How to Maximize Your Outcome in a DSO Deal – Episode #372

If a DSO comes calling, making a mistake during negotiations could be extremely costly. Here’s how to control the discussion and maximize the outcome. On this episode of the Dentist Money™ Show, Ryan interviews Brannon Moncrief of McLerran & Associates. Whether a DSO is showing interest, or you’re selling a practice, find out why adding a sell-side advisor improves your position.

 

 

 

 

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Podcast Transcript

Ryan Isaac:
Hello everybody, welcome back to another episode of The Dentist Money Show, brought to you by dentist advisors, a no commission, fee only fiduciary, comprehensive financial advisor just for dentists all over the country. Check us out dentistadvisors.com. Today on the show, I’ve got a new friend, Brannon from McLerran & Associates, that’s dentaltransitions.com. We are talking about all things DSO today, really good conversation about common mistakes, dos and don’ts, deal structure the nature of the industry where things are headed, what he has seen in recap events, points of negotiation the dentist typically miss as sellers, this guy knows his stuff and was really cool to spend some time with us and part some wisdom. So many thanks to Brannon, I’m pretty sure we’ll do more stuff with him down the road. This is really helpful and many thanks to you for tuning in. If you have any questions for us, as always dentistadvisors.com. Book a free consultation with one of our friendly dental specific advisors. Ask your money questions to dental CFP. We would love to help you. And thanks for being here. Enjoy the show.

Jess Reynolds:
Hey there, it’s Jess with Dentist Advisors. Did you know we recently launched a new service called the Dentist Money Membership. It’s an affordable way to support your personal financial strategy with cutting edge technology and guidance from dental-focused CFP advisors. The dentist money membership includes the elements financial monitoring app, an annual financial check-up, CE courses, an automated investment platform and more. To learn more about the dentist money membership and to get started go visit dentistadvisors.com/money.

Announcer:
Consult an advisor or conduct your own due diligence when making financial decisions. General principles discussed during this program do not constitute personal advice. This program is furnished by dentist advisors of Richwood Investment Advisor. This is dentist money. Now, here’s your host, Ryan Isaac.

Ryan Isaac:
Welcome to The Dentist Money Show, where we help dentist make smart financial decisions. I’m your host, Ryan, and I’m joined by a new friend of the show, Brannon from McLerran & Associates. Brannon, thanks for being here. Welcome to the show.

Brannon Moncrief:
Yeah, absolutely. Thanks for having me.

Ryan Isaac:
Yeah, and I’m excited about this. Coming to us from Austin, Texas, and I think the name McLerran & Associates is gonna be familiar to a lot of dentists, a lot of our listeners, especially, man, in this day and age. Today’s conversation we’re having is about DSOs and the DSO space, transitions, just thinking about that segment of the market that’s growing so much. We probably, as advisors have… I mean every advisor in our firm’s probably having one to two conversations about an offer every single week. Actually, as a matter of fact, as we started hitting record, I got a message on my phone from our advisor group. I’m just gonna read this to you ’cause I think this is just kind of funny. The first part of it says, “I’m knee deep in a DSO analysis and I’m meeting with a group with two of my clients later afternoon… ” and they’ve got questions. And this stuff is happening. It’s so common. So thanks for being here. Would you mind maybe just introducing yourself and McLerran, and just telling our audience a little bit about who you are and what you guys do.

Brannon Moncrief:
Yeah, absolutely. I’m Brannon Moncrief, I’m the CEO and a partner in McLerran & Associates. I’ve got over 20 years of experience in the dental world, about a decade as a banker, and now about 12 years as a sell-side advisor/broker. My firm’s based in Austin, but we do business nationwide, and we do sell side advisory for large practice owners who are considering going down the DSO path. So helping them determine, is a DSO sale affiliation the right route for them to go? And if so, let’s make sure we create a competitive environment, control the narrative regarding EBITDA, maximize the outcome and find the DSO that’s the right fit for them. So it’s all about education and then maximizing outcome, should a doctor decide to ultimately go down that path.

Ryan Isaac:
So sell side, that would be… I just read you that message, so one of our advisors meeting with a couple of clients that are thinking of selling to a DSO. That’s where you guys get involved. Do you get involved… And we’ll probably talk about your business model later too. But do you get involved in the middle of something like that, or do you get involved only from the beginning, like brokering things or finding the buyers, when do you guys jump in?

Brannon Moncrief:
All too often, we do get involved in the middle of it. Where a doctor’s already had a conversation with one or multiple DSOs, maybe even has several offers on the table. And typically when we walk into that environment, I like to say, “Hey, let’s call time out, take a step back, let’s do our EBITDA analysis, our evaluation and kinda reset the playing field, reset the table, and then go back to those buyers that are already at the table along with potentially bringing some new buyers, putting the deal in front of new buyers as well.” It’s all about creating optionality, creating competition and leveraging that environment to maximize the outcome. My preference is obviously to be involved from day one before the practice sees the light of day in the DSO marketplace, because controlling that narrative and how you present your practice to potential buyers is critically important. So I prefer to have it in a formal bid process with us having established a relationship with the doctor, done EBITDA analysis, done evaluation before we ever start introducing it to potential buyer.

