As Dental Service Organizations (DSOs) continue to make inroads into private practice ownership, we occasionally see one of their practices from their inventory hit the marketplace. We suspect as Private Equity (PE) increases its stake in these DSOs, they continue to evaluate their inventory of practices so that they maintain their stronger assets in that inventory. The sale of these practices might provide good opportunities for the next private owner…or maybe not. I am hopeful that this blog provides some insight on to prospective buyers on what they need to consider when looking at one of these DSO practices.
Whenever a buyer brings me a DSO practice to assess, the very first thing I wonder is why are they selling THIS practice? Was it a practice that was part of a multi-location purchase they made, and they really weren’t interested in it? Was it a practice in an area where they purchased another practice with better performance metrics? Was it an underperforming practice they thought they could improve on? Was it a practice that was performing well and it slowly declined under their ownership? The fact is, you will never get the answer to these questions, at least an answer you can trust. However, as a buyer, this is one aspect of a DSO practice sale you need to think about.
Here are other aspects of a DSO practice sale that buyers need to watch out for when assessing these opportunities. These issues come from our experiences looking at these practices on behalf of buyers.
Tax Returns – Whenever you are looking at a practice, one of the main documents you want to see are the past three years of practice income tax returns. The problem with DSO practices is that many times these practices were simply an item of inventory that was combined with all their other practices and reported on one tax return. Therefore, the DSO may not be able to provide you with a tax return just for this one practice. If they can provide a tax return, many times it won’t have some of the typical items you would expect to see on a normal practice tax return. It may be missing all the tangible assets, which are owned by another DSO owned entity. Also, it may be missing a lot of expenses you would normally see in a practice tax return since they are getting paid by the DSO management company entity. Therefore, if you do get a tax return, it’s unlikely that you can rely on it for the entire picture.
Profit & Loss\Cash Flow Statements – Without a practice tax return you are left with asking for the specific practice’s P&L and\or cash flow statement to use for your analysis. Even though these will be more helpful to a prospective buyer compared to a tax return (in this case), the P&Ls need to be viewed with a discerning eye. The problem is the practice P&Ls will likely be missing many expenses that the next owner will probably have. The reason for this is the DSO will typically have a management company that covers many administrative and management services and other expenses that this practice will need. Examples of these missing expenses may be advertising and marketing, payroll processing costs, computer repairs and expenses, software & IT expenses, subscriptions, some insurances and some general office expenses and supplies. In addition, there may be some wages for administrative and management functions that might be provided by a shared employee who is getting paid from another DSO owned entity. There is also the possibility that the dental supply and lab expense costs are lower than the next owner will experience. For example, the DSO may receive discounts from certain vendors due to the bulk ordering for all the practices in their inventory. These discounts can extend to any vendor of services or materials a practice might use, not just dental supplies and lab. Sometimes, the practice actually pays a management fee to a DSO owned management company entity to cover the cost of some of these services. The DSO might eliminate this management fee on the P&L they provide to prospective buyers, chances are they don’t add back those services and expenses. As a prospective buyer, you truly need to evaluate every expense line item and ascertain if it’s at the level you can expect if you take over the practice.
Production and Collections – Another aspect that needs to be scrutinized is the production by the providers of the practice and how this relates to collections of the practice. Just as a DSO might benefit from discounts on certain expenses, they might also benefit from higher reimbursement rates from Preferred Provider Organizations (PPOs). It’s quite common for DSOs to negotiate with PPOs for higher reimbursement rates since they have a ton of practices that might participate with these PPOs. You must wonder if the sole owner of this practice will enjoy the same PPO reimbursement rates that the DSO enjoyed. There may also be the pressure to produce aspect of a DSO practice placed upon the practice providers. A prospective buyer will need to review many patient charts of the practice to see if the diagnosis and the treatment on a patient is similar to what the buyer would have diagnosed and treated. When there is pressure to produce it is entirely possible that certain procedures and treatment may have been excessive and NOT how you would have handled the patient. It is also possible that this practice has added production from a traveling specialist the DSO employees or contracts with, that may not exist when you take over the practice.
If possible, depending on how long DSO owned the practice the prospective buyer should ask for the tax returns and production reports of the previous owner and compare with the current financials of the practice. When we are able get this information, sometimes the differences we see can be quite eye-opening, in a good way or a bad way.
The bottom line is that as a prospective buyer, when looking at a practice being SOLD by a DSO, you must take your time to understand what you are seeing and approach your due diligence with extra caution. It is not uncommon that we see these practices being presented with much better cash flow than any other buyer will experience. It could be that the production\collections are higher than you will experience and/or the expenses are understated because they are getting paid by another DSO entity or simply non-existent within the DSO organization.