Understanding the Basics of Invisible DSO Partnerships – Episode #508

As the dental industry evolves, Invisible DSOs are becoming pivotal in influencing the future. Operating behind the scenes, “invisibility” denotes their unique blend of support and autonomy, making them an attractive option to many dentists. On this episode of the Dentist Money Show, Matt and Chip Fichtner, Principal at Large Practice Sales, discuss the nuts and bolts of Invisible DSO partnerships.

Show Notes
Large Practice Sales

 

 

 

---

Podcast Transcript

Matt Mulcock:
Really appreciate you being here. This is such a pertinent topic we’re going to talk about today. I just got off a call with a client earlier today that was talking about wanting to know more about consolidation and just generally speaking, not even like a specific offer, just kind of what’s happening in the, the DSO space, private equity, how this is all working. So I’m going to tell him to listen to this podcast after, but why don’t we just start with you and large practice sales and maybe just give us some, some history there and how you got to the place you are now.

Chip Fichtner:
Sure, absolutely. My partner and I founded Large Practice Sales over seven years ago, and we made two very great strategic decisions then, which I would love to tell you were strategic and intelligent at the time, but it was really more luck. And we decided two things. One, we were only going to focus on larger practices. The average GP practice in the US does about $850,000 in collections, and the average specialty does about $1.2 million.

Our minimums are generally around a million eight in collections for specialists and 2 million for GPs. So we focus on larger practices, hence our name at large practice sales. The second decision that we made that turned out to be, uh, why we became the largest in this industry so quickly, uh, as we decided, unlike everybody else, we were only going to get compensated by the doctor, most of the people in the practice advisory business or transition business, as some call it.

The brokers are getting paid on both sides. They’re getting paid by the buyers and the sellers. And that was a good strategic decision because A, there’s no conflict of interest. Our sole goal is to achieve high values for our clients. Whereas if you’re getting paid on both sides, you are somewhat, what’s a good word, compromised. So we only represent doctors. And so that enabled us to achieve multiple bidders for every client. So today an average client might have six or eight qualified bidders in the process of partnering with an invisible DSO. So those two decisions worked out really well. We’ve completed over a billion dollars of partnerships for our client doctors with invisible DSOs just in the last 24 months and I expect we will grow again this year because more and more doctors are considering invisible DSO partnerships once they understand them.

Matt Mulcock:
So a couple of things. So I guess when was this, you said you and your business partner, um, when was this, these decisions that were made that you started moving forward, when did that come to be? Okay. Awesome. And already grown to, you know, to the size you are. I’m curious, you mentioned luck. I love the modesty, but I’m sure there was some strategy behind that. I’m curious for the first decision here of going kind of the larger route.

Chip Fichtner:
2016.

Matt Mulcock:
What were those discussions like and how did you come to that conclusion or what was the intent behind it?

Chip Fichtner:
You know, the intent was that, you know, historically DSOs were considered as your an exit option. That you potentially when you were ready to retire would sell to a DSO, work for a couple of years and then you’d be fully retired. But you’d sell 100% of your practice. In our world, it’s not a retirement strategy. It’s a partnership strategy where a doctor of any age can sell a part of their practice for cash up front and keep apart for years or decades. And what’s kind of interesting that’s changed in the last two or three years is the number of younger doctors that are considering and joining Invisible DSOs. So out of our billion dollars in transactions in the last 24 months, 150 million of those partnerships were for doctors in their 30s. So this is not an exit, it’s not a retirement. It’s an opportunity to partner with a group and access their resources to help a crack practice grow bigger, better, faster, more profitably. And with less administrative headaches for the doc.

Matt Mulcock:
Okay, I’ve got so many thoughts on that. I want to come back to this because I love that you just said that and something that we’re hearing a lot, but I want to circle back. I want to come to the second point that sets you apart being truly sell side. My question on that is how do you go about knowing if someone you’re working with, how they’re actually paid? Are there regulations around this that has to be disclosed? How does that work?

Chip Fichtner:
You know, actually there are not any regulations around it, but obviously it’s the only fair thing to do as far as I’m concerned. And I think many of the other advisors are telling the dentist when they are getting paid on both sides, but not always. But no, there are no regulations around it. It’s just the right thing to do.

Matt Mulcock:
Got it. So, but have you seen, I guess, I guess, have you seen where a dentist either a assumes or is maybe led to believe that they’re working with someone who is truly sell side like that was again, kind of like put out there with maybe some tricky language or whatever it is and then they don’t realize that actually it’s, they’re getting paid on both sides. You don’t need to name names. I’m just curious.

Chip Fichtner:
Well, you know, usually the way a doctor can tell whether a an advisor is getting paid on both sides is what the fee is. So in our case, people always whine about how high our fee is, because we charge a percentage of the value of the transaction at closing. Otherwise, we get paid nothing if there’s no closing. And so we have the highest fees in the business. And I always point out to doctors, well our fee may be 9% of the value of a transaction, but the little advisors who are quoting you five are also getting paid five from the buyer. So when you see a low fee, that usually means they’re getting paid by the buyer, even if they accidentally forgot to tell you.