Ryan Isaac:
Yeah, you can probably control a lot more, probably avoid some mistakes or pick up some efficiencies. I’m just curious. When you jump in in the middle of a thing like that, if we just called you or if this… Our advisor, Taylor, if he just reached out and said, “Hey, we’re in the middle of this two clients, jump in.” What are some… I’m just curious, like what do people miss in that beginning phase when they’ve collected three offers and have some letters of intent or whatever, and then you get involved, what are some common, maybe mistakes that they’ve made up to that point as the potential selling doctor?

Brannon Moncrief:
That’s a great question. I think a lot of it comes down to, do you have your practice in front of the right DSOs, right? What is your why? What are you looking to accomplish? And are the people at the table actually prepared to help you accomplish that? Is that work-life balance? Is it financial? Is it infrastructure and support? Is it scaling and growing the business? So one, putting in front of the right people. A lot of times, doctors don’t clearly identify their why on the front end, and then when they go to market, when they start talking to DSOs, if they can’t articulate why they’re looking to sell, the DSO can’t answer if they’re the right person to help them accomplish their goals. Financially speaking, controlling the narrative regarding EBITDA is critically important, so EBITDA should be completely objective, right. You should do analysis. I should do an analysis. The DSO should do analysis. We should all come out with a relatively similar result, but the reality is is that private equity is somewhat predatory.

Ryan Isaac:
Yeah, sure.

Brannon Moncrief:
Yeah, their goal at the end of the day is to buy the practice for the lowest possible price they can, and treating EBITDA as a subjective number is a way that they do that in regards to, they’ll adjust EBITDA to layer on infrastructural cost occasionally, they won’t give credit for personal discretionary, non-recurring expenses.

Ryan Isaac:
Right. Can we slow down on some of these? This is one of the questions. So differences in EBITDA, and this is maybe one of the biggest questions that clients end up asking is like, “They arrived at this number, I think it’s this number.” So what was the first one you just mentioned that are some of the discrepancies.

Brannon Moncrief:
Some DSOs will play games in the sense that, they’ll adjust EBITDA based on cost that they are going to layer into the business.

Ryan Isaac:
Oh, they’ll say, “In the future, okay, in the future like, this was your EBITDA, this is your profit, but when we are involved, we have different cost layers, so it’s actually gonna be lower.”

Brannon Moncrief:
Correct.

Ryan Isaac:
We’re gonna give this evaluation based on the future EBITDA when we’re involved, not what it currently is at.

Brannon Moncrief: Right. Now, in reality, we all know that their goal is to leverage economies of scale to drive down cost and drive up EBITDA. But in the situation where we are negotiating purchase, they’re going to try to drive down EBITDA to save money on the purchase. And so many people get caught up on EBITDA multiple. You’ll hear people brag, “I got this multiple, I got this multiple.” Multiple of what? The EBITDA matters far more than the multiple, right? If you’re summoned for seven times multiple, every dollar of EBITDA is worth $7 in value. It moves the needle considerably when you control the narrative regarding EBITDA.

Ryan Isaac:
So I’m just curious, what did they say gets layered in is like higher costs in this privately run practice? What are they saying it’s gonna be? That’s kind of funny.

Brannon Moncrief:
I’ve seen the layer in advertising. Oh, well, our practice is all run at 3% of revenue on advertising, so we’ve got to adjust our advertising accordingly. We have to layer in benefits. You don’t currently provide benefits to your team. We’re gonna provide benefits, so therefore we have to layer in that cost. There’s all kinds of different ways that you can manipulate EBITDA. That’s just one of the ways, right?

Ryan Isaac:
Okay. And then you mentioned a second one, I think you said doctors comp, did you say that, or…

Brannon Moncrief:
Well, the other primary one is add-backs, right.

Ryan Isaac:
Add-back. Oh yeah.

Brannon Moncrief:
If you’re being aggressive in writing off personal discretionary expenses, maybe you have some one-time expenses, maybe you remodel the office or bought a expensive piece of equipment or what have you, you have to fight for those add-backs, and you’ve gotta provide evidence to support those add-backs. So that’s a big part of what we do, is do an investigation on the front end, call it a mini quality of earnings before it ever goes to market, to make sure that we get as many add-backs as we possibly can, but also make sure that they’re defensible, both during the negotiation of the letter of intent and once we move into diligence and the quality of earnings process.

Ryan Isaac:
Yeah, okay. And so, my question was, when you get involved in the middle, people maybe have already accepted offers or started just anchoring to some multiples, instead of really drilling down on EBITDA and figuring out if that was the right number in the first place. Is it hard to go back then, like if you jump in in the middle of this process and like, “You guys, we gotta go, we have to go re-do this number to base all these multiples on,” does that apply?

Brannon Moncrief:
It’s possible but not ideal.

Ryan Isaac:
Yeah, it’s gonna be like bars.

Brannon Moncrief:
Because what happens… Yeah, so when you send your information to a DSO, a business development person, taste into their investment board and essentially pitches the deal. And they’re dialing in on EBITDA and valuation during that conversation. So if we come in mid-stream, there’s already an offer on the table, they’ve already done an EBITDA analysis, the doctors already answered questions and helped draft that narrative without the knowledge, maybe that they were actually drafting that narrative or negotiating it ourselves. It’s more difficult to move the needle when there’s already offers on the table, than it would be if we have a fresh start and we were controlling the narrative from the beginning.

