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THE SALE OF ORTHODONTIC PRACTICES TO PRIVATE EQUITY BACKED DENTAL SERVICE ORGANIZATIONS

Introduction

As many orthodontists are aware, the economics and management of the orthodontic practice space has evolved considerably in recent years and will continue to evolve in the years to come. The dental space, which includes orthodontic practices, is one of the most active healthcare sectors in connection to purchases, consolidations, affiliations, and the like. Some projections have the dental sector forecasted as a $170 billion dollar industry by 2022, and accordingly, this results in orthodontic practice owners having the ability to reap the benefits of such economic growth, notwithstanding their position as a buyer or seller.

There are different factors that assist in determining whether the sale of your orthodontic practice to a dental service organization (“DSO”) is right for you; this analysis is a blend of economics and “quality of life.” There are numerous large private equity-backed DSOs such as Aspen Orthodontics and Heartland Dental, as well as smaller private-equity backed DSOs, which, in substantial part, follow the economic purchase models introduced by the larger entities.

Purchase Model

The purchase model, in its humblest form, follows a strength in numbers approach, which concurrently brands affiliated dental practices, including, pediatric practices and orthodontic practice under the same practice name, while attempting to capture the goodwill created through the provider-patient relationship developed by the selling orthodontic practice owners.

When determining the purchase price for an orthodontic practice, the current marketplace trend is for DSOs to make an offer based on a “multiple” of a selling practice’s EBITDA. EBITDA stands for Earning Before Tax plus Interest plus Depreciation plus Amortization. The EBIDTA multiple is a valuation tool that determines the orthodontic practice’s potential return on investment using a normalized ratio, which allows for comparisons to similar businesses. For example, if a selling orthodontic practice’s EBIDTA is $500,000, and they are offered a multiple of 3, the orthodontic practice will receive a purchase price of $1,500,000. Often times, the purchase price offered by the DSO will be markedly higher than offers from a competing independent orthodontic practice. One reason for the potentially higher price is that the DSO may have branded pediatric practices in the geographic area of the selling orthodontic practice and there is the potential for increased referrals.

Note, however, the selling orthodontic practice may only receive a portion of the purchase price at closing in cash or cash equivalents, with the remainder of the purchase price being structured as equity in the DSO venture or one of its affiliates (“Roll-up Equity”). The selling orthodontic practice owners are thus incentivized to keep growing the affiliates of the DSO so that their recently acquired Roll-up Equity is fully realized. Additionally, the purchase documents may contain provisions which permit a “claw back” of portions of the purchase price previously paid or forfeiture of the unpaid portion of the purchase price upon the occurrence or non- occurrence of certain stipulated events.

Generally, DSOs initially target a large, productive orthodontic practice in the geographic region into which they are looking to expand (the “Platform Practice(s)”). The Platform Practices are typically purchased at higher multiples of EBIDTA than smaller practices. The smaller orthodontic practices are purchased and “rolled in” with the Platform Practices under the brand name(s) utilized by the DSOs (the “Roll-In Practice(s)) to create a significant brand name presence in the given geographic region.

The DSO Methodology

The DSOs introduce strategies to the Platform Practices and Roll-In Practices to minimize inefficiencies and optimize the synergies of standardized operational policies in order to increase EBIDTA. The DSOs provide capital to the acquired orthodontic practice, which is used to invest in new products to maximize marketing effectiveness, strengthen relations with potential referral sources, reduce operating expenses by paying down debt and acquiring new Roll-In Practices in the Platform Practice’s geographic region. These processes create economies of scale and increase market share. Moreover, the aggregation and standardization enhance pricing power; allow for improved collection options; permit more cost-effective laboratory fees; and increase negotiation strength with insurance carriers, landlords and other vendors.

Is Selling Your Orthodontic Practice to a DSO Right For You?