Matt Mulcock:
Okay, so that’s a good, okay, that’s really good to know. So that’s a good kind of like measuring stick of just, or maybe a sign of like, depending on what their fee is, they might sell you on that lower fee, but what they’re not selling you on is being con to your point, compromised and having that conflict of interest, and they’re going to make it up somewhere else that at the end of the day would truly impact the value you’re going to get most likely out of that sale.

Chip Fichtner:
Absolutely. And it’s why we end up getting the highest values in the businesses because we’re able to create bidding contests among many invisible DSOs more than the little guys, because the little guys will only show their clients to the groups that will pay them a fee. So you’re missing more than half of the qualified bidders.

Matt Mulcock:
Got it. Got it. Okay. That totally makes sense. So it’s, you got to see the whole picture there and not just looking at the surface level fee. Okay. I want to circle back to this administrative burden. Um, and then I want to also jump into this invisible DSO concept and talk about that. But, um, it is interesting. You’ve mentioned, and we’ve seen this in just the last two or three years. Uh, it went from DSO. I, well, here, here’s my interpretation. Tell me if this is wrong.

It went from DSO as a four letter word, like super negative for a while. It then sort of got better as the market got more competitive and these DSOs started realizing they have to get more creative and actually trying to add some value to the, to the doc as they’re competing and, but it’s still even at that point went from, or was still like a very much an exit strategy. And then to your point, it does feel like over the last couple of years, specifically it’s transitioned more to this kind of even partnership model as you’re saying. I guess my first question as we jump into the administrative stuff, what do you think has been the catalyst for that evolution? And it feels like a quick revolution.

Chip Fichtner:
Yeah, it’s, it’s been relatively fast because, you know, keep in mind invisible DSOs, let’s define those real quick. So we know what we’re talking about.

Matt Mulcock:
That’s probably a good place to start, yeah.

Chip Fichtner:
So an invisible DSO is not something that’s new. They’ve been around for 35 years. But the thing that differentiates an invisible DSO from a DSO or the things are number one, an invisible DSO rarely owns 100% of any of their practice partners. They own a majority, but typically a doctor will sell anywhere from 51 to 80% of the value of the practice for cash upfront the doctor will retain ownership in the balance and that ownership may be directly at the practice level or it may be in the parent company or it may be a combination of both. So number one differential is a DSO, uh, is, does not have owner doctors in most cases. So invisible DSO is making the bet that an owner doctor is going to run a better practice, one who has skin in the game than an employee doctor. So that’s differentiated. Number one.

Number two. They’re not going to rebrand your practice. The invisible DSOs believe in the power of the local brand that has been created by the doctor. And so they don’t come in and homogenize the practice or try and micromanage it or change the name or tell the doctor who to hire, who to fire, when to be open, when to take a vacation, what products to use, what payers to take. They’re not dictating any of that. The doctor is retaining not just clinical autonomy, but operational autonomy. Because the invisible DSOs are going to only invest in a doctor that’s built a great practice that’s growing and they don’t wanna break what they just spent millions of dollars investing in. So the next differential really is that the invisible DSOs are enabling all of the benefits of a larger group to their partner practices. And keep in mind the invisible DSOs, some of them have 10 partner practices and some of them have 700 partner practices. And again, this is not new. Part of what has driven the consolidation is the profitability of the invisible DSOs as an investment. So just so far this year in the first quarter, there’s been over three and a half billion dollars invested in invisible DSOs. And that’s on top of tens of billions of dollars over the last three years. Now, keep in mind, that’s not going into the branded DSOs.

That’s going into the invisible DSOs. So you have invisible DSOs that have gotten more capital to grow, you have new invisible DSOs that have been formed. There’s a new invisible DSO formed at least once every two weeks. And the thing with the invisible DSOs, and we estimate there are about a thousand DSOs and invisible DSOs out there.

Matt Mulcock:
Oh wow, that’s higher than I thought.

Chip Fichtner:
Yeah, there are far more of them that are invisible DSOs. So you don’t necessarily know they’ve come into your community. They’ve partnered with a doctor down the street and all they don’t change the name and they’re not telling your patients that, Hey, you have a new big partner. It’s not communicated. I mean, just in Salt Lake, we’ve done over 50 transactions in the last three years. And you wouldn’t know it right. Because they’re not putting, you know, Joe’s dentistry on the sign or Aspen or whatever.

Matt Mulcock:
You’d never know.

