practice. The DSO almost must have a specific formula for those dental offices that are acquired since the hope of having many offices leads to sellers asking each other questions about how their compensation and benefits compare to each other. That doesn’t happen with an earn out since an office is purchased on its own and is not part of a general mix of offices.

Which buying entity approach is the best for the solo dental practice owner thinking of transitioning his or her dental office?

The answer to this question depends on so many things that those advisors to the seller should be totally immersed in the transaction from beginning to end. An example is the base price and the incentives compared from the earn out and achieved by himself or herself since the buyer who may achieve the earn out provisions remains as the owner. The DSO comparisons with the earn out are those where the seller is not the owner anymore.

The compensation being offered by the earn out and the DSO is another major point that must be reviewed by the buyer. The benefits that are available and which will or will not be achieved by the seller are also critical items needed to be understood. The basic question besides the financial points can be summarized as one in which the buying dentist becomes the owner. The selling dentist to the DSO is no longer the owner and must be satisfied with that role.