Ryan Isaac:
Totally.

Brannon Moncrief:
That said, we walk into the room all the time when there’s multiple offers on the table, and we’re able to reset that stage and move the valuation considerably 10, 25… 10, 20% in most cases somewhere in that room.

Ryan Isaac:
Okay. Something else you mentioned earlier too, and I wanted to circle back on was, you were talking about the why, picking the right DSO to match the why, which is, man, it’s so important to match the why or what your personal value is to financial decisions. I think that gets overlooked a lot, but you were mentioning things like, it sounds like you were saying you have to figure out what you want to maximize ’cause you can’t maximize all three. You can’t maximize continuing to grow and scale the business you’ve been working on while also maximizing getting the highest possible pay out. You can’t maximize probably the most cash upfront and also the most equity on the back end. Do you wanna maximize for getting fully out of the business and relieving yourself of everything and just being an associate for a few years and being done, or do you wanna maximize for remaining a partner? That’s what I heard you saying. We gotta pick what matters most to us. Did I hear that right or like how would you do that?

Brannon Moncrief:
Absolutely. Yeah, you’ve gotta find your why. You’ve gotta prioritize your priorities, right. So you’ve gotta figure out, if we were to list five things that you’re trying to accomplish through affiliating with the DSO, let’s put those in a pecking order, and that may determine who we put the practice in front of. It will certainly determine what offer we ultimately accept. Most of my clients go through the exercise and tell me, “Hey, you know what I’m trying to accomplish, but show me everything, let me meet everybody.” So we’ll get 10, 15 different buyers at the table, and let them meet everybody, hear their story. If you met one DSO, you’ve met DSO. They all have a different history. They’ve all grown differently, they all have a different number of locations, they all have a different culture, management style, infrastructure, financial backer, financial goals. Every single one of them is different. Yeah, at the end of the day, if they’re backed by private equity, the goal is to make money, you know at the end of the day and recap the investment. But how you go about that, from DSO to DSO is very unique.

Brannon Moncrief:
So responding to an unsolicited offer, only talking to one buyer, not controlling the narrative, not defining your why, these are a lot of the mistakes that we see doctors make when they start to go down this path.

Ryan Isaac:
Yeah, and I think a lot of dentists just figure a DSO bio, like you said, if you talk to one, you’ve only talked to one. I think a lot of people misunderstand that a DSO bio is only about a huge payout and an exit, and you’re done, boom, it’s over. But you’re saying there are so many different types of incomes based on what you’re trying to do, or outcomes. So could you… Maybe let’s run through those really fast, so you’re saying there are DSOs that would keep… If you are someone who likes to grow and build and scale your business really big, you could partner up with the DSO that’ll help you keep doing that.

Brannon Moncrief:
Yeah.

Ryan Isaac:
If that’s like your ‘why’, that’s your passion.

Brannon Moncrief:
Absolutely, that’s a very specific buyer, right? That is either a private equity that’s gonna treat you as a platform and build robust infrastructure around you, or it’s an existing DSO that maybe as a joint venture model where you’re gonna partner with them and leverage their infrastructure to help you grow without driving yourself completely insane. So that’s just one example of a why and then what type of DSO you would gravitate to. But, yeah, you’ve gotta put that complete story together and then go to market. Go to market, create a competitive process, get multiple bids, meet a lot of people, and then help… We help our clients to cipher all that noise, all that information and ultimately make a decision. By creating that hyper-competitive environment, at the end of the day, the goal is to identify what DSO is best positioned to accomplish my ‘why’, and then leverage that competitive environment to get the best economics or really favorable economics out of that particular buyer.

Ryan Isaac:
Yeah, I think that’s a huge… That piece just might be huge insight to a lot of people who, again, I think just misunderstand that a DSO is a DSO, and it’s all about maximizing the payout.

Brannon Moncrief:
Yeah. DSOs have built huge business development teams. There are people on their team that all they do all day long is go call on doctors and bird dog deals. They’re paying referral fees to doctors within their network to refer their buddies. So just because your buddy says, “Hey, you should sell this particular DSO,” doesn’t necessarily mean that it’s the right fit for you, and it doesn’t necessarily mean that it’s in your best interest. So, there is a industry that’s been built around finding doctors that are interested in selling to a DSO and negotiating a deal in the dark, rather than having advisors like us at the table that are gonna hold their feet to the fire.

Ryan Isaac:
Yeah, that’s interesting. And that… You’re just saying that’s kind of the way that it’s been going as an industry, but it probably is changing a lot. Can you talk about, this is kind of on our list of things I wanted to hit, current market conditions of just this whole space, obviously just a huge point of interest? And it’s really fascinating to me, I would say… I don’t know, four or five years ago. Mostly just doctors in their 50s and 60s were the ones talking about this, but now we have people in their 30s calling me and being like, “I got an offer,” [chuckle] like, this is crazy, man, this is just so different than I think anyone could have ever thought it would end up being. So what’s the market like out there? And when someone’s asking, what are market conditions like? How would you describe that?

Brannon Moncrief:
Yeah, the dental market’s been white hot over the past few years, it is probably the hottest vertical that private equity is looking to invest.