Chip Fichtner:
But the invisible DSOs, you know, the benefits that they provide to the doctor besides cash upfront are really important and different. So let’s sort of run through the list of what an invisible DSO will do for their partner practices. They’re going to, the administrative minutia they’re going to take off the doctor’s back are banking, accounting, payroll benefits, administration, compliance, credentialing, tax, legal, IT support and vendor and payer negotiations. And really the most important piece of that are vendor and payer negotiations. These groups are paying 25% less for pretty much everything, including team benefits costs, which are going up every month. And something that’s relatively new post-COVID is that many of these larger invisible DSOs are getting reimbursed at higher rates from insurance companies than independent dentists. We just did a transaction in the mid-Atlantic. It was a four million in collections practice, all insurance. And our client’s new partner is getting reimbursed at 20% higher rates than he is from the same payers. So you have a significant driver between costs and revenues that are driving doctors to at least consider the invisible DSO partnership. And that’s accelerating due to the new capital and due to the fact that many of the invisible DSOs have returned values on the equity that the doctor kept as a part of the transaction. We’ve had some clients in the last two years that have made three times their money, five times their money, and some even more. So when you choose the right partner, and keep in mind of that 1,000 invisible DSOs out there, we only consider less than 100 of them to be qualified to bid on our clients. So you’ve got to be careful.

But the potential equity returns, not just for the investors, but for the doctors are phenomenal. And that is why so much new capital from new sources has flowed in to the invisible DSO in the consolidation business. And the sources of that new capital are kind of interesting. Doctors, for some reason, think that the only backers of dental consolidation are private equity. And that’s just not true. We’ve done over $350 million of transactions in the last couple of years with family offices. One of the largest investors last year who now owns two invisible DSOs is BlackRock. BlackRock is the world’s largest money manager with 10 trillion under management. So they made their first entry into the invisible DSO. Keep in mind, not DSO, invisible DSO space in November of 22 and they made their second entry into it by buying another one through a different fund that they manage in December of 23.

Matt Mulcock:
Oh wow.

Chip Fichtner:
You’ve also had sovereign wealth funds get involved. So one of the largest invisible DSOs in the country is now owned by the sovereign wealth fund of the country of Abu Dhabi. Now Abu Dhabi is kind of interesting because they only have two and a half million people, but they’re the third largest sovereign wealth fund in the world behind China and Norway. So a lot of new capital from new sources have entered this game and that has driven up values to new records and has created a bunch of new bidders for great practices.

Matt Mulcock:
Yeah, this is great. There’s so much here, Chip. So when you talk about the – I’m going to – oh, I got my thumbs up there. The dynamics of the cash that’s coming in, you mentioned that all this money – I think it is a bit of a misconception and this is something I’m learning as you said this even before we started airing that private equity is not the only source of capital here. I’ve kind of always assumed that myself or heard that. Are these new sources of capital, you’re mentioning sovereign wealth funds, family offices, are those in the DSO space in general, or you’re saying specifically they’re targeting the invisible DSO space?

Chip Fichtner:
They are specific. Now, certainly there’s plenty of private equity and family office in the branded DSOs, as we call them. But the growth has been the invisible DSOs. 10 to one.

Matt Mulcock:
Okay. Got it. That makes sense. And then, uh, the other thing that I’m learning today, as we talk is that there’s a thousand DSOs across, you know, between the branded DSOs and the invisible DSOs. That’s over double what I’ve always kind of quoted or thought. So it’s good to know that. Uh, and then you mentioned that only about a hundred of the ones that you would actually target. What are the factors you’re looking at when, or what, what should a doctor consider when you talk about 10% of the market only being worthy of partnering with, what are those kind of main factors they should be thinking about?

Chip Fichtner:
Well, we keep something that we call the blacklist. And the blacklist are the invisible DSOs that are not permitted to bid on our clients. And the blacklist changes every week. We have a meeting once a week to talk about who’s on it and who’s not on it, who’s going on it, and who’s coming off of it. So it changes. So for example, there’s one group that was on the blacklist in December, but was not on the blacklist in January because they got a new $400 million credit facility which meant that they would be able to create value for their partner doctors by growing. So with 400 million, they’ll be able to add X dozens of new partner practices, and growth is key to creating equity value for the doctors and the investors. So they came off the blacklist and are now allowed to bid. Another example is a group that we’ve sold several hundred million dollars of practices to over the last seven years, and they went on the blacklist in the fall because their new investor changed out the entire senior management, CEO, CFO, CDO, Chief Operating Officer, Chief Revenue Officer. It was a wholesale change of the management. And what we did was they went on the blacklist, maybe not permanently, but we want to understand what new management’s going to do with that group, what their philosophy is, how they’re going to operate it, will the doctors that we have partnered with them continue to be happy. So they went on the blacklist and at some point probably later this year they’ll probably come off because fairly smart investors. And that’s another thing that we look at is the source of the capital behind the invisible DSO. One of the things that we really like are invisible DSOs that are backed by capital, whether it’s family offices, private equity, whoever, where the investor has built other invisible DSOs over the last, let’s call it 10 years, and monetize them. There are some investors who have built and monetized invisible DSOs, one, two, three, five, and some will break 10 this year in the last 10 years. And they may have been different geographically, they may have been specialty targeted or multi-specialty targeted, but there are some of these investors that have been exceptionally successful. There’s one group that we really like that’s returned over $3 billion to their doctors and investors just in the last nine years.

So when you can find, when you’re looking at invisible DSO, you always want to understand who the money is because there’s no shortage of money at the moment. You just want to go with the money that has a track record of success, preferably in dental, but at least in healthcare consolidation.

