Is the Window Closing on Dental Practice Equity Arbitrage?

With consolidation in the dental industry expected to jump from 25%–30% to 60%–70% in the next 10 years, it’s important to leverage the equity in your businesses correctly during this all-important arbitrage event. Professional Transition Strategies (PTS) Founder and President Kyle Francis recently sat down with Dr. David Phelps of  Dentist Freedom Blueprint Podcast to discuss the window on equity arbitrage events in the dental industry. Here are some key takeaways from their conversation.

What is equity arbitrage?

Even if you’ve heard the term before, you may not know that equity arbitrage is a financial concept that was rarely utilized by dentists before private equity started investing in the space. In short, it all has to do with how valuable the equity is in your practice currently and how much your equity ends up being worth after the sale of your dental practice. Equity arbitrage occurs during a consolidation wave, such as the one occurring now with dental service organizations (DSOs). DSOs can offer more money for the same practice because they’re backed by private equity and, therefore, not beholden to the same debt ceilings that private owners have to deal with.

What is the state of the economy?

“A lot of what’s going on in the dental state isn’t new,” Francis says, noting private equity is leveraging buyouts and use of low-cost capital. “[Dentistry] isn’t the first part of medicine that has been consolidated.” Francis points out that most mom-and-pop dentistry shops are valued at less than $5 million, making them notoriously hard to consolidate, but thanks to competition and the emergence of DSOs, arbitrage opportunities are increasing.

What opportunities are being presented?

DSOs currently present some of the biggest opportunities in the dental industry since they can grow your dental practice faster than an individual practice can. Arbitrage is based on the lower cost of federal funds capital, and as competition increases, private equity investors emerge. “Dentistry is just one of hundreds of industries going through consolidation,” Francis said. “But dental practices are undervalued compared to every other industry out there.” Francis noted that as competition ramps up, that increases the multiples that can be paid, resulting in dental practices possibly going public or becoming nonprofits over the next seven years or so, while 30% to 40% will stay as “mom-and-pop shops.”

What insights and tips are there regarding dental practice transitions?

Francis emphasizes there’s no wrong time to know the worth of your dental practicing, adding that just because you consider a transition option, it doesn’t mean you have to take it. “Ultimately, you have to do what is the best fit for you and your dental practice,” he said. That could mean selling to a DSO sooner rather than later due to retirement, selling to an individual and rolling that money into a stock program, partnering with a joint venture or some hybrid of those options. “Competition is very high, and private equity companies are willing to give up part of their return because it’s more important for them to grow,” he added.

What are the key indicators of success?

Francis cites the 97% success rate of DSOs, pointing out that the risk profile is very slim, especially in an industry with a 0.3% failure rate. As for who to transition ownership to, ask yourself: Do the groups end up doing what they say they’re going to do for the doctors? What is the track record of that group? How easy was it for the doctor to exit? What is the retention rate? Francis elaborates that PTS presents potential buyers on a scorecard that narrows down the top options based on the seller’s goals and get offers from there.

What are the key attributes that make a dental practice more salable?

Francis said PTS lays out the factors that contribute to the risk analysis, noting it could take as long as five years to come up with the right type of transaction structure. Age and replicability of provider, payer mix, and PPO versus Medicaid are all taken into consideration. Buyers also want to see the growth trajectory of the dental practice — ideally 5% to 10% year over year. Is the dental practice located in a larger metropolitan area where it’s easier to recruit or a smaller rural area that already has another person on staff to take over in the long run?

What’s next?

“It’s never too early to jump in and have those conversations, beginning with the end in mind,” Francis said. “The important part is to have someone in your corner. Just like you have a financial advisor, a dental practice broker with expertise can walk you through all the options, especially new options on the table, like joint ventures.” Contact the experts at PTS to get the process started.