Ryan Isaac:
Why? I mean, is it just because it’s so steady and profitable? Like you were… Okay, you were a banker. I’ve heard a lot of dental industry bankers tell me, like one specifically was saying that the default rate on start-up dental practice lending, is less than a quarter of a percent or something. I don’t even know if I heard that right, but I remember it was less than a percent, and so I’ve always just thought, “Man, there’s probably not a safer profession, as much profitability as the dental industry,” It’s kind of insane, is that why… Or what’s driving some of this?

Brannon Moncrief:
Yeah, it is. Dentistry is very profitable, and it is kind of… Recession, pandemic, nothing really impacts it remarkably, so it’s very resilient. It’s also a very fragmented industry where the doctors are not necessarily highly educated about their options, and you can leverage economies of scale by building a larger group as opposed to doctors on their own don’t have that leverage to negotiate with payers or negotiate with vendors. So, a highly fragmented industry that can be organized relatively quickly, you can leverage economies at scale to make a very profitable business even more profitable, and then it’s very resilient, very risk-averse, like you said, default rates in the dental lending world are basically non-existent.

Ryan Isaac:
[chuckle] Yeah, it’s like a rounding error.

Brannon Moncrief:
Yeah, yeah. And then if there’s interruption like COVID, dentistry has proven to rebound extremely quickly.

Ryan Isaac:
Oh yeah. Big time.

Brannon Moncrief:
So private equity was already…

Ryan Isaac:
Interested.

Brannon Moncrief:
Putting a ton of money into dentistry pre-COVID and then watching how fast dentistry rebounded post-COVID…

Ryan Isaac:
It is frothing.

Brannon Moncrief:
Yeah, exactly. It got frothy. So, you saw multiples go up, you saw evaluations go up, you saw demand go up, there’s now over 200 DSOs operating across the country.

Ryan Isaac:
200? Real fast, what’s the definition of a DSO to be in that 200?

Brannon Moncrief:
The definition, in my opinion is that you’re legally organized as a DSO and you have to have more locations.

Ryan Isaac:
More than how many?

Brannon Moncrief:
I’d say more than two locations.

Ryan Isaac:
Okay, okay. Yeah, legally, your legal entity is a DSO and you have more than two locations, then more than 200. How many of those… When people think of DSO big scale, maybe 100 plus locations. Big, big scale. Is that a big percentage or are most of these small, half a dozen or so regional kind of…

Brannon Moncrief:
There’s only about, I would say 15 DSOs with 100 plus locations. Most of them, and some of those don’t buy practices. So most of them are more in that emerging or mid-sized category. There’s somewhere in the range of 30-75 offices. And then, you have the smaller emerging DSOs, the privately-owned bank funded, I’ve got five locations with five to 10 million in revenue. There’s a lot of those out there.

Ryan Isaac:
Yeah, there’s a ton. How many do you think aren’t gonna make it? How many of these smaller emerging DSOs are like… Let’s say in five years, I’ve known maybe two that clients sold to that were kind of emerging, I’m in early, the equity upside could be very big, but the risk is obviously higher and they actually did end up folding and liquidating and not existing anymore.

Brannon Moncrief:
I think very few of them are gonna completely fold and be forced to liquidate in bankruptcy or something like that.

Ryan Isaac:
Some will be consolidated in themselves even though? Like gobbled…

Brannon Moncrief:
Yeah.

Ryan Isaac:
Up by… Oh, yeah.

Brannon Moncrief:
There’s definitely gonna be some consolidation among bigger players buying some of the struggling smaller players, so it’s not gonna be a complete bankruptcy, complete loss of funds, but it’s gonna be essentially a re-capitalization at an undesirable multiple. And you’re gonna be folded up under a much larger entity. I think we’re gonna see some of that over the next couple of years, especially if interest rates stay high, we enter a recession, I think you’re gonna see some DSOs that don’t have the operational fortitude. They were really never built to be run and operated long-term, they were built to aggregate and flip to the next investor.

Ryan Isaac:
And just didn’t time it right.

Brannon Moncrief:
Yup, and you’re gonna see some of those that are gonna struggle. They never intended to operate it, now they’ve gotta enter a long-term holding pattern because the economics have changed, money is not as loose, people aren’t buying emerging DSOs and they’re gonna be tested from a leadership, from an infrastructure perspective, and then from a deal structure perspective. I think those DSOs that are doing the joint venture model that have vested doctor partners at the practice level, I think they are better positioned to survive long term because it’s just a more sustainable model. You’ve got a DDS at the practice level that has a vested interest in the performance of their specific practice, they’re not just holding equity in the parent company, and what they do locally doesn’t move the needle that much one way or the other.

Ryan Isaac:
I’ve heard people refer to those as DPOs, I don’t know if there’s an official way, dental partnership organization, I don’t know if there’s an official way to call them, but you’re just talking about the…

Brannon Moncrief:
Yeah, we need to coin that DPO marker. Yeah, now you’re seeing quite a few people following their footsteps, calling themselves DPOs and then doing the joint venture model.

Ryan Isaac:
Yeah, and they’ll usually come in and buy up to what, 80% of the practice, leaving 20 for the doc, as high as maybe leaving 40% for the doc or how… What’s the range kind of in there? I think it varies.