Matt Mulcock:
Yeah, that’s it. No, it’s a good call. And there’s so many of these. I’d imagine there’s a lot of opportunities of getting this wrong, right? I mean, even before when I was quoting the number I’ve always heard is around 400 DSOs in the country, but maybe that’s referring to just the branded ones. And that’s maybe even underestimating that. But I’d imagine again, there’s so much that can go wrong. Even we’re saying here, there’s about a 10% hit rate based on what you’re describing of like getting it right within at least this group. So I guess I’ll ask this. When you see, I’m guessing you’ve seen some of these things go wrong, even if it’s just like stories you’ve heard. What, what is it that, because we’ve seen this too. We’ve seen things go wrong on our side. Um, uh, clients we’ve worked with who have taken deals or just clients we are, uh, dentists we talked to at events. What are the things that you’re seeing Chip? When something goes wrong, what are those things that, uh, the dentist didn’t see coming, what are the biggest risks here?

Chip Fichtner:
You know, to me, you break that down into two elements. What went wrong for the dentist specifically who partnered with them and what went wrong systemically with the parent company. So there’s two different things. So we see unhappy dentists who have joined an invisible DSO and they’re unhappy because they did not get what they expected. And in our process, you know, we’re going to have six or eight qualified bidders. We’re going to cut that down to three finalists. The doctor’s going to meet with the three finalists and pick a finalist or two. And then we’re going to put that doctor, our client on the phone with other doctors who have joined the invisible DSOs that, that he is, he or she is considering and we want him to have a doctor to doctor him or her to have a doctor to doctor conversation and understand what the real world is like, because a lot of these groups are making promises that they can’t or won’t deliver on. And so it’s important that you consider multiple options because ultimately this is a cultural fit. You’re hopefully going to spend the balance of your career married to a particular group. You need to be very careful in understanding what life will look like after marriage.

And doctors who don’t have multiple bidders don’t get to see multiple options. And so doctors should see every option that’s qualified and then they should have conversations with other doctors within the group to understand what life is like. So you see unhappy doctors, generally because they weren’t represented by an advisor in the process, they didn’t have multiple bidders. And they went there because their buddies went there. And their buddies are getting paid a fee to refer them there, though sometimes the buddies forget to tell them that. But that’s happening. Then you look at the systemic aspect of an invisible DSO. Some of these do not have good management such that they’re not able to add value to the practice partners that they have. And so you can always judge a good invisible DSO or one of the elements is, okay, are the practice partners that they have partnered with growing? Are they growing top line? Are they growing bottom line? Have the services that have been promised by the invisible DSO partner been delivered? So right now you’re seeing, particularly in the ortho only invisible DSOs, ortho case starts have dropped. Down 8% in 22, down 6% in 23. So some of the ortho only invisible DSOs have been challenged. And some of them are not bringing in any new partners right now. They’re certainly on the blacklist. Many of them have been on the blacklist before that.

Matt Mulcock:
Do they know they’re on the blacklist when they get put on?

Chip Fichtner:
No, they don’t. They just don’t hear from us, because we’re not giving them the opportunity to bid on our clients. It is a very internal document, and it’s a very valuable piece of data. Because what we don’t want to do is have our clients, or us for that matter, waste our time with an unqualified partner. No, there are plenty of groups out there that have stopped partnering because they’ve run out of money. As interest rates have gone up, their credit lines have been choked. And so they’re not doing transactions or the ones that they’re doing. They’re offering doctors a whole bag of funny paper that isn’t cash. So you got to be very careful in your selection process. And we’ve just learned not to waste our time with those that will either play games or don’t have the money or not well managed or won’t grow or won’t create equity value, because ultimately that’s a very important piece of this puzzle is what’s the value of my retained ownership going to be five years from now, 10 years from now, or in the case of our 30-something doctors, 30 years from now.

Matt Mulcock:
Yeah. And that’s actually a really good point Chip, I want to focus on for a moment. You mentioned this at the very beginning around the different structure of the deal itself. That’s generally a joint venture type structure of a partnership of some kind. The invisible DSO takes a majority ownership, but that could be anywhere from, you said anywhere from 51 to 80. Okay. Somewhere in that range. And then the other, you just hit this, and I think this is so important to focus on for a moment, is the equity piece.

Chip Fichtner:
51 to 80 is kind of the working number. Yep.

Matt Mulcock:
We see this so much where dentists confuse, they hear equity and they think that is equal across the board. They think that just means the same thing from one deal to another. So could you spend some time talking about the complexities of equity and the different things to be considering? You mentioned one factor here being what is the equity actually in being the hold co versus the actual individual business or practice you still own? Can you just talk about that and like, what are the factors that Denists should be thinking about there?

