Why You Need to Know the Nuances of DSO Deals – Episode #402

With conditions fluctuating within the dental industry as more consolidation occurs, it’s important to know how to react to a buyout overture from a DSO. On this episode of the Dentist Money™ Show, Ryan interviews Brannon Moncrief of McLerran & Associates, who talks about current market conditions, how to understand practice value, and why a buyout might be a good move for some dentists but not for others.

Show Notes
McLerran & Associates
brannonm@dentaltransitions.com

 

 

 

 

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Podcast Transcript

[music]

Ryan Isaac:
Hello, everybody. Welcome back to another episode of the Dentist Money Show brought to you by Dentist Advisors, a no commission, comprehensive, fee only, dental specific financial advisor for dentists, only dentists, all over the country. Check us out at dentistadvisors.com. Today on the show, returning guest by popular demand, Brannon Moncrief, talking about DSOs, dental transitions. We talked about interest rates, recaps, regrets. Who is not a right fit. The future of the industry. Where this is all headed. Bundling groups together for a bigger sale. We talked about all these subjects, really kind of like current hot topics. So great interview. Many thanks to Brannon for coming on and doing this again. He’s just seen so much of this stuff and I think it’s a value to everyone. So thanks to him and thanks to everyone for tuning in. If you have any questions for us, always just go to dentistadvisors.com. Click on the, Book Free Consultation, link and we love answering your money questions and helping you get pointed in the right money direction. Thanks for being here and enjoy the show.

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, a registered investment advisor. This is Dentist Money. Now here’s your host Ryan Isaac.

Ryan Isaac:
Welcome to the Dentist Money Show where we help dentists make smart financial decisions. I’m your host Ryan Isaac. I’m here with now what is a long time old friend of the show, Brannon Moncrief from McLerran & Associates. Brannon, what’s up, man? Thanks for being here. How you doing?

Brannon Moncrief:
Hey, what’s up, Ryan? Good to see you.

Ryan Isaac:
Yeah. You’re a bit, you’re like a, you’re a star now from the last episode. People just like… [laughter] They’re like, who’s that guy? I gotta to talk to him. So welcome back. Thanks for doing this again.

Brannon Moncrief:
Yeah, absolutely.

Ryan Isaac:
I’m excited.

Brannon Moncrief:
Absolutely.

Ryan Isaac:
I feel like the DSO market is something that changes so much, and is so dynamic that it’s probably worth doing updates fairly [chuckle] regularly from a perspective from someone who sees a lot of this stuff. But just in case someone’s not familiar, tell us about who you are, what you do, what are you guys up to? What is your business? And give us a little background.

Brannon Moncrief:
Will do. So my name is Brannon Moncrief, principal and CEO of McLerran & Associates. I’ve got over 20 years of experience in the dental industry as a banker and a sell side advisor. So did dental lending across the country for about a decade before I purchased McLerran & Associates. And really what I focus on day in, day out is helping large practice owners get educated about their options in the DSO private equity space. So teaching them about their EBITDA, EBITDA multiples, current market conditions, and identifying if going down the DSO path is the right fit for their particular situation. And if so, be their advocate and represent them in pursuing a DSO affiliation or private equity partnership. So take the practice to market, create a competitive environment. Introduce the client to all the DSOs we feel would be a good fit, and then leverage that competitive environment to maximize the economic outcome for our clients.

Ryan Isaac:
Love it, man. Speaking of something you just said, I love doing business with people who will willingly and frequently turn down business. And you just said, you’ll tell somebody like, this is not for you. This isn’t the path for you for one reason or another. And I appreciate that. I like people who will turn down business when it’s not the right thing to do. So I think people are in good hands.

Brannon Moncrief:
Yeah, it’s a good place to be. We’re blessed to be busy, right? And when you’re busy, you don’t have to convince somebody to do something that’s not in their best interest for your own benefit. So we try to just give objective guidance to doctors, and I always say, our job is to educate and empower them to make good decisions with their business. And, whether that be, “Hey, a DSO is not a right fit,” or, “Now’s not the right time.” So be it, I need to be busy, 2, 3, 4, 5 years from now, just as much as I need to be busy today.

Ryan Isaac:
Yeah, totally, man. We’re on the subject. So let’s just start with maybe something high level before we get into the weeds. Let’s just talk about the pros and cons of selling and partnering with a DSO, maybe from a few different perspectives. First of all, DSO does not mean just one thing anymore, kind of like it did years ago. So maybe touch on that a little bit. And when you do meet with someone who’s like, “Oh, this would be a great fit for what you’re looking for,” and finding the right partner versus someone who is not. What are the pros and cons? What makes it good for some and not a great path for others?

Brannon Moncrief:
Yeah. So we’ll start with the first thing you mentioned. I mean, DSOs kind of have a bad rap with a lot of people. And I think that’s born from the first iteration of DSOs that were really kind of doc-in-the-box, clinic style dentistry. They looked at doctors as employees and not partners and production quotas, crap like that. Right? There’s still those DSOs out there, but those DSOs are really more of a De Novo model. They’ve kind of got their own ecosystem and their own playbook they want to operate under. They do startups, they don’t acquire practices.