Brannon Moncrief:
Yeah, they’re typically buying 60%-80%, and the doctor is retaining 20%-40% at the practice level, and then they have the opportunity to participate in recap events in the future and sell down some of that joint venture equity.

Ryan Isaac:
Yeah, one question you probably get a lot, it might be just cliche and annoying, but what’s the prediction for total industry consolidation? What percentage of this industry becomes a group-owned practice, corporate practice?

Brannon Moncrief:
I think of the practices that private equity and DSOs would wanna buy, in other words, they’re not really chasing smaller practices with no EBITDA. You’ve gotta be about a million in revenue to be an acquisition target for a DSO and generate substantial value.

Ryan Isaac:
Okay. What percentage of the dental industry is that in the first place?

Brannon Moncrief:
I don’t think anybody knows. I have not heard a good statistic.

Ryan Isaac:
That’s hard to say.

Brannon Moncrief:
So when you talk about consolidation, it’s like, are we talking about how much dental revenue is going to be managed by DSOs, how many response, how many practices? But I think of the practices that DSOs would wanna own, I think we’ll probably get to somewhere around 50%-60% of those will be DSO, private equity owned, within, I’d say seven years from now.

Ryan Isaac:
Man, and after that, it just cools down, money cools off, interest cools off?

Brannon Moncrief:
After that, I think you will see interest cool off to some degree. Most of the institutional investors that own the DSOs at that point will be more in a long-term investment pattern, maybe a 10-15 year hold like Heartland is now, rather than being in a three to five year aggregate and flip game.

Ryan Isaac:
Yeah, that’s a good example with Heartland being one… Was it the first big major organization? I don’t know if it’s probably the first, or…

Brannon Moncrief:
It was one of the first of the new generation of DSOs.

Ryan Isaac:
Of the new generation. I just wonder to myself sometimes, where does this end? If it’s, let’s say it starts as a regional thing, it’s got a dozen practices gets gobbled up, and then it recaps once, recaps twice, does private equity wanna hold these things for 30-50 years? Do they go public eventually? These companies get so big, they have to go public, or/and I guess is there a scenario where some of these end up getting bought and sold, and bought and sold so many different times that eventually somebody’s left holding these practices and just starts liquidating them back individually back into the market for new students, does that happen?

Brannon Moncrief:
It could build up and then to some degree, fall apart in the sense that it moves back towards the private practice model, but I think you’re gonna see a handful of DSOs go IPO once this recessionary period passed. Heartland, MB2, several others were eyeing an IPO just as recent as a year ago. But now, I think those plans are on hold for most people, given where we’re currently at, the economic climate. And then, I think you’re gonna see massive consolidation. The consolidator is buying the consolidators. So seven and 10 years from now, I think you’re gonna see massive consolidation among the DSOs themselves, and then they enter into more of a long-term holding pattern, and private equity, there’ll be some other bright shiny object that private equity starts paying.

Ryan Isaac:
Totally. It’ll be my industry. Actually, it’s already started.

Brannon Moncrief:
It’s started. Yeah.

Ryan Isaac:
Yeah, it started. Is it as evil and sinister corporate dentistry has always been? It’s always had the reputation of just being bad care, no love, no passion, it’s just cold and corporate. Or does the amount of just where it’s all heading and the people getting involved in this from a DSO level, does it change that reputation? Does it change that whole, just kind of like cold, unfeeling, faceless corporate vibe?

Brannon Moncrief:
No, it’s a great question. So I would say up until about five years ago, we didn’t even bring up the DSO option to most of our sellers because half of ’em would run us out of their office.

Ryan Isaac:
Yeah, they’ll be like…

Brannon Moncrief:
Don’t wanna talk about it, DSOs are evil. But I think that Moniker has changed and become more acceptable for several reasons. The new iteration of DSO is focused on, “Hey, let us take the operational part, the administrative part of the practice that you don’t… You’re not trained to do, you don’t enjoy doing, let’s take that off your plate and remove that from the practice, that’s our lane, that’s what we’re good at, and let’s let you do what you’re good at and keep your clinical autonomy. So, the new generation of DSOs is really, really big on clinical autonomy, and I’m talking about… I’m not talking about Pacific, Aspen, Castle, I’m talking about the DSOs that acquire practices. They’re not the de novo model, I’m talking about the DSOs that are actively acquiring practices. They’re huge on clinical autonomy, they’re big on infrastructure and support, and they have allowed dentists to occupy C-level positions within the organizations as well as invest alongside private equity.

Brannon Moncrief:
The old school model was, we’re gonna buy 100% of your practice, you’re gonna get 70% cash at close, we’re gonna put you on a three-year earn-out and you’re gonna get to the rest of the money over time. The new school model is, you’re gonna have holding company equity or joint venture equity, you’re gonna be able to participate in recapitalization events. They’ve allowed the doctors to create potentially generational wealth alongside private equity and sharing that arbitrage, sharing that return where that wasn’t available previous to this generation of DSOs. So I think for those two reasons, learning to stay in their lane and give the doctor’s clinical autonomy and then allow the doctors to participate in the upside financially, those two things, I think have made this generation of DSOs far better than the previous generation of DSOs.

