Equity Arbitrage
Even if you’ve heard the term before, you may not know that equity arbitrage is a financial concept that was rarely utilized by dentists before private equity started investing in the space. In short, it all has to do with how valuable the equity is in your practice currently and how much your equity ends up being worth after the sale of your dental practice. “It may be appealing to wait until retirement before starting the sale of your practice, but you would be leaving value on the table,” Professional Transition Strategies Founder and President Kyle Francis said in an article for Dental Economics. Here are all the ways equity arbitrage could play out during the transition of your dental practice.
When does equity arbitrage take place?
Equity arbitrage occurs during a consolidation wave, such as the one occurring now with dental service organizations (DSOs) since they can offer more money for the same practice because they’re backed by private equity and, therefore, not beholden to the same debt ceilings that private owners have to deal with. Francis explains that by owning your practice, you essentially own the cash flow that exists after all the expenses of the practice are paid, including a fair doctor’s salary to do the work. This cash flow works like an annuity, which you can leverage as an investment much differently than before consolidation. If your equity can be combined with multiple other practices’ equity, the large investment vehicle can grow faster and provide more returns. In the case of DSOs, this means a much higher financial result is accomplished, and the dentist can be the beneficiary of that arbitrage.
What is needed for equity arbitrage to occur?
Since dental practices have a steady cash flow and recurring clientele, they can be very profitable, which is appealing to private equity investors. During a consolidation wave, a private equity firm can buy a dental practice at fair market value and increase the value of the equity that has been invested by five times over the course of a typical five-year private equity investment cycle. Equity arbitrage can take the form of a 100% buy-out, sub-DSO concept or joint venture.
How does the equity arbitrage process start?
Francis notes that yes, DSOs approach dental practices all the time, but the best way to know the true value of your dental practice is to have it appraised by a professional broker. Only then will you learn its enterprise value, which calculates earnings before interest, taxes, depreciation and amortization (EBITDA), along with how many multiples of this value groups will consider offering. A professional advisor will be able to assess your risk profile to determine how much you want up front versus how much potential you must earn with the sale of your dental practice.
Bottom line
Francis concludes by adding there’s always risk in investments, and nothing is ever 100% guaranteed. Contact the experts at Professional Transition Strategies to determine when is the best time to transition ownership of your dental practice.