Brannon Moncrief:
This new iteration of DSOs predominantly private equity backed. They’re really in the lane of buying really good businesses, partnering with great doctors and not trying to reinvent the wheel, not screw up, what’s made these practices successful. So because DSOs have learned to stay in their lane and just support doctors from a business perspective, admin perspective and allow them to have still complete clinical autonomy and a lot of operational autonomy, I think it’s been more widely accepted among practice owners to give a hard look at going down the DSO path. So we always start with defining your why, right? What are you looking to accomplish? Are you looking for administrative support? Is this an economic decision for you? I mean, economics really matter to everybody, but normally there’s another layer there, right? As to why you would look to sell your practice to a DSO.

Brannon Moncrief:
So from an purely economic perspective, I mean, once you cross about 1.5 million in revenue, the DSO private equity valuation starts to run away from the private buyer valuation very quickly. So, private buyer valuations as a general rule, you’re talking somewhere in the range of 70%-100% of annual revenue, whereas in the DSO world, they don’t care about revenue. It’s all about a multiple of EBITDA. So We’ll see practices…

Ryan Isaac:
Which I wanna ask about, I wanna ask about that in a little bit, but, yeah.

Brannon Moncrief:
Yeah, yeah. So we’ll see practices in the DSO world, depending on their size and how they’re engineered financially, sell for upwards of 2%-300% of revenue in some cases. So easily, 2, 3, 4 times what a private buyer would pay for a large practice. And honestly, it’s hard to find a private buyer with the clinical chops, the confidence and the financing to acquire a practice with top line revenue at $3, $4, $5 million.

Brannon Moncrief:
So the economics are compelling when you have a larger practice to look at the DSO private equity route. And there’s just a lot more optionality in the DSO world as opposed to the private buyer world. So economics are a huge consideration, a huge, typically a positive when you’re comparing selling to a private party versus going the PE DSO route. And then de-risking, a lot of clients are, they’ve built a very valuable business and they wanna take some chips off the table while valuations are really at an all time high. So being able to monetize the value of your business, or a portion of the value of your business, put that money away with somebody like you invest it and benefit from your compounding returns over a long period of time for a lot of our clients, that’s compelling.

Brannon Moncrief:
And then the administrative management burden of being a large practice owner has increased dramatically, over the past few years. So the labor market’s obviously a mess. That’s probably everybody’s biggest pain point currently. But as we all know, we’ve got downward pressure on pricing from PPOs. We’ve got upward pressure on overhead. You know, overhead never goes down over time, it always goes up, specifically labor at the moment and occupancy cost.

Brannon Moncrief:
So there’s a lot of pressures, a lot of headwinds from an operational and management perspective. A lot of our docs have built really successful businesses. They manage a large team, they still work chairside, and they’re burned out to some degree. So they want to lift some or all of that managerial burden. And because of how this iteration of DSOs has been designed to really support doctors from that perspective, it’s a legit option to help get some of the BS that most of our docs don’t like to deal with on a daily basis. HR benefits, compliance, legal bookkeeping, accounting, payroll. DSOs are designed to help lift that benefit so that you can focus on what you do best. Taking care of patients.

Ryan Isaac:
Yeah. Or still just being a leader. I was just on the phone with a client this morning who’s 10 plus locations, mostly still the sole owner has a little few chunks of equity to some key employees, but first thing he said on the phone this morning, I was like, “How you doing?” And he’s like, “I’m just doing the normal thing where I’m trying to be a good influence and leader and help people grow, and see their potential.” And I’m like, “How’s that going?” He’s like, “I feel like I’m always failing.” [laughter] It’s really hard, man.

Brannon Moncrief:
It is hard.

Ryan Isaac:
You start getting up to like high single digit number of practices, double digit number of practices, and you’ve got maybe a hundred people that you’re in charge of or more, and it’s just easily that many, it’s, that is so many people to feel responsible for, let alone be a clinician if you still are. Let alone do marketing and HR and payroll and books and ordering supplies and blah, blah, blah, blah, all this stuff. It’s a lot on someone’s plate when they get to that size. Who gets to that size and still turns down the decision to partner with the DSO, who’s that personality or profile.

Brannon Moncrief:
Yeah. And that’s where we talk about one of the drawbacks, right? And if it’s purely an economic play, the longer your runway. So in other words, if you’re cool with the administrative part of managing the business.

Ryan Isaac:
Yeah.

Brannon Moncrief:
You’re not really looking to lift that burden. It’s more of an economic play. The longer your runway to exit, the less compelling the argument to go down the DSO path is, right?

Ryan Isaac:
Yeah.

