“I want a 9X on 1.8MM in EBITDA, 80% cash at close and no earnout!”
“I want an 8X on 550k in EBITDA, 100% cash at close and a 12-month employment agreement.”
I hear this all the time. At times, I must sit back and wonder where it all comes from and how these expectations began. There are a dozen funnels of information that can find their way into the general dental population, however I believe that there is a vast chasm between expectations and reality right now that simply has to be addressed, and the fault lies everywhere.
DSO’s say they’re offering premium multiples with huge equity upside, conditioning sellers to numbers that are out of market and generally unobtainable. Brokers do much the same to “win” the listing. PE groups are desperately trying to find platforms and regularly throw out recap multiples to founding partners that may or may not have any obtainable goals attached to them, and minimal attachment to the reality of a platform investment without existing infrastructure. CPAs and Attorneys with minimal M&A experience always believe that practices are worth more than they are. So, where do you go? Selling in today’s space is a landmine laden playing field that is difficult to successfully traverse while maintaining all the emotional speed bumps that you would imagine selling your life’s work would bring with it. Understanding expectations from both the buyer and seller is critical as a part of the up-front process, as is gaining a better understanding of how valuations are driven, and what the critical components are that influence valuation.
Traditional Valuation Methods
For decades, the traditional method of transitioning a practice involved simply finding an associate that you believed would take good care of your patient base, and either quickly or slowly, transitioning the business to that associate. Valuations were consistently between 70% and 90% of prior year collections, with that variance due largely to geography, condition of the equipment/space, composition of the payor environment and procedural mix. The good old days. When being a practice transitions specialist was a piece of cake and the variables were known and understood.
DSO Valuations - Risk Mitigation and Opportunity For Growth
Fast forward a couple of decades and we have the influx of private capital into the dental space, bringing with it far more complex funding mechanisms, analytics, objectives, and a new term not heard in dental previously, EBITDA. Essentially a base profitability metric, this now shown a light brightly on those practices that operated efficiently and profitably, vs. those that were just revenue hogs without efficiency. And as a result, the payoff for those healthy, profitable practices was considerable, providing a massive difference in valuation between a private practice sale, and a private equity backed valuation. Acquisitions increased at a frenetic pace, as did the thrill of victory for those sellers that rang the bell, and subsequently, the agony of defeat for those that couldn’t. So, what should viable expectations look like, and how do you as a practice owner plan for your inevitable transition, be it doctor to doctor, or DSO/PE driven?
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Evaluating Risk
- Provider Risk: What is the timeline of the doctor transitioning? Will it be easy to recruit a replacement? Is the doctor a super producer, thus indicating significant key-man risk? Does the practice have the requisite footprint to support transitioning an associate in? Are there existing DSO assets in the geography for support? Will the lead doctor commit to 4 or 5 years post close? All are significant considerations in a DSO transaction, and all factor heavily into the valuation they will provide. A key focus is stability of the organization post close, and the lead provider is the most important part of that equation. Try to subtract that early (1-4 years) and you’ll see a valuation decrease. Comfortable committing full time for 4-5, and a lessening schedule thereafter and your risk profile is reduced, and valuations increase accordingly. Start your process early, rather than late.
- Payor Risk: Heavy PPO involvement can provide a significant amount of upside lift for a large DSO that’s heavily negotiated their reimbursement rates. However, comparably, a practice that has a heavy delta premier presence will lose that benefit at re-credentialing with most acquirers thus impacting overall profitability. Medicaid is difficult to process across the board, and most buyers shy away from any concentration higher than about 20% or so. Similarly, fee for service can be a warning signal to some buyers, as FFS practices tend to be largely reputation dependent within their local markets and replacing a legacy provider in a practice such as that tends to be more difficult, even with the significantly higher margin rates. Obviously, your business is what it is, and there’s little you can do to truly change that ahead of a sale. However, being cognizant of these hurdles can help you set expectations, and determine when the time is right for exit. Additionally, understanding these market dynamics can inform changes you may make now for growth purposes if your exit is likely 5+ years away.
- Geography: The sad fact of the matter is that there are some states that are business friendly, and some that simply aren’t. States that have favorable tax environments, and population growth are valued at a premium, and those experiencing decline simply do not. DSO’s want to go where the patients are, and they want practices where the patients are going, so these types of geo-political shifts have a tangible impact. I mention this less to inform change, and more to help provide some context to the vastly different multiples being paid in various geographies.
- Financials, Interest Rates, & Environment: You might think that having a PE backer will provide unlimited dry powder investment into a given space. However, that couldn’t be further from the truth. In many cases, PE groups are leveraging their free capital against bank financing and that incestuous relationship leads to challenges when rates skyrocket, financing gets restricted and cash becomes expensive, as it is now. This also brings into focus the type of PE group backing the DSO you may be speaking with, as well as the longevity of the fund, experience within the healthcare vertical, operational experience within dentistry, timeline of the investment and leadership of the organization. All have an impact on cost and availability of capital, which has a direct correlation to the offer values presented. This may seem like a lot to consider, but the “highest offer” is often not the best option. The people writing the checks behind the scenes have full control over the support services offered, the growth of the organization, your stock value, operational oversight, etc. They can turn on the spicket or shut it off equally as quickly and in instances where very likely 30% of your transaction value will be tied up in company stock, you need to know who the puppeteers are.
The Good News
There are hundreds of buyers in the dental space, and invariably there are a few “hot hands” in the acquisition market who are utilizing whatever environmental factors (positive or negative) to their advantage in an effort to hit growth targets. This can have a muting effect on many of the factors listed above, and finding those golden ticket buyers can alleviate issues with funding, lower valuations, difficult purchasing terms, completely irrational future value projections, etc. And better news? TUSK Partners works with over 200 buyers and finding the right one, that will be an optimal partner while maximizing your value at exit is our job. There are a LOT of variables to work through and our process extracts the highest possible EBITDA number, defendable at QofE, and positions you optimally in front of a pool of buyers who will look favorably on all the various intricacies of your business, future goals and risk factors. Take stock of your situation, give yourself a reasonable exit timeline, and give us a call. There isn’t a firm in the space that is better positioned to maximize your exit value and provide you with the counsel you’ll need to make one of the most impactful decisions of your professional career. Selling your life’s work isn’t something to be trifled with and understanding fluctuations in the industry will go a long way towards ensuring a favorable process for you, your team, and your family!
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About TUSK Partners: TUSK Partners (“TUSK”) provides M&A Advisory services in the dental industry. TUSK has completed over $800M of transactions across all specialties. With an in-depth understanding of the marketplace and access to 100’s of buyers nationwide, we help our clients confidently pursue M&A transactions that maximize their long-term value. With our significant collective experience of over 40+ years of dental practice transactions, we offer our clients solutions that help them achieve their strategic and financial objectives. For more information, visit https://tusk-partners.com
