Demystifying Group Practice Structures
The modern dental service organization ("DSO") has been around since the 1970’s. Growth began increasing in the late 1990’s with a handful of dental IPOs. The DSO space exploded in the early 2000’s with the growing involvement of private equity in the sector which continues to present day.
Naturally, structures can and do vary widely however there are generally two classes of DSO – the TopCo Model and Non-TopCo Model.
This write-up is intended to address some of the more common topics I encounter in my daily DSOland travels.
The TopCo Model
- The TopCo Model is straightforward - 100% of the economic ownership interest in the practices is held at the parent company entity (“TopCo”)
- The cash flow of the underlying and/or affiliated entities – i.e. the dental practices or professional corporations – all rolls up to the TopCo entity
The Non-TopCo Model
- The Non-TopCo Model is where things can get very interesting and tricky, quickly
- They are referred to by many names – “JV”, “SubDSO”, “Hybrid”, “Distribution”, “DPO”, “DMO”, etc.
- Non-TopCo models come in endless varieties but tend to settle into two major categories – JV-Only and Hybrid
JV-Only
- JV transactions are where the residual ownership retained by the sellers remain at the practice entity/professional corporation level
- There is no go-forward ownership in the parent entity or TopCo
- Post-closing, the value of the retained equity is tied exclusively to the performance of that practice and its future value
Hybrid
- Hybrid transactions are where the residual ownership retained by the sellers is split between the practice entity and TopCo
- The weighting between TopCo and SubCo equity varies
- Hybrid structures are intended to offer a blended TopCo/SubCo return
- Hybrid structures can inadvertently introduce conflicts of interest
Key Considerations
In a vacuum, all models have their pluses and minuses. Some limit both upside and downside. In others, risk and reward are unrestrained. Most are somewhere in between.
There are some key terms to familiarize yourself with when it comes to analyzing JV offers:
Management Fees
- Is the TopCo entity charging a management fee to the SubCo entity - e.g. 5-10% of collections
- Management fees are generally considered as a preferred return to the TopCo equity at the expense of the SubCo equity
- Management fees should always be considered when looking at relative returns and risk sharing
- Can management fees be suspended or clawed-back in a downside scenario?
Distributions
- A common selling point to JV structures is the availability of ongoing distributions tied to the retained ownership interest
- It is crucial to understand how distributions are going to be calculated and paid out
- What is being deducted “above the line” – e.g. management fees, capital expenditures, interest expense, principal amortization, etc.?
- How are deductions being determined and disclosed? Are they being prorated? Do you have any input on major deductions, like capital expenditures?
- Be sure to ask for some real-world examples of distribution calculations from other practices to review as part of your sell-side diligence
Subordination
- Are any of your interests being subordinated to lenders, the private equity investors, management investors, etc.?
- Have you contemplated scenarios under which your liquidity in your retained ownership could be compromised by the parent entity’s financial health?
- How much ($) debt and equity capital is senior to or “ahead of” your JV interests?
Liquidity
- Assess your liquidity – under what circumstances can you sell and to whom?
- Are there put and call rights? Under what circumstances?
- Are there limitations on how much of your ownership you can sell off at the next recapitalization event? If so, who controls that?
- Are there any arbitrary valuation constraints limiting the JV-interest from getting the “full ride” on the parent company valuation or implied multiple? Sometimes this is achieved structurally and sometimes there is a hard cap on the “inside valuation” of the JV interests – e.g. 8x EBITDA.
Personal Guarantees
- TopCo structures do not require the personal guarantees (“PGs”) of new affiliates on the debt of the parent company
- Non-TopCo structures may require that minority shareholders personally guarantee some or all of the acquisition-related debt
- A need for personal guarantees from minority owners speaks primarily to the financial health of the parent entity as a well-capitalized parent generally doesn’t require such credit enhancement from sellers
Hope this was helpful. Please LMK if you have any questions.
Best,
Sean