Brannon Moncrief:
Because you’re gonna lose all or a portion of that EBITDA by selling your business. So unless you’re trying to de-risk, or get that help from the managerial perspective, you’ve got a weigh, what are the economic implications if I continue to own the practice for 5, 10, 15 more years versus monetize it now and look at, what is the potential of hitting a recapitalization event? What’s the return at recap gonna be? What’s the probability that I get there, gonna be? And what’s the probability that I hit one recap versus a couple of recaps and benefit from that compounding impact. If it happens, you could be talking about generational wealth.

Ryan Isaac:
Yeah.

Brannon Moncrief:
And it could easily outrun the no sales scenario. So you’ve gotta really weigh what’s your why, right? What are you trying to accomplish? What’s compelling you to look at the option? What’s your runway? And then what’s your EBITDA? What’s your valuation in the DSO, PE marketplace? And then if you’re gonna go to market, you gotta make sure you vet the buyers at the table, partner with somebody that’s got a high probability of getting to that recap at a favorable outcome and is really gonna unlock that generational wealth opportunity.

Ryan Isaac:
Do you think that there will be many people, let’s say 10 years from now, that are large group owners that never sell that kind of just they back out of clinical, they hire good key people like MBAs, smart business people that run things, and they’re kind of just mentors in the business, and maybe they own 25%-50% of it, everything else is internally owned. Do you think there’ll be a lot of those still standing?

Brannon Moncrief:
I think there’ll be few and far between 10 years from now.

Ryan Isaac:
Okay.

Brannon Moncrief:
I think you described earlier how challenging it is to be the mascot, the leader of a business with 10 locations, 15 locations, over a hundred employees.

Ryan Isaac:
So many.

Brannon Moncrief:
Most dentists that’s not… They weren’t trained, to be a CEO at that point. You’re the CEO.

Ryan Isaac:
You’re the CEO, and they didn’t choose dentistry to be a CEO of a hundred person company.

Brannon Moncrief:
Right.

Ryan Isaac:
Yeah. Totally.

Brannon Moncrief:
So you either have to be a very unique individual, right? That it is innate, it’s part of who you are and you’re also a lifelong learner and you’ve constantly evolved with the growth of your business, or you’ve gotta build a really, really strong team of business people around you.

Ryan Isaac:
Which is also kind of rare in dentistry. Sorry to cut you off but…

Brannon Moncrief:
Yeah. No.

Ryan Isaac:
Isn’t that pretty rare in dentistry too, to hire, like other industries will hire CMOs, CFOs, highly educated experienced professionals to come and run the business side of many types of industries. But that’s not as common in dentistry where it’s usually the owner is trying to be, wear all the business hats, but that gets really hard, the bigger and bigger it gets. And so I wonder how the industry is kind of young in the, like the CEO experience of hiring a team, like a C-Suite team, where in tech or other companies or industries, that’s pretty normal. It’s not normal in dentistry.

Brannon Moncrief:
It’s not, it’s really, really hard to find good operational talent. It’s hard to find good C-suite talent that understands dental, right? And has the pedigree, the experience, the wherewithal to actually bring value to the organization and steer it in the right direction. The other thing is, it’s also really expensive. So if you’re gonna build out a full C-suite and you’re gonna build out centralized infrastructure…

Ryan Isaac:
And you have no funding, you don’t have backing, you don’t have funding. Yeah, exactly. Bootstrapping you know…

Brannon Moncrief:
Yeah. And I think you’ve gotta understand what it does to your organization temporarily. You’re gonna reach this inflection point where you out kick your coverage, either from an operational pedigree perspective, or from a time perspective or both, where you’ve got to either partner with a DSO in private equity that’s already built it, right. And you can leverage their infrastructure and their operational pedigree and management to continue to grow your business without taking the risk of making that investment.

Brannon Moncrief:
Or you’ve gotta build it yourself. And if you build it yourself, you’re gonna make a massive investment, and time and energy. And you’re gonna take a step back temporarily from an EBITDA perspective, by making that investment. But your’re temporarily eroding the value of your business. And if you’re gonna make that investment, you better grow. Your top line revenue is gonna need to grow by probably at least multi-millions, by 3-5 million just to absorb that hit.

Ryan Isaac:
Yeah. Cost of a C-suite.

Brannon Moncrief:
Yeah. And get back to where you were pre, going the C-suite route and building out that centralized infrastructure.

Ryan Isaac:
Oh yeah.

Brannon Moncrief:
So when you reach that inflection point around, it’s normally around five to seven locations where you either have to partner with PE or a strategic buyer, an existing DSO, and leverage their infrastructure, or build out your own, take that step back, take that hit from an EBITDA perspective…

Ryan Isaac:
That’s tough.

Brannon Moncrief:
Before you can go to the next level.