Chip Fichtner:
Sure, absolutely, because it’s really important. Some of the groups that are on the blacklist will come to a doctor and offer them, let’s say 51% of the value in cash, and then they’ll say, we’re gonna give you preferred equity in our parent company, which is preferred by definition means it’s senior to common equity. Well, the challenge is that sometimes the common equity is far more valuable than the preferred, because the preferred is just paying a dividend of let’s call it 8 percent, but it has no conversion rights, which means there’s no upside in preferred equity. And so functionally preferred equity is just a subordinated note. And in fact, it’s worse than a subordinated note because a subordinated note is going to be higher on the capital stack than preferred equity. So a lot of the groups on the blacklist are using that little trick to try and convince doctors that they’re getting a great deal.

You also see it in different classes of common. So you may say, all right, I’m getting common equity, so I’m shoulder to shoulder with the investors and the other doctors. And that may not be true, because they have multiple classes of common equity. And the class that you get, I promise you, if they have multiple classes, is probably subordinate to the first class that the investors got in the common equity. So there are a lot of things to understand in the capital structure when you’re getting ownership, because that ownership may have upside value and it may not, and it may have protections and it may not. But, you know, the probably a third of the transactions that we do, the doctor is retaining ownership at the practice level. So the doctor as a practice level owner will be getting his pro rata percentage of the cash flow from the practice, typically paid to them monthly or quarterly. And they will have upside in that equity, but it will be limited. Not to say it’s bad, but just say it’s not going to be as much as taking parent company equity in many cases. And here’s why. When you take parent company equity, unlike practice level equity, you’re getting no cash distributions. So you’re not of the partial owner of your practice anymore, you’re an equity holder in the group. And therefore you’re betting on the success of the group, not the success of your practice directly. And when you take holding company equity, in most cases, you’re going to have higher upside in the value of that equity over time than keeping practice level equity, but what you’re trading is you’re not getting the cashflow paid to you monthly or quarter. There are no dividends paid by these groups in 99% of the cases.

Matt Mulcock:
So this all just comes down to understanding number one, you’ve highlighted perfectly and I love that you just broke that down because this is something we see if a deal goes wrong, usually on the backend from a financial standpoint, it’s the things you mentioned but one of the main reasons we see is the doc didn’t understand the equity piece and what they actually were getting. They just think equity is equity. So I love that you just highlighted that and then you’re mentioning here too. It just comes down to the trade-off understanding. It sounds like you’re saying, and tell me if I’m wrong, but it sounds like you’re saying there’s not necessarily a right or wrong hold co versus the individual practice that comes down to your individual situation.

Chip Fichtner:
Yes. And it comes, and it comes down to the group that you’re partnering with. We did a transaction for a 39 year old doctor in November. It was a $43 million transaction. Now he could have gotten practice level equity. This was a single office practice too, by the way, one office, $43 million. Yeah. 39 year old single owner doctor, plenty of associates, but this guy was a hustler. So in his case, he was big enough and growing and young and dynamic. And he was the perfect guy to become a platform for a new invisible DSO. So we went to a group that had done seven successful invisible DSOs over the last 10 years and said, here’s our client. This guy is exactly what you need to build a new invisible DSO around focusing on a specific segment of dentistry. And let’s talk about how we’re going to carve up the pie. So he therefore is now shoulder to shoulder with multi-billionaire successful, in this case it was a private equity firm. And they offered him a very high cash component and practice level ownership.

And we were like, no, no. We’re getting in on the ground floor here. He doesn’t need the cashflow from the practice. We would much, much rather be shoulder to shoulder with you, the investor. And we want to do a 51 49 deal so that my client is ending up in that case with about $22 million of equity in the new entity with the right investors. So in that case, he, he could have taken practice level equity, but he was willing to make the bet that.

These guys knew what they were doing and therefore his $22 million in equity could be worth a hundred million dollars based on their past track record over the next three to five years. Uh, so, so the, no, it’s phenomenal doctor. So the, uh, you know, it, it depends on the situation. It depends on the bidders you have, the opportunities that you have. Another client of ours in Tennessee is also the launch platform for a new, uh, this deal will close next week for a new invisible DSO that is backed by a group that’s done it five times already. And he’s practice number one, again, charismatic young doctor, he’s probably 42. But this is a private equity firm that’s done this before many times, plus they’ve done other healthcare, so it was the right fit. And so in his case, same thing, he’s getting equity at the parent company shoulder to shoulder, same class of stock as the investor.

Matt Mulcock:
Amazing to hear these. There’s just so many different ways to do this. So creative. I’ve got a couple more. I could actually talk to you all day. This has been amazing. So much information here. One question that I get a lot is, so let’s say I’m a dentist. I want to do this. And something’s been laid out for me as far as like what this could look like. The deal, let’s say the deal all works. Sounds good. We figure out the equity. We figure out the proportion of ownership, all that. There’s going to be administrative support.  What’s the final exit strategy for the dentist? Like what are the options there? We do this joint venture, I give up so much percentage, whatever, what’s the final, or what are my options as the dentist to eventually exit down the road?

Chip Fichtner:
Great question and a really important question. So the options will vary. So let’s look at a couple of them. So option one, you take a parent or practice level equity and you have in your agreement the ability to force your partner to buy that retained equity at a predetermined formula based on the EBITDA in the future. So let’s say you say, I’m going to work for five years and then I want to retire.