Ryan Isaac:
Can we talk about deal structure? This is still a big question mark for people who have never been through this or haven’t researched this much. Can you talk about the normal parts of a deal? How they work with each other? From my understanding, in most deals that I’ve seen, you’ll have, like you were just saying, cash up front, you’ll have some kind of earnout based on hitting certain metrics while the doctor still employed after the sale. And then now, equity in the larger organization for future recap events and new investment. Those are the three main parts that I understand. Can you talk about those? Any others that exist and how… I don’t know, how you can kinda play with those numbers? Some people want more cash, some people want to bet bigger on the DSO and have more stock. Can you negotiate your salary? I’ve heard stories from very successful big practice owners who sold, got so much money, and they’re working back, but they’re kind of bummed that they’re making 350 grand running a $6 million business. [chuckle] They know they got paid and they know they’re still gonna get paid, but it just feels weird. There’s just some other emotional dynamics in it, but can you break down like a typical deal structure and how it can maybe be molded?

Brannon Moncrief:
Yeah, absolutely. Before we get there, you made this point earlier, I’ll make it again. Deal structure and fit, this is important, if not more important especially if you’re younger than valuation. Valuation matters but deal structure and fit are just as important. So when we talk about deal structure, yeah, there’s several components, obviously, cash at close. Some people are trying to max their cash at close, especially maybe if they’re a little closer to retirement and they’re trying to hit their nest egg, or they have plans to invest that money in some other business or venture. While others are less sensitive to cash at close, they would prefer to allocate as much as they can to the equity component ’cause they’re younger, they wanna keep some joint venture equity and continue to share in the cash flow of the practice, and they like that recap potential. But there’s always gonna be a cash at close component, it’s gonna be somewhere in the range of 60%-80% of the enterprise value of the practice.

Brannon Moncrief:
You mentioned earnouts, holdbacks, things like that. I will say, in most cases, we’ve been able to get rid of earnouts and holdbacks outside of the scenario where you’re doing more of kinda like the Heartland, the older school deal structure. If you’re selling 100% of your practice up front, you’re gonna get a cash at close component, and a holdback, earnout component. But if you’re doing some type of joint venture or holding company equity deal, you’re gonna have your cash at close component and likely the remainder of the transaction is gonna be allocated to either joint venture equity or holding company equity, no earnout, no holdback.

Ryan Isaac:
Interesting. Well, is that something that a savvy dentist would have to know to say, “No holdback no earnout, I don’t want this,” or is that… It doesn’t seem like that’s standard, like they would offer.

Brannon Moncrief:
They used to be really common. There would be cash, holdback, earnout and an equity component. But given that the market’s gotten so competitive, the holdback earnout component has gone away in most of these transactions where there’s multiple buyers at the table, therefore, you’re able to leverage that earnout, that holdback and get it removed from the transaction. Now, the equity component may have some type of dissolution or claw-back or what have you, if the practice moves backward post-close. But there’s not necessarily a holdback or an earnout carved out upfront. That said, we normally negotiate an earn up, where if the practice grows post-closing, the valuation actually increases and the doctor is due an additional payment on top of the initial enterprise value. Let’s go back to the question, deal structure. We’ve got the old school deal structure where you’re selling 100% of your practice, 70% cash up front, the remaining 30% put on let’s say a three to five year earnout, broken down in annual installments contingent upon the practice maintaining pre-closing revenue and you fulfilling your employment obligation. So that’s kind of the Heartland model.

Brannon Moncrief:
The joint venture model is, let’s call it the MB2 model ’cause they pioneered it. You’re gonna sell 60%, 70% of your practice, retain 30%-40% of your practice equity at the practice level. You’re gonna continue to share in pro-rata and then income distributions post-closing, so you don’t take as big of a hit in personal income because you’re still seeing some cash flow from the business post-closing, not solely your chairside income, and then you have the opportunity to liquidate all or a portion of that joint venture equity at recap at the parent company EBITA multiple. How much equity you can liquidate, you need to talk about that upfront. Again, do you get the full parent company multiple at recap or is there a cap, a ceiling on it? You gotta negotiate that up front.

Ryan Isaac:
This would include, as a few of our clients have started a recap for the first time, there’s questions that are coming up that didn’t come up in the deal structure, which are things like, “Okay, recap happened but part of the recap stipulation was that I had to re-sign a new non-compete and sign on for another two years to actually get the cash from the recap. Or, in order to keep investing, I got… ” Things they’re just not thinking about, those that all have to be thought of during the time of the deal.

Brannon Moncrief:
You wanna at least ask about it. The DSOs, the private equity firm that owns that DSO doesn’t know exactly what the buyer, their buyer is going to dictate when they go to the market and negotiate a transaction, but you at least need to ask the question, and there are certain baseline deal points that you can ask for in regards to how the liquidation of equity functions at recap. I can sell up to a certain amount. I get the parent company multiple rather than a ceiling.

Ryan Isaac:
I hadn’t heard of ceilings before. Is this gonna be in fine print that people aren’t gonna know about till it happens?