Ryan Isaac:
It’s tough too, because in other industries, in order to attract and retain that kind of talent, you’re talking about multiple six figure salaries, usually plus equity, which infers a future sale and for equity holders. And that’s also rare in dentistry to start shelling out equity grants and it’s just, there’s just really new concepts. And so, but I don’t think we’ve seen dentistry aside from a couple old school giant corporations get to the point where a C-suite is even on the table as a discussion point for a need.

Brannon Moncrief:
Yeah. I mean, most practices don’t get to that size.

Ryan Isaac:
No, no.

Brannon Moncrief:
0:17:50.8 BM: And oftentimes when they get to that inflection point, they realize what I just said, and they decide to go ahead and either partner with PE and let them help build out the professional team. Or partner with a DSO that’s already got the infrastructure.

Ryan Isaac:
Totally.

Brannon Moncrief:
To support the business and scale it.

Ryan Isaac:
Yeah, that’s true. I want to ask about regret. I know we both probably have met people who have sold, even if they got paid well and financially it worked out. Are there any common denominators from people who regret a sale to a DSO that you’ve noticed at all? I think I could probably toss a couple in, but I’m just curious what you think.

Brannon Moncrief:
Yeah, so that’s a great question. We really haven’t seen any sellers remorse with our clients. And the reason being is because we take a really, really careful pragmatic approach on the frontend and try to prevent them from going down the DSO path if it’s not a good fit for what they’re trying to accomplish. And then make sure they vet the hell out of the buyers, create optionality and maximize their outcomes. So they don’t have to lay in bed at night and wonder, did they sell prematurely? Did they sell to the wrong buyer? Did they leave money on the table?

Brannon Moncrief:
So for those reasons, because of how our affiliation process is designed, we don’t see a lot of sellers remorse, but we certainly hear the stories. And most frequently, the stories that I either hear revolve around a several different things. They weren’t emotionally ready or capable of being, selling their business and becoming an employee, it’s been a very, very hard shift.

Ryan Isaac:
Yeah.

Brannon Moncrief:
From, owner, leader to employee taking a step back from that perspective, that’s a big mind shift for a lot of people.

Ryan Isaac:
Yeah.

Brannon Moncrief:
So they either sold prematurely or shouldn’t have sold to a DSO at all. They were better continue to own the business until they were ready to step away or cut back significantly, or they sold to the wrong DSO. They sold to a DSO that doesn’t take the approach that we described earlier, and tried to reinvent the wheel and force a lot of change on the practice. And as a result, made the doc, made the staff miserable and impacted the financial success of the business.

Ryan Isaac:
That’s just a lack of due diligence and time spent probably.

Brannon Moncrief:
Yeah. Absolutely. And, that’s where… Making sure that you dig around, talk to a lot of different DSOs. Talk to doctors that have partnered with that particular DSO to get a feel for, what was their why, and what has the experience been like, since, post affiliation? So it’s, you shouldn’t take this conversation casually. I mean, it’s the biggest decision…

Ryan Isaac:
Yeah, I know.

Brannon Moncrief:
A practice owner is gonna make, and we see all the time where, or we hear about all the time where practice owners, they sold to a particular DSO because their buddy did.

Ryan Isaac:
Yeah.

Brannon Moncrief:
You know, or they got, they had a bad day and they had a mailer sitting on their desk from a particular DSO. They made a phone call and before you know it, that phone call leads to them selling their business without shopping around.

Ryan Isaac:
Dude, you know what we call that? We’ve called that for 15 years, Random acts of finance.

[laughter]

Brannon Moncrief:
I like that.

Ryan Isaac:
And we… It’s the biggest threat to a dentist financial life is, and it stems from the same problem, which is a lack of organization, a lack of data, and a lack of time spent like thinking about the data with a uninvolved third party, that leads to random acts of finance. That’s a big one though. That’s, a big one, man.

Brannon Moncrief:
Yep. Absolutely.

Ryan Isaac:
I’m curious about, I hear this question all the time too, is the subject of recaps. And we’re starting to see more of these groups hit their first ones or second ones. And, of course, the projections that people get in their email, in the flyers that you’re talking about on people’s desks are always really great. And they, you know, they seem like no-brainers and they’re very big. What are we seeing in recaps? Are people hitting, their projections of what they’ve been saying? Are they falling short? Are they beating projections? What are we seeing out there? Has that changed at all?

Brannon Moncrief:
That’s a great question. So we have had numerous clients hit favorable recaps that were in line with what the DSO promised on the front end when they were courting our client. So we’ve seen some successful recaps. Some of them have actually exceeded expectations.

Ryan Isaac:
Cool.

Brannon Moncrief:
But all the DSOs are gonna tell you that they’re financially healthy, and the recaps create an outstanding outcome.

Ryan Isaac:
Totally.

Brannon Moncrief:
And the reality is that we know of DSOs that have hit unremarkable outcomes. There was a huge DSO that recently recapped that generated zero return for the doctors that have, that entered the recap cycle within the past three years. Now, they got their money back, right?

Ryan Isaac:
Yeah. Yeah.