So typically in a transaction like that, you would at the end of the fourth year, give notice to your partner, Hey, I’m leaving at the end of the fifth year. And I’m exercising my put option, which means you have to buy my retained equity from me, and it would typically be a negotiated upfront formula based on the profitability of the practice or the parent in that 12 month period after his initial notice, but in that case, you have a defined known exit date and, um, and value, assuming your practice has performed, um, in other cases, uh, and this is really most common where the investors and the management say, Hey, look, we’re all investors in this thing. And our goal is to build it and ultimately sell it to a bigger investor down the road. That’s the standard story. And so we’re going to build it over the next three to five years, and we’re going to make three to five times our money and you’ll get to exit when and if we can complete that transaction, if being the key word. There are several groups last year that tried to recapitalize and were unsuccessful because the investors in dental consolidation at the, let’s call it 50 million in EBITDA level are becoming very picky. And they are interested in quality groups that have shown organic growth across their practices and have integrated their practices properly. So there were a number of groups that started in, let’s call it 18, um, that tried to recapitalize in 23 and were unsuccessful. And it was pretty easy to figure out that they were, were going to be unsuccessful just because they hadn’t integrated, they hadn’t grown, they hadn’t provided services that, that helped the practices have organic growth. So you’ve got to choose. So that’s exit option number two, right? I get, I get to sell what everybody else sells at a recapitalization.

And there are other different exit options and strategies there, but they’re all different. But it’s key that you understand what they are because ultimately you want to be able to exit, not every doctor wants. So we have doctors who are very concerned that they want to be able to retain the equity for as long as they want, that they can never be forced to sell their equity. And they want to be able to retain it past retirement. So there are several groups out there that mandate that the doctor liquidates his equity as after retirement, meaning he cannot keep that equity in his portfolio for his heirs.

Matt Mulcock:
Okay. This prompts kind of another thought here around, it sounds like this is something, a part of many things to be negotiated at the deal, at the deal level when you’re going to that process. What are other kind of key things to be thinking about that? And I guess there’s two ways to ask this. It’s either what’s negotiable or maybe we can narrow it down even more and say, what are things that are not negotiable would you say? Like the doctor has no power to negotiate on. Is there anything?

Chip Fichtner:
There are plenty of things that are non-negotiable, uh, or hard to negotiate. One of the hardest ones is to negotiate compensation. All of these groups want to pay the doctors more, not less. And when you have a, let’s do simple math. Let’s say you have a $2 million practice and the buyer wants to pay you 35% of collections on a go-forward basis as your compensation for practicing dentistry.

So that’s going to be a $700,000 number. Now the smart doctor would say, you know what? No, I don’t want 35. I don’t want 30. So then it’s only a $600,000 bill. There’s a hundred thousand dollars swing in the doctor’s compensation down. Right. So his compensation for the next five years is going to be $100,000 less at 30% and 35%. However, that extra hundred thousand dollars in EBITDA by taking a lower future compensation.

In our world is going to be worth seven or eight times EBITDA. We’ve done deals last week at over 11 times EBITDA, but let’s use eight for easy math. Right. So that $100,000 in lower compensation that he’s going to get for the next five years, a total of $500,000 is worth $800,000 upfront. So would you rather take a lower compensation that could total $500,000?  Or would you rather have $800,000 today at 20% federal long-term capital gains tax rates? Or would you rather have $100,000 a year at 37% federal tax rates? So really one of the hardest things to negotiate is to get compensation down.

Matt Mulcock:
interesting. I mean, that totally makes sense. I guess it depends on the deal and the organization that’s coming. But that’s an interesting concept. So you’re saying that sometimes the biggest issue is they actually won’t let you take that trade off. Oh, okay. That’s interesting.

Chip Fichtner:
Right. Yes. Yeah, because what they’re targeting, and we see it a lot in the specialties, um, in, in oral surgery, for instance, you’ll see compensation ranges from the bidders at between 30 and 45% of collections. And that can make a massive swing in the initial value of the practice. Certainly the doctor gets more ordinary income, but it’s only for five years because that’s a typical contract. Um, but lower compensation is better from a cash upfront and a tax perspective. No, once doctors understand this, they beg to work for a dollar a year. Unfortunately, I have not been able to pull that off.

Matt Mulcock:
That totally makes sense. So, okay. So it sounds like the cash or the income is the harder to negotiate part. Any other factors that docs should be thinking about out there of things that are, are negotiable versus not any other key things. I mean, we’ve talked about equity. We’ve talked about the income after the fact. Uh, what other factors go into this deal or these deals that doctors should be thinking about?

