“I want nine times on $1.8 million in earnings before EBITDA, 80% cash at close, and no earnout!” “I want eight times on $550,000 in EBITDA, 100% cash at close, and a 12-month employment agreement.”
I hear the above statements all the time. At times, I sit back and wonder where it all comes from and how these expectations began.
Kevin Cumbus.
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 must be addressed, and the fault lies everywhere.
Dental service organizations (DSOs) say they’re offering premium multiples with huge equity upside, conditioning sellers to numbers that are out of the market and generally unobtainable. Brokers do much of the same to “win” the listing.
Certified public accountants and attorneys with minimal mergers and acquisition (M&A) experience believe that practices are worth more than they actually are. So, where do you go?
Besides dealing with all of the mixed emotions that come with selling your life’s work, selling today is a landmine-laden playing field that is difficult to successfully traverse. Understanding expectations from both the side of the buyer and seller is critical, as is gaining a better understanding of how valuations are driven and what the critical components are that influence dental practice valuation.
Traditional valuation methods
For decades, practice valuations consistently hovered between 70% and 90% of prior-year collections, with that variance due largely to geography, condition of the equipment/space, composition of the payer environment, and the procedural mix. Ah, 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, or earnings before interest, taxes, depreciation, and amortization.
Essentially a base profitability metric, EBITDA shined a light brightly on practices that operated efficiently and profitably versus those that were just revenue hogs operating inefficiently. Acquisitions increased at a frenetic pace.
So, for a practice owner dentist, what do viable expectations look like? And how, as an owner, do you plan for your inevitable transition, whether you sell your practice to another doctor or if the sale is DSO/private equity driven?
Evaluating risk
It’s important to realize that DSO valuations are largely driven by a measure of risk. Here are three considerations that play heavily into the valuation of a dental practice:
- Provider risk. Will it be easy to recruit a replacement? Is the doctor a super producer, thus indicating a significant key-man risk? Will the lead doctor commit to staying four or five years after the sale’s closing? All are significant considerations in a DSO transaction, and all factor heavily into the valuation they will provide. A key focus is the stability of the organization post-close, and the lead provider is the most important part of that equation.
- Payer risk. Heavy involvement with a preferred provider organizer can introduce significant upside for a large DSO that has heavily negotiated its reimbursement rates. However, a practice with a heavy Delta Premier presence will lose that benefit at recredentialing 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 these 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.
- Geography. States with favorable tax environments and population growth are valued at a premium, and those experiencing decline simply do not. DSOs want to go where the patients are and they want practices where the patients are going, so these types of geopolitical shifts have a tangible impact.
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 using whatever environmental factors (positive or negative) to their advantage 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.
Selling your life’s work isn’t something to be trifled with, and understanding fluctuations in the industry will go a long way toward ensuring a favorable process for you, your team, and your family!
Kevin Cumbus is the founder and president of Tusk Partners, an M&A advisory firm focused exclusively on large and group practices that want to partner with a dental service organization or private equity group.
The comments and observations expressed herein do not necessarily reflect the opinions of DrBicuspid.com, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.