Brannon Moncrief:
So it’s not a total loss. They got their money back. But they didn’t generate…

Ryan Isaac:
The 2x, the 3x, the 5x, that everyone was thinking about. Yeah.

Brannon Moncrief:
Yeah. So for the time being because of what’s going on with interest rates, what’s going on with the lack of availability of capital and, the capital markets at the moment, you’re not seeing a lot of recaps currently. We saw quite a few recaps, up until about six months ago. So you had a lot of specialty DSOs, recapped in 2021, 2022.

Ryan Isaac:
Yeah.

Brannon Moncrief:
Some of the larger, general DSOs recapped all at very, mostly very favorable outcomes. But because of the current economic climate and what’s going on in the banking and capital markets, you’re not seeing IPOs, you’re not seeing recaps, and you probably won’t for another 6-12 months.

Ryan Isaac:
Just real… While you’re in this exact, subject, can you talk about, for people that might not be familiar with why that is, kind of the mechanisms behind the way rates are affecting people and what, like… What is even happening when a recap occurs? I think a lot of people hear that and aren’t really sure exactly what’s going on. They just know kind of the numbers you get paid out again when they get bought or something. Can you talk about maybe just generally the mechanism and how current economic, just the situation is affecting that?

Brannon Moncrief:
Yeah, absolutely. So when a recap occurs, it essentially means that the investor, typically private equity firm or family office that currently owns the DSO is selling to the next investor. And at that point, the investor as well as the doctor partners and the management team of the DSO have the opportunity to liquidate all or a portion of their equity, hopefully at a much higher valuation than their initial investment. So…

Ryan Isaac:
Real fast. Are… When the DSO, let’s say the DSO, the current owner or the current private equity firm that’s the current owner, has their first recap and they sell to another owner, are they usually like selling full ownership and it literally moves like completely to a new one? Or do they keep like partial, and just raise new money and then there’s like two PE firms, or three or four that own the DSO at that point?

Brannon Moncrief:
They’re typically selling at least a majority ownership. Oftentimes, a 100% of their ownership.

Ryan Isaac:
Makes sense. Okay.

Brannon Moncrief:
So the goal of the new owner is essentially to repeat the cycle and continue to… They recapitalize the business. They have a lot of dry powder. At that point, they have a new banking relationship. And they’re gonna try to continue to grow that DSO likely at an even faster clip and sell it again in a 3-5 year recap cycles. So most recap cycles are on a 3-5 year window. And it’s been all over the board. Some DSOs over the past few years have recapped two and a half, three years while others have taken 5-7 years. So what is currently going on is, there’s a regional banking crisis, right? There’s a lack of availability of capital. Banks are starting to pull back. They’ve started to pull back considerably over the past, I’d say three months.

Ryan Isaac:
Okay.

Brannon Moncrief:
And as a result, when a DSO goes to recap, the next investor is typically using a lot of leverage. A lot of bank debt to fund that acquisition. Well, if the banks aren’t lending at nearly the levels they were pre three, four months ago, the private equity firm, the investor has to pony up a lot more cash. In order to acquire a DSO. Well…

Ryan Isaac:
Makes the returns worse on paper when… Yeah.

Brannon Moncrief:
Exactly.

Ryan Isaac:
It’s not as leveraged. Right.

Brannon Moncrief:
Exactly. So it starts to destroy the arbitrage. The more cash you have to come out of pocket. One, you’ve gotta have the cash. And two, it’s gonna impact the returns. Not only from the standpoint that you’ve gotta inject more equity, but you’re also borrowing the money that you are getting from the bank at a significantly higher interest rate.

Ryan Isaac:
Yeah. So your margins are just getting chewed up by all these factors right now.

Brannon Moncrief:
Right. Right. So as a result, those institutional investors that are looking to acquire DSOs at the moment are not willing to pay the elevated multiples that they were willing to pay 1, 2, 3 years ago. So a lot of the DSOs that have gone to recap recently have not been able to find a suitor at all. Or the offers that they’re getting are not commiserate with the financial promises that they’ve made their investors and their doctors. So they’re saying, “Hey, this isn’t the right time for us to recap. We’re gonna look at going back to market a year or two from now.” So there’s been quite a few DSOs that’ve tried to recap over the past six months that have failed to find a suitor at a financial outcome they’re happy with.

Ryan Isaac:
Yeah.

Brannon Moncrief:
So they’ve decided to hit pause, and go back to market 12-18 months from now. There’s other DSOs that are in a situation where they’re a little over-levered, and they’re under a lot of scrutiny from their lenders. And their lenders are not willing to extend as much leverage to them as they were previously. But valuations haven’t really changed. So if they don’t have the cash to bridge the gap between what practices are selling for, and this new level of lending that their banks is willing to extend, that’s significantly lower than what it was a year or two ago, they’re not able to continue to grow. So they’ve entered more of a holding pattern.

Ryan Isaac:
Yeah.