Chip Fichtner:
There are dozens and dozens of points that you got to look at. One of the other ones is the tax allocation negotiation. Uh, in these transactions, um, you’re going to negotiate as a part of the, of the initial agreement in the letter of intent, you want to have the tax allocation negotiation done because the amount of the purchase that is applied to goodwill versus tangible assets is really important because goodwill is going to get taxed at 20% federal, whereas the tangible assets are going to get taxed at 37% federal. So we’ve seen doctors who do their own deals, who the DSO says, you know what, doc? Let’s just split the baby. We’ll make it 50-50. That is not how you’re supposed to do it. We have a way that we get away with very high goodwill allocations. Our average over the last $2 billion has been about 94% goodwill, therefore federal tax. And it’s a bulletproof IRS strategy that the DSOs that we deal with always know, okay, we know the strategy on the tax allocation, so we agree, we’re not gonna fight about it, right. You know, that one’s important. And then the third issue to look at is many of the doctors that we represent own their real estate.

Matt Mulcock:
Let’s go. Let’s hear it, Chip.

Chip Fichtner:
So you need to understand the lease that you’re going to enter into this because there are many of them that we’ve seen where the doctor represented himself and he had his brother-in-law, the attorney, do the deal. And he’s entered into leases that make his property unsellable. Because you don’t want to enter into a lease when you own the building, such that your new partner can keep you from selling your property. Because today, one of the great benefits of an invisible DSO partner that most doctors don’t realize is they’re going to sign a five, 10 or 15 year lease with the doctor. And they’re a triple A credit tenant. So if you have the right lease, that’s negotiated correctly, you’re going to have 10 bidders for your real estate coming from the real estate investment trusts that are eager to own dental practices occupied by triple A credit invisible DSOs. So the value of your real estate goes up if you structure it correctly. If you structure it wrong your practice could be or your real estate could become unsellable.

Matt Mulcock:
Wow. Okay. So many factors here. So many different risks to be considering here. This is amazing stuff. I’m curious from your perspective, Chip, where are we at as far as the current landscape around valuations, not only at the practice or like the individual level, but maybe at the bigger recap levels. And then maybe a second part of this, and we’ll kind of wrap up with this. Where do you see this ride ending, right? Meaning full consolidation, what does that look like? For context on this, another question I get a lot is a lot of these groups we feel and we’ve seen are using kind of fear tactics, like jump on is never going to see this again, you better get on or you’re, you know, you’re going to get left behind. I just want to get your perspective on that too.

Chip Fichtner:
What I tell doctors is there’s no rush. This is not going away. The ADA, and I think their data is a little light, but they believe that 13% of all dentists in the U S have affiliated with an invisible DSO or work for a DSO. They believe the number for orthodontist is 18%. So we have a long way to go in consolidation. This is not going away. And the reality is while MDs today, 77% of them, work for a hospital, a large group, or an insurance company, MDs are very well consolidated. Not all of them, obviously. But in dentistry, I don’t think we will see that same level of consolidation because the typical GP practice that’s doing $850,000 in EBITDA.

It’s not a business. It’s a great job. It’s a fantastic job, but once you pay him the market rate for what he or she does every day, um, there’s no profit there and therefore there’s no interest by businesses to buy a typical GP practice. The way a typical GP practice sells is they sell to another doctor who steps into that, the selling doctor’s shoes and makes the selling doctor’s income by working and performing dentistry every day. So I do not see the dental practices across the U S crossing the 50% consolidation threshold, certainly in my lifetime. And I doubt we’ll even get close to that in my lifetime. So yeah, and GP, and it’s true of all the specialties, none of the specialties, the highest consolidated of the specialties at the moment is ortho. The most rapidly consolidating type of dental practice at the moment is oral surgery.

Matt Mulcock:
Interesting. And you’re saying specifically the GP side.

Chip Fichtner:
The oral surgeons have a giant recruiting problem and the invisible DSOs, for example, will take 60% of this year’s residency graduates, which leaves less than 100 for the 5,000 independent oral surgeons out there eager to find an associate to buy him out so he can retire. So oral surgery is rapidly consolidating, but it’s, no, the train’s not left the station. I do believe that values have peaked for this cycle. I think we could see practice values decline, not massively, but let’s call it 10% over the next 12 months. But we’ll see. And the only reason I say I believe that is because the recapitalization bids that are coming in for some big quality groups going through the process right now have dropped, let’s call it 25% from the high water mark, which was set in 22 that dictates what these groups can pay for new partner practices is they’ve got to look at what’s my ultimate exit value. And I can’t overpay if I’m only gonna sell it 15 times even though not 20 times even though. So that’s gonna impact values I believe in the coming year.

Matt Mulcock:
Yeah, totally makes sense. So I’m a dentist and I’m not really a dentist, hypothetical, I’m a dentist, I’m considering these options, I’m thinking about it. You just differentiated between the difference between being like a high income professional, like a high income paying job versus owning an actual business. What are the things a dentist can do or what are the biggest things they’re thinking about or they should be thinking about as these invisible DSOs are coming in, like what’s gonna make them prettier, right? For a DSO to come in and give them a high evaluation.