Brannon Moncrief:
A lot of it you see show up in the legal agreements post-LOI. You gotta make sure…

Ryan Isaac:
I don’t think I’ve ever heard anyone say anything about a ceiling before, which makes you wonder how many times it’s been in the language, but they just haven’t known that yet. ‘Cause a lot of these recaps haven’t happened yet, it’s so new that…

Brannon Moncrief:
That’s correct. That’s correct. A lot of this is TBD. Unless you ask about it and negotiate it within, a lot of times the LOI, but at least the legal agreements before you sign. So making sure you’ve got an advisor like us, and a good experienced dental attorney at the table, critically important. Because details matter, especially, when you get to that recapitalization event, and you could be talking about a sizable chunk of change that could be left on the table if you didn’t have these conversations on the front end. And limiting the EBITDA multiple, putting a ceiling on the recap multiple is just one way you could do it. You also need to ask, “Hey, is my EBITDA, that my practice is throwing off, is it gonna be burdened by the management fee of the DSO, when it comes to talk about my recap proceeds? So do you back out the management fee before my recap is calculated, or does my EBITDA not get hit for the management fee, in calculation of my EBITDA at recap?” That can move the needle substantially depending on what the management fee is. By the way, the management fee is negotiable with a lot of DSOs, whether it’s the percentage or you can put a cap on the management fee. That matters, from an ongoing perspective and at recap.

Ryan Isaac:
Geez.

Brannon Moncrief:
So there’s all these little nuances of these deal structures that on the surface in singular nature, may not look like they move the needle substantially, but as a whole…

Ryan Isaac:
Yeah, combined.

Brannon Moncrief:
They make a massive difference in your ultimate outcome from the sale. Not just at the point where you sell the initial equity, but at recap as well. So, talked about the joint venture structure, talked about the 100% sale kinda older school DSO model. And then we’ve got the holding company model, where I’m gonna sell a 100% of my practice, I’m gonna get, let’s say, 75% cash at close, and I’m gonna roll the remaining 25% into stock in the holding company of the DSO. So rather than owning equity at the practice level, I own equity at the parent company level. Now, one of the disadvantages there is that you don’t continue to receive your pro-rata net income distributions, right?

Ryan Isaac:
Right, yeah.

Brannon Moncrief:
That 25% equity went into stock in the holding company, not at the individual practice level, so you lose the ongoing cash flow from the practice. One of the great things about the holding company model is owning stock at the parent company level, you’re diversified in all the practices that the DSO owns, could be a good thing, could be a bad thing, depending on how strong the other practices in the group are. You could see significant upside from that equity when you’re able to liquidate it at recap, but it’s difficult to get a line of sight into what that equity is gonna be worth at recap, and is the stock price that you’re paying for that equity today, when you buy it upon closing your transaction, is it at market? Does it make sense? You’re really not gonna be able to get a clear line of sight into why you’re paying $3 for that equity as opposed to $5 for that equity, when you purchase it at the time of sale.

Ryan Isaac:
Yeah. Geez man, there’s so many questions, and I could keep going for a long time, but maybe we’ll do a part two another time down the road. I have two more things that were standing out to me. One would be with the amount of new DSOs entering the space relatively recent, like I was saying, we haven’t seen a lot of recaps from some of these companies yet, from the ones you’ve seen, are they hitting their targets that they’re putting out in their brochures?

Brannon Moncrief:
So far so good.

Ryan Isaac:
Okay.

Brannon Moncrief:
So all of our clients that have hit a recapitalization event have been very, very happy with the financial outcome. And they’ve been right along the lines of what was outlined when they originally transacted with that DSO. But you’re right, there’s a lot of DSOs that have yet to hit a recap, we’ll see how that goes, obviously, we’re entering a little bit different economic climate than we’ve had over the past decade, so this model is gonna be tested to some degree, and then you’ve got other DSOs that have hit one, two recaps that are now looking, eyeing a second or a third recap. I can tell you that as a DSO grows in size, the return at recap is typically muted. So doctors need to think about that, risk reward, right? If you’re signing on with a smaller DSO, maybe that hasn’t hit a recap yet, your potential reward, your return should be higher than signing on with a DSO that’s already into their third recap, they’re a much larger enterprise, safer, right? Far less likely to have major financial issues than a smaller player.

Ryan Isaac:
Yeah, it’s the same reason why small cap value stocks have higher returns than large cap gross stocks.

Brannon Moncrief:
Absolutely.

Ryan Isaac:
You’re just taking the risk on a smaller untested company. There is this question about why so many dentists are interested in DSO offers. And it does make me wonder, is this kind of consolidation from an efficiency standpoint, a business operations standpoint, a collaboration between getting multiple partners in a business standpoint. Is that something that this industry would want eventually, anyway, they gravitate towards that for those reasons, or is it mostly just because money hit the table?

Brannon Moncrief:
Well, we talked about why the industry is so white hot, why DSOs are buying practices. But why are doctors so interested in this? I think you’ve got a few reasons, I think the evolution of dentistry towards group practice was gonna happen one way or the other. Doctors, I think especially younger doctors that are more social, are sick of being on an island unto themselves. You’re the by far the most educated person in the office, they don’t really have any peers in the office, that’s kind of been the model up till now, and I think dentists have realized that they want to be surrounded with peers under their own roof, within their own four walls. So, and there’s a common scale to be leveraged in doing so. So I think dentistry was already headed towards that model.