Brannon Moncrief:
Where they’ve gotta focus on same store sales growth or De Novos, rather than acquisitions and in order to continue to grow. So it’s been an interesting environment over the past six months where you’ve seen a lot of DSOs are having to really sharpen the axe from an operational perspective, and focus more on buying quality assets and then making the practices that they buy better, because they know that when they go to recap, they’re gonna face a lot more scrutiny than they did.

Ryan Isaac:
Oh yeah.

Brannon Moncrief:
A few years ago because of the economic climate, the banking climate that we’re operating in.

Ryan Isaac:
Do you feel like, are some people’s fears or maybe preconceived notions about what DSOs are in this kind of like crappy corporate environment that they were years ago? Are some of those kind of maybe justified a little bit the more times a DSO gets sold and repurchase? Because as time goes on the… I don’t know if margins get thinner or harder to squeeze, or you just have to like really squeeze all of the individual practices across, all of the holdings even harder to get more margin out of them. I mean, is that justified a little bit in some people’s worry or anxiety that the more times it gets sold, the more corporate’s gonna come down in the practice and mute, like meddling in the stuff and cutting costs and cutting programs and perks, and making the supplies you used to love ordering, now you have to order some cheaper generic stuff. Like is there some, does that happen? Is that justified when people worry about that?

Brannon Moncrief:
It is possible. I mean, look, when a DSO gets in trouble and gets over levered. And they’re under pressure, that’s when you can expect that they’re gonna start leaning on you. Right. And trying to control cost, which oftentimes is counterproductive. Right?

Ryan Isaac:
Totally. Yeah.

Brannon Moncrief:
Yeah. I mean, you end up stepping over dimes to pick up pennies sometimes if you destroy the culture and the morale of the doctor and the staff. Now I’d like to think that a lot of DSOs are smarter than that, and they’re gonna pull other levers and try to grow the practice, rather than try to squeeze every…

Ryan Isaac:
Yeah. Choke it out. Yeah.

Brannon Moncrief:
Dollar they can out of it. The good news is that typically as a DSO gets larger, the investor that invests in a large business like that, their investors that are giving them money to manage, require a lower level of return. So because the DSO is larger, it’s perceived to have less risk, therefore…

Ryan Isaac:
It’s like a growth stock, these big ones. Yeah. Instead of like value stocks.

Brannon Moncrief:
Exactly.

Ryan Isaac:
Where they’re trying to really juice up returns. Yeah.

Brannon Moncrief:
So they don’t have to squeeze as much return out of a large DSO, as they would a smaller DSO, where the investors are requiring a higher level of return because there’s more risk.

Ryan Isaac:
Yeah.

Brannon Moncrief:
But you do touch on a good point. I mean, as you get larger and larger and larger, you’ve got to standardize certain things. You gotta put everybody on the same practice management software.

Ryan Isaac:
Yeah.

Brannon Moncrief:
You’ve got to standardize things.

Ryan Isaac:
Totally.

Brannon Moncrief:
Because it will become completely unmanageable.

Ryan Isaac:
Yeah, operations won’t work that way. Yeah.

Brannon Moncrief:
Exactly. So you can expect that typically as a DSO gets larger and larger, there’s gonna be a few more mandates that come down the pike, because you’ve gotta run the business in a more homogenous fashion, or it gets completely outta control, which causes its own issues. Also as you get larger and larger, if you’re partnering with a DSO and you’ve got an equity component involved, which you typically do in all these deals, the larger the DSO, the more muted typically the return on the equity component is gonna be. So if you’ve got a couple buyers at the table, one of ’em got 30 locations, one of ’em got 300 locations, the upside in the equity is probably gonna be more robust on the smaller DSO.

Ryan Isaac:
Yeah.

Brannon Moncrief:
As opposed to the larger DSO. Just because you can only create so much arbitrage when you merge.

Ryan Isaac:
Out of 300. Yeah.

Brannon Moncrief:
Right, right. So if we just look at, alright, if I’m 30 locations, then I add 30 offices…

Ryan Isaac:
Yeah. You just grew it a 100%. Yeah.

Brannon Moncrief:
I grew it a 100%.

Ryan Isaac:
Yeah.

Brannon Moncrief:
But if I’m 300 locations, and I add 30 offices, I only grew it 10%.

Ryan Isaac:
Ten. Yeah.

Brannon Moncrief:
So the return on equity is gonna be a lot higher. There’s a little bit more risk.

Ryan Isaac:
Yeah.

Brannon Moncrief:
Typically, they’re smaller.

Ryan Isaac:
Exactly.

Brannon Moncrief:
But it’s gonna be higher on the smaller DSO. So those are the types of nuances, the types of things that we walk through with our clients. Because normally, when we take an opportunity to market, we’re gonna get 5, 7, 10 offers. It’s gonna be a mix of really small emerging DSOs all the way up to…

Ryan Isaac:
Yeah.

Brannon Moncrief:
The 300, 400 location DSOs.