Chip Fichtner:
Growth, as long as you’re growing, we’ll bring you six or more qualified bidders. The practices that are flat, the practices that are declining. I was on the phone with a orthodontist yesterday, nice $4 million practice, but he’s down 8% year over year. And I said, you don’t want to go to market when you’re down because you’re not going to get the right bidders and you’re not going to get the right value. So when you turn around and you’re now growing year over year, even if it’s just 1%, then let’s talk. So growth is the number one issue today to value. Number two is age. Um, if you’ve got a six in front of your age and you don’t have a flock of young associates, your value is going to be impacted. Uh, if you’re two 64 year old doctors with a great GP practice, I don’t care how profitable it is if you don’t have a young associate in there right now, I can’t help you at all, at any price.

Matt Mulcock:
Wow, okay, that’s good to know.

Chip Fichtner:
Now you can still do a doc to doc transaction and get 70 or 80% of collections. But you know, in our transactions, I think our high water mark last, last year was five times collections or 500% of collections. And we did several at 400% of collections, but I don’t think we’ve done many at less than 150% of collections in the last two years. So you don’t want to do a doc to doc transaction if you don’t have to. Um, and the reality is if you’ve got a larger practice the kids can’t afford to buy your practice anymore. They can’t get the financing and interest rates are up. So when you do the pro forma, it’s tough.

Matt Mulcock:
Yeah, totally makes sense. That’s interesting. Uh, so, okay, we will finish with this. I’ve taken, I’ve already taken more of your time than I should. This has been so helpful. So much information. Uh, how, so Dennis hears this wants to engage with you, talk to you. What’s your process like? How does someone, how does a dentist, um, what does that look like if a dentist were to engage you and again, what that process is?

Chip Fichtner:
You know, really my mission is to educate every doctor to understand what an invisible DSO is and how it’s either right or wrong for them and how to compete with them when they come to your town because they’re there and they’re coming fast. So you need to understand how to identify one and what’s going to happen. So what I urge any doctor to do who’s listening to this is take a look at large and be sure and look at our advisory board because that’s very telling. Our four star admiral on our advisory board has been a little busy lately. And take a look at that and contact us. And let’s have a conversation. I love talking to dentists because I learned something from every dentist I talked to. And our process has no obligation. We will tell you the value of your practice after going through a process at no cost, no obligation. And worst case, you’ll learn something. And oftentimes we’ll be able to give you some pointers on, hey, your personnel expense is out of whack. Your supplies cost is too high. You might want to consider this. We’re not in the consulting business. That’s not what we do. But every doctor I talk to who goes through our valuation process is going to learn something. In the worst case, they’re going to learn the value of your practice. So.

Matt Mulcock:
Love that Chip. I got that from you and I actually use that because we like you have a foundation of education for the dental space. That’s literally what we built our business on and so we very much love and respect you guys for having the same approach. But what I got from you is this idea of the worst case you’re going to learn something. I’m giving you credit. I’m openly telling you, I stole that from you and I actually use that sometimes and I tell people to talk to us is, Hey, worst case you’re going to learn something and hopefully we’ll learn something as well from you. So I love that. So Chip, I want to give you final word. Any other thoughts, things Dennis should be thinking about risks or anything around this topic.

Chip Fichtner:
You know, one of the interesting changes that’s coming fast is technological adoption. Doctors who are not on, we won’t call it the bleeding age, but certainly the leading edge of technology today are gonna have a problem. They’re gonna have a problem growing their practice and keeping their patients. So if we had an audience here and I asked them to raise their hand, as I did a couple of weeks ago to conference, how many of you adopted AI in your diagnostic processes? And in the room of, I don’t know, 200 people, five put their hands up? Well, I can tell you AI is gonna become a standard of care very shortly and it will improve your practice and it will increase your revenues. It will increase your confidence of driving case acceptance. And to put that in perspective, your friends at Heartland, the world’s largest DSO with almost 1800 offices, are busily implementing AI throughout all 1800 offices. So another thing to understand is that the world is changing fast and you need to change with it. And then Invisible DSO Partner can help you do that.

Matt Mulcock:
Love that. So embrace growth, embrace the, or focus on growth, embrace technology. Are the key takeaways. And it sounds like as well kind of summarizing this is there are so many factors to consider here. You need the right people in place, the right team like chip in place to make sure you’re able to navigate this to your point, ever changing, evolving landscape.

Chip Fichtner:
Yeah. And don’t wait till you get old. You know, I’m sick. I’m 64. So I get to pick, I get to pick on old guys, but you should start at least understanding this in your thirties. You may not do a deal now. You may not do a deal ever, but you should at least understand it. Become educated.

Matt Mulcock:
Yeah, that’s a life lesson right there, Chip. We’re going to end with that life lesson. Don’t wait till you’re old. I love that. So Chip, thank you so much for being here. Check out largepractice sales.com. Uh, uh, this was fantastic chips loaded with information. We love it. Uh, and then of course, from our side, if you want to know more about this and other, uh, topics, other things we’re going to be talking about at the Dennis Money Summit coming up in June, Park City, Utah June 21st and 22nd. If you want more information on that, deni Thank you everyone for listening. Chip, thank you for being here. Cannot thank you enough. It was so amazing, so much information. Until next time, everyone. Bye-bye.

Chip Fichtner:
Thank you, Matt.

Practice Transitions