Typically, a DSO transaction is an asset sale and except for certain negotiated “excluded assets”, such as cash, real estate and personal items, the DSO acquires all of the selling orthodontic practice’s right, title and interest in and to the orthodontic practice’s assets. Assets include, but are not limited to, equipment, tools, machinery, furniture, fixtures, computer hardware and software and source codes and other assets, properties and rights of every kind and description, tangible and intangible, wherever situated, that are used in connection with or related to the orthodontic practice. Moreover, as a component of the asset purchase, the acquirer purchases the goodwill value of the orthodontic practice. In order to transition the goodwill of the selling orthodontic practice to the DSO and “protect” the DSO’s investment in the goodwill, the DSO will require employment contracts with all of the orthodontic providers and will want non-compete and non-solicitation agreements with, at a minimum, all of the owners of the selling practice 1 . Since the purchase price is typically paid in cash, promissory notes and Roll- up Equity in the DSO, it is not unusual for the full realization of the purchase price to be conditioned on the owners continued services pursuant to the owner’s employment contract for a term certain (a finite period of years). The owner’s employment contract will have so-called “for cause” termination provisions. Although avoiding being terminated “for cause” may seem easy (“I would never do anything in violation of the terms of my employment contract”), often times the initial iteration of the employment contract (prior to negotiation by counsel) will contain “for cause” provisions that are open to interpretation, and thus could lead to technical, non-material violations of the employment contract. Such minor breaches could result in a termination “for cause”, which may result in a “claw back” of a portion of purchase price paid or a forfeiture of a portion of the purchase price still to be paid.

Providers need to consider the pros and cons of selling an orthodontic practice to a DSO. Intangible and tangible factors to consider include lifestyle post sale (continued “private practice” culture versus “corporate practice” culture); the number of administrative/managerial  responsibilities to be assumed by the selling owner; the economic viability of the DSO in connection to its ability to pay installments of the remaining purchase price; and of course, the amount of the purchase price itself. For some providers, typically providers nearing retirement, selling to a DSO may be the best way to maximize their return on investment.

Owners nearing retirement will have materially different prioritization of expectations as compared to provider owners not nearing retirement (whether by age or choice). Owners who are not planning on near term retirement have expectations of an ability to practice orthodontics for more than the term of their employment agreement, which render the restrictions on competition and related restrictive provisions in the asset purchase agreement and employment contract more important than they are for the retiring providers.

Regardless of whether the selling owner is near retirement age or has a significant professional practicing horizon, going from owner to associate may be a difficult transition. An unhappy provider is understandably at a greater risk that (s)he may breach the employment contract with the DSO employing entity.

Conclusion

Regardless of who the acquirer of the orthodontic practice is, the selling owner should not look solely at the “stated purchase price” but should carefully consider the likelihood of satisfying all “conditions precedent” to realizing the full “stated purchase price”. Further, careful due diligence should be conducted to determine an accurate “net worth” of the acquirer, which will assist the selling owner in forecasting the acquirer’s ability to make installment payments of the purchase price. Equally important to money are the intangibles. The selling owner must understand what the policies and procedures of the “new operating practice” will be and determine if they are policies and procedures with which the selling owner can continue to practice orthodontics for the duration of the employment contract, with particular focus on the culture and the “decision making process”. Is it a new and different bureaucratic corporate governance or is it a similar type “private practice process?”

Shub & Associates, P.C. is a boutique business and healthcare law firm located in Dartmouth, Massachusetts providing in-depth, personalized legal advice to professionals, businesses, organizations, and individual entrepreneurs internationally, nationally and locally for almost 50 years. Shub & Associates has assisted numerous clients in the successful negotiation of complex DSO orthodontic practice purchases. If you have any questions in connection to DSO purchases, or other business and/or healthcare law issues, please contact the authors of this article at:

Mark G. Shub, Esq.
Email. mshub@lslawfirm.com
Phone. 617.367.0333
Andrew J. Weissenberg
Email. aweissenberg@lslawfirm.com
Phone. 617.367.0333

 

 

 


1 States have different laws in connection to non- competition, and accordingly, the non-solicitation, proprietary rights restrictions, and non-compete provisions in the purchase documents and employment agreements may affect selling practice owners differently.