Ryan Isaac:
I always hear the question. Maybe we can end on this one too. Where does this end? I always have people ask, and I wonder too, like after two recaps, three… What do you, is it just an IPO and you go public and then what? Like where does all this kind of 10 years from now end up? Is it just a small handful of publicly traded dental corporations that own 70% of the industry? Or how does this, how does this shake out?

Brannon Moncrief:
I think we end up probably at somewhere between 60%-65% consolidation. And there are gonna likely be some IPOs, assuming the economic cycle swings back around and the capital markets improve. Some of the larger DSOs are likely gonna IPO, you’re gonna see some consolidation at the top. So you’re gonna see consolidation, consolidators consolidating consolidators, so…

Ryan Isaac:
Yeah.

Brannon Moncrief:
You’re gonna see DSOs buying DSOs at some point. And yeah, at some point, 10 years from now, you might be left with 7-10 really, really large DSOs. And at that point, they’ve either IPO-ed or they’re in a long-term holding pattern.

Ryan Isaac:
Okay.

Brannon Moncrief:
And the returns on equity are gonna come down to something more normalized, 10%, 15% a year as opposed to…

Ryan Isaac:
Yeah.

Brannon Moncrief:
But right now, some of these DSOs are generating ROI of 50%-70% a year.

Ryan Isaac:
Yeah. Totally sustainable. [laughter]

Brannon Moncrief:
Yeah, right. Well, look, I mean, private equity, these cycles play to a bit of like the greater fool theory, right? There’s always gonna be somebody there that’s willing to pay more for the business than what you paid for the business. As long as we’ve got enough runway for DSOs to continue to grow organically and through acquisition, there’s gonna be arbitrage to be had. But at some point where the industry gets so consolidated that there’s not a lot to buy, and there’s not a lot… Those that we’re gonna sell to a DSO are, were the caliber to be able to sell to a DSO have sold.

Ryan Isaac:
Yeah.

Brannon Moncrief:
There’s not gonna be a lot of arbitrage to be had. You’re gonna have to live on the EBITDA that you generate from operating the DSO long term.

Ryan Isaac:
Yeah. Really interesting man. So cool. There’s so many good parallel lessons. Anything else on the table, like right now that you’re seeing that’s kind of like hot topic, hot button issue that you think is important for people to know and understand about this stuff? And then tell us all where to get in touch and find you guys?

Brannon Moncrief:
Yeah. The one thing I’ll touch on before we wrap is, there’s a big push by a handful of advisors to do like the roll-up concept right now. We’re seeing a lot of that. Like…

Ryan Isaac:
Explain what that is, Yes. And explain what that is for people who might not know what you’re saying?

Brannon Moncrief:
Yeah. So there’s people out there that have built an audience, right? They’re almost like influencers in the dental world, whether they’re consultants or former dentist or whatever it may be. And they’re trying to convince dentists, “Hey, don’t sell to a DSO on your own,” because on your own, you’re only worth 6, 7, 8 times EBITDA, “Join our co-op, you’re gonna pay a fee to join the co-op and you’re gonna pay administrative fees on a monthly basis. And we’re essentially gonna aggregate 50, 60, 70 practices and pretend like we’re one company. Pretend like we’re a DSO.”

Ryan Isaac:
Yeah. To get the multiples higher for all of us.

Brannon Moncrief:
To try to push the multiples higher. Right. To try to achieve a 10, 11, 12x multiple at exit. “We’re all gonna sell simultaneously to the same buyer.” That concept doesn’t work, and it doesn’t work for multiple reasons. I mean, look, it works for the person that started it, right? Because you’re gonna pay them a fee to join and then you’re gonna pay monthly administrative fees. So whether this unicorn transaction happens or not, they make money. But for you, it does a couple of things. One, it’s a promise that I don’t think people can deliver because the dumb money has left the market. Right. Private equity is not stupid. They, they’re gonna look behind the veil and quickly realize that that’s not a DSO, that is 50…

Ryan Isaac:
A bunch of friends.

Brannon Moncrief:
Unaffiliated practices. Yeah.

Ryan Isaac:
Yeah.

Brannon Moncrief:
A bunch of guys and girls that got in a room together and came up with this master plan.

Ryan Isaac:
Yeah.

Brannon Moncrief:
It’s totally obvious what the goal is.

Ryan Isaac:
Yeah.

Brannon Moncrief:
And if the practices aren’t fully integrated and aligned. The private equity firm at the table’s not gonna want all of them. And then the cost and the time and energy, not only to close that many transactions simultaneously, but then to integrate them and build infrastructure around them to make that…

Ryan Isaac:
Truly get them on the same page.

Brannon Moncrief:
Right. To make that a truly scalable platform…

Ryan Isaac:
Not smart business for a lot of the smart DSOs. Yeah.

