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Affiliations with dental service organizations could pick up before the close of 2020.
DSO executives believe COVID-19 is causing dental practice owners to take a closer look at affiliating with a dental services organization. Deal-making could pick up before the year’s end.
“DSOs are seeing renewed attention from potential affiliates who are uncertain of the future and are trying to take some risk out of that future,” says Craig Woods, J.D., member, Dykema Dental Service Organizations Group.
George Radigan, vice president of business development for North American Dental Group, says, “The pandemic has put a spotlight on the benefits of being part of a DSO, where dentists can rely on administrative support to navigate challenges brought on by the pandemic while collaborating with fellow doctors on clinical topics.”
An Equal-Opportunity Challenge
COVID-19 has proven to be an equal-opportunity challenge for DSOs and private practices alike. At its peak, in the week of April 20, 66% of DSO dentists and 80% of non-DSO dentists (80%) were seeing emergency patients only, while 28% of DSO dentists and 17% of non-DSO dentists were not seeing any patients at all, according to the American Dental Association Health Policy Institute.
By mid-July, the status of both DSO and non-DSO practices had improved, with 51% of DSO practices and 41% of non-DSO practices open for business as usual. Still, 42% of dentists in DSO practices and 57% of those in non-DSO practices reported they were open but experiencing lower patient volumes than usual.
Meanwhile, operating expenses across the profession were expected to climb. In Illinois, for example, the state Department of Public Health advised dentists to mitigate the potential for aerosols by using high-efficiency particulate air filters and ultraviolet systems, reports Crain’s Chicago Business. Ideally, suspected or confirmed COVID-19 patients would be treated in negative pressure isolation rooms.
“A lot of doctors are entrepreneurial, and they’re going it alone,” says Woods. “They don’t have a large infrastructure, or a legal or HR team. When COVID-19 arose, they were forced to do a lot of things on their own. They had to learn about the PPP [Personal Paycheck Protection] loan process, or whether they qualified for government grants. They had to figure out how to treat their employees. That’s a tall order to ask of someone who has one, two or three offices and no legal team of their own.”
Adds Radigan, “New challenges related to safety protocols, team management, patient communication and financial stress are what has led some dentists to explore all options, including affiliating with a DSO such as NADG.”
The Climate for Deal-Making
The deal-making climate for DSOs was already warming up prior to COVID-19, says Don Schwall, senior vice president of Viper Equity Partners, an M&A investment bank that represents, consolidates and sells practices into private equity.
“The majority of dental practices are still private, but more practices are transitioning to DSOs and private equity each year,” he says. “If you look at 18- to 34-year-olds—new grads and dentists—the percentages are much higher. Many young doctors are going directly to DSOs and private practices to practice as associates. They have too much debt from school to buy a practice, and they don’t want the administrative and operational headaches of owning their own practices.”
Sales have increased, he continues. “We are receiving more new clients, [letters of Intent] and closings than in 2019—and that was a record year. Transactions are also getting larger due to the fact that higher-quality multi-office practices that originally did not consider a transition are now interested, because DSOs and private equity will pay a premium for them.”
Speaking to Dental Practice Management this summer, Woods predicted heightened M&A activity for the second half of 2020. “A lot of planning is going on. We have a number of deals in the past month that have come back around.” Some of that volume has been driven by specialty practices, which, as “essential services” operated close to normal throughout the pandemic.
Given the decline in patient volumes and revenues, COVID-19 has complicated the process of valuating practices. But deal-makers are working through that.
“The only changes we see with practices that were hit hard by COVID are holdbacks, which are paid out at a later date as ‘super adjustments’ once they hit their previous monthly numbers,” says Schwall. “There are also guaranteed notes and earnouts based on the same parameters.”
Woods says that most DSOs at press time were increasing their reliance on earnbacks. “Effectively, it’s a holdback, where the [DSO] says, ‘We know you’re a strong practice, and but for this pandemic, you’d be doing fine. But we do want to make sure motivation is there and the practice remains strong, so we’ll hold back some of the purchase price until you’re back to pre-COVID levels.’
“The DSOs that succeed will be those who are fair, and who set up a structure that recognizes the value the practice had prior to the pandemic,” he continues. “So rather than just reducing purchase prices and offering punitive terms—which still occasionally occurs—they provide opportunities for the affiliate to return to its pre-COVID performance and to be compensated for it.”
Says Radigan, “From a business perspective, we’re probably no different than most other industries that are facing a great number of challenges and an unpredictable outlook. How long will the pandemic last? What’s the short- and long-term impact on our industry? How will we keep our team members and patients safe?
“Our recruitment strategies have remained largely unchanged. We continue to look to partner with dentists who are aligned with our patient-focused culture. We can learn a lot by understanding how the practice responded to the pandemic, and how they ensured they were able to protect their team while providing excellent clinical care for patients.”