Ryan Isaac:
Just because of new generations. Yeah, people have different mindsets and they want different things out of their careers. Yeah, I totally agree with that, I think it’s true.

Brannon Moncrief:
Yeah. And then you have to be more sophisticated from an operational business perspective, to be successful in private practice, then you had to be back in the ’80s and the ’90s, right?

Ryan Isaac:
Totally, yeah.

Brannon Moncrief:
Back in that day, the industry was underserved, it was not near as competitive…

Ryan Isaac:
Yeah, just open up a shop of Four Ops, and do your own hygiene, answer your own phones, and you can make a living. It’s fine.

Brannon Moncrief:
Yeah. I mean, you could do really well, having a very low business acumen, you didn’t have the PPO infiltration that…

Ryan Isaac:
Advertising, marketing, messaging, content, branding, it wasn’t a thing.

Brannon Moncrief:
Yeah, so you have to be much more dynamic to be a successful practice owner in today’s environment, and that takes its toll on a lot of people, and I think you’ve got a lot of young entrepreneurial dentists that have absolutely crushed it, they’ve built these big businesses. In the interim, they’ve had families and they’ve missed a lot of time with their kids, and they’re starting to reprioritize, they’ve done well financially, they’ve saved up some money, they’ve create a really valuable asset, and they’re starting to look at their work-life balance, they’re like, “Man, it would be nice to take some chips off the table, monetize the equity that I’ve built in my business, and then get some help from an operational perspective, to where I could balance out my life a little bit better.” And then also be part of something larger than themselves. So I think that’s caused a lot of younger dentists to look at the DSO model, and then you’ve got this generation of baby boomers, those that have successful practices, that are ready to take the chips off the table, but not ready maybe emotionally to retire, that they sell their practice to a private buyer, the writing’s on the wall that they’re gonna be out relatively quickly, because private buyer, that practice is gonna be their baby and they need the production, they need the income.

Brannon Moncrief:
So it’s a conduit to them taking the chips off the table, monetizing the equity in their practice, but being able to stay on long-term post-close, and likely alleviate a lot of the administrative stuff that they don’t enjoy doing anyways.

Ryan Isaac:
Yeah, totally. Yeah, it is really interesting. And I’ve wondered over the years, maybe the last five to seven years, just the changing nature of the industry, kind of leaning towards favoring a more entrepreneurial business-minded dentist, not just a really good clinician, it takes a toll on people who are really good clinicians who don’t want to be business people.

Brannon Moncrief:
You can be a fantastic clinician, and be a terrible practice owner.

Ryan Isaac:
Yeah, and just bum. Yeah, you can. And I’m not sure that was… Like you’re saying, I’m not sure that was always the case in the past.

Brannon Moncrief:
Yeah, no, back then you could be a terrible business person, and be a successful practice owner ’cause you’re a good clinician.

Ryan Isaac:
Yeah, you’re just a good dentistry.

Brannon Moncrief:
That paradigm has changed.

Ryan Isaac:
Yeah. It’s changed. And that, like you said, that does take a toll on people. Yeah. Wow, this has already gone like 45 minutes, and I don’t wanna keep you too much longer. Is there anything else that you… Or maybe we missed or didn’t hit on, that you think is important for people to know, just in this environment that we’re in right now?

Brannon Moncrief:
Well, I think… Look, things have changed remarkably over the past five years, and they continue to evolve day-to-day, especially with the new economic climate we’re entering, I think it’s critical for doctors to get educated, understand their options, make sure you’ve got great advisors at the table when you’re making these massive professional decisions. I’m always available if anybody wants to reach out.

Ryan Isaac:
Yeah, where do they find… Where do they… What’s the process with you guys? How do they reach out? And like you said earlier, you don’t care if they’re in the middle of negotiations or just starting to think about it, reach out. What is the best way to get in touch?

Brannon Moncrief:
Yeah, I’ll give my cell, I mean, I’m always available.

Ryan Isaac:
[chuckle] Okay. Alright.

Brannon Moncrief:
Yeah, 512-660-8505, and you can reach me at Brannon@dentaltransitions.com, that’s our website. There’s actually a resources page for DSO transactions, a lot of podcasts, a lot of articles there. Again, that’s dentaltransitions.com. But yeah, I’m always available as a resource. Whether they need an advisor like me or not at the time, happy to have a conversation and be a resource to you and your audience.

Ryan Isaac:
Well, you have been today, so thanks for spending some time. It was great to have you on the show and make a new friendship in the industry, so I really appreciate it, man. Thanks for being here.

Brannon Moncrief:
Thanks for having me, Ryan.

Ryan Isaac:
Yeah, and thanks to our audience for tuning in and listening. If you have any questions for Brannon, you have his cell phone, it’s tens of thousands of people every month. So I’m sorry if it’s… [chuckle]

Brannon Moncrief:
Hey, that’s alright man.

Ryan Isaac:
You’re at your own risk, man.

Brannon Moncrief:
That’s okay.

Ryan Isaac:
Reach out to Brannon if you have any questions. And thanks for everyone tuning in, we’ll catch you next time on another episode of The Dentist Money Show. Thanks. Take care. Bye-bye.

Practice Transitions