Brannon Moncrief:
It could take years, it could take years and a tremendous amount of capital to do it. So the reality is you’re not really gonna generate meaningful arbitrage compared to what you would sell for on your own. And the worst of it is it completely limits your optionality. If you’ve got 50 people at the table, all those sellers all have a different why, right? They’re all trying to accomplish different things.

Ryan Isaac:
Totally.

Brannon Moncrief:
And if you’re all forced to sell to the same buyer with the same deal structure, the majority of you are going to end up in a bad place, a place where you’re not accomplishing your why. And what did you get in return? Marginal lift on economics? And by the way, once you remove the fee to join the co-op, all the administrative fees and a transactional fee, you’re typically gonna pay whoever set up the co-op some type of brokerage fee when you sell. You’re really left with a marginal economic return in exchange for limiting your optionality severely. So I don’t like the roll-up concept. I don’t think it works.

Ryan Isaac:
I think that’s a good take, man. I haven’t heard a lot about that, although I’m seeing it everywhere, even just in local markets where it’s just, maybe just one influential dentist that has a good network and is starting to do that study clubs, masterminds, influencers, like you said. What if you’re one of the people, you’re not the ringleader of it all, you’re not starting it, but you’re kind of, it’s a group of friends or a mastermind group that you’re part of, what better options would that person have? What should they maybe also look at at the same time?

Brannon Moncrief:
Yeah, so look, can it be done on a small scale, right? If you’ve got…

Ryan Isaac:
Small being?

Brannon Moncrief:
If you’ve got a handful of practices, 3-5 offices in the same geography, the doctors all have the same why, they’re all…

Ryan Isaac:
Same specialty?

Brannon Moncrief:
All a particular specialty or general dentistry practices. Similar patient mix, similar service mix. If all those things are aligned, could you sell simultaneously to the same buyer for an extra turn of EBITDA? Yeah. Yeah. Is it possible to pull that off?

Ryan Isaac:
Sure.

Brannon Moncrief:
It is. But it’s not really possible to do it on a grand scale…

Ryan Isaac:
Dozens of… Spread across a country or a wide range or like multi-specialty and then everyone becomes in such a different position, that’s hard. The buyer is looking at that like,”Why would we want this mess?”

Brannon Moncrief:
Yeah, exactly. That would have to be broken apart and sold to different buyers. And as you start to begin to break it apart, well, you ruin the concept of accomplishing all of this arbitrage. But on a small scale, it’s certainly possible. Here’s also why I don’t love it because it does severely limit optionality. Right now, the delta between what a single practice with a million dollars in EBITDA will achieve between that, which could be 7, 8, up to 9 times EBITDA, 3, 4, 5 practices with $2-3 million in EBITDA, they might trade for 9x or 10X. It’s not a massive delta between those two valuations.

Brannon Moncrief:
So why not go to market on your own, find the absolute right fit for your practice, maximize your valuation. And then you’ve got the equity play on top of that, rather than trying to get an extra turn of EBITDA when you’re only gonna monetize 60%-70% of the business to begin with, and limit your optionality and end up in a place where it might not be a great fit for you, might not have been the right deal structure for you.

Ryan Isaac:
Yeah, not the right buyer, might not even have addressed your personal why, in the first place. You kinda just got absorbed into this group and that’s really good, man. Where do people find you? Where do they reach out? How do they beat down your door and seek your advice and your wisdom and guidance?

Brannon Moncrief:
Yeah, absolutely. We always start with a discovery call just to get to know each other, talk about your why. And talk about your practice, figure out if it makes sense to move on to the next step. And typically the next step with us is to do an EBITDA analysis, to do evaluation, really quantify economically, does this make sense? So I did it last time, I’ll do it this time. I’ll give my cell phone number.

Ryan Isaac:
Here we go.

Brannon Moncrief:
I know you think I’m crazy.

[laughter]

Ryan Isaac:
Do it, let’s go.

Brannon Moncrief:
My number is 512-660-8505. You can also reach me via email, Brannonm@dentaltransitions.com. Encourage everybody to visit our website, dentaltransitions.com. We’ve got a DSO transactions resources tab. It’s got a lot of podcasts like this, a lot of articles, great place to start getting educated about this part of the industry.

Ryan Isaac:
Cool, man. Everyone only text him if you have serious inquiries only.

Brannon Moncrief:
It’s all right, man.

Ryan Isaac:
How’d you guys score the website, dentaltransitions.com?

Brannon Moncrief:
I bought it, oh God, it’s probably been 10 years now. I bought it about 10 years ago.

Ryan Isaac:
It seems like it would be a hot commodity these days, that URL. Good domain.

Brannon Moncrief:
It’s a good one, we love it.

Ryan Isaac:
Solid, man. Well, thanks. Welcome back to episode 2. Thanks for being here. I appreciate it, man. I thought this was a really good discussion. Thanks everyone for tuning in and listening and we will catch you next time on another episode of The Dentist Money Show. Take care now, bye-bye.

Brannon Moncrief:
Thanks Ryan.

Practice Transitions