What does it take to start a dental service organization?

November 23, 2020
Bruce Bryen, CPA, CVA
Bruce Bryen, CPA, CVA

Bruce Bryen is a certified public accountant with over 45 years of experience and is a part of Baratz & Associates CPAs. He specializes in deferred compensation, such as retirement planning design; income and estate tax planning; determination of the proper organizational business structure; asset protection and structuring loan packages for presentation to financial institutions. He is experienced in providing litigation support services to dentists with Valuation and Expert Witness testimony in matrimonial and partnership dispute cases. He is also a financial writer for several dental journals. You may contact him at 609-502-0691 or at Bryenb@baratzcpa.com, or through www.Bryen-BryenLLP.com.

Although there is no magic number, there are many factors to consider to ensure financial success for all parties involved.

It certainly appears that the dental service organization (DSO) is the trending concept in dental practices today. Is there a standard or an accepted number of dental practices needed to start up the DSO and make it viable from the beginning?

What exactly do interested dentists look for in this undertaking because it is a very hot topical item and the financial rewards, if properly managed, are quite high? There is really no number that is a definite answer to the question of how many, but it certainly helps to have as many as possible from an economic standpoint. If a dentist owns 2 or 3 practices, that is a good number to start as well.

An important first step is to determine the value of what the dentist is starting with and to do that, perform a dental practice valuation. The reason for this is to make sure that all of the practices are evaluated with consistency. Once the value has been determined, others may join based on the same format of value but with different entering requirements. The payment for those joining after the initial start-up will have different pricing schedules for payment and acceptance into the DSO, as well as varying roles to play in it.

Here are some examples of formats for joining DSOs and valuation of the initial dental practices, as well as caution in not making mistakes.

If cash is the initial contribution, it is easy to determine the value because it is today’s money and can not be misconstrued. If the payment is based on a subscription or some type of formatted payment terms, determine the present value of those payments to decide what has really been contributed as the initial capitalization. For example, if $50,000 in cash is contributed in a lump sum at the closing date of the DSO as an initial capital contribution, the value of that amount is $50,000. Suppose that$50,000 is contributed to the DSO over 5 years at the rate of $10,000 per year plus 6% interest. Is that the same value as the lump sum of $50,000? The answer is no. The present value of that 5-year annual contribution is about $45,000. Not counting the value of the dental practices, one of the partners has contributed $50,000 in capital and the other about $45,000.

The consistent methodology and normalization of profit items for add backs in determining what the dentist is really taking home is important in determining a formula for adding dentists and dental practices. What is needed or not needed to operate the practices? Those items should determine the add backs to profit. These determine what each dentist is contributing to the value of his or her dental practice.

Valuations prepared by different evaluators with varying methods and profit normalization formats are a mistake. The difference in evaluators will cause a problem with the first contributions of dental practices as to their values. It will also cause future acquisitions in determining a dental practice value based on various constants and not consistent methodologies to create havoc with advisors. The next dental practices to join the group must have a basis that is easily understood because they will probably each have their own advisors who will look for holes in the presentation. That will cause delays in acquisitions and a lack of goodwill to those dentists who may consider joining with their practices or as individual practitioners. The number of practices owned by each contributing dentist is not the most important point in determining the value being contributed to capital.
The value of the practices being contributed is the answer so that someone with 2 practices may have more value than a dentist with 4.

Approximately how much is needed to start the DSO and who must be hired to assist in its organization and continued operations?

The amount of $40,000 to $50,000 is a reasonable sum to consider when hiring an attorney with DSO experience, a certified public accountant (CPA) who is considered a dental CPA, and a certified valuation analyst or dental practice valuation expert. All of these experts should have dental experience regarding financial and legal expertise. Trying to get away with less will only cause delays and a severe initial undercapitalization. Besides that amount, hire a chief financial officer (CFO) or financial vice-president with additional funds. It should be someone with oversight responsibility who can prepare budgets by meeting with the dental CPA. QuickBooks reports prepared on a frequent basis with each individual dental practice within the DSO must be segregated so that each offices’ profit or loss can be determined quickly and compared to their budgeted amounts. Proper inventory control, banking relationships, and reporting techniques developed from experience will assist the job description for the CFO to present to the DSO management team all of the vital reports necessary to assist in its growth. It will help to determine the relationship with the individual office managers and the flow of information. It will keep the CFO from becoming an office manager.

Properly determining the market rental, especially if some of the dental office buildings are owned by the DSO principals, is another step, of which there are many. There are many steps, one of which is also very important and is described in the next paragraph.

What is the goal of the originators of the DSO and its future owners?

Many of the originators see the DSO as a way to reduce operating costs such as dental supplies, equipment costs, and overall accounting and legal, once the operations are ongoing. This is because of the ability to purchase in volume and get special pricing and payment terms from suppliers. They also see a built-in exit strategy with those joining the DSO later and paying in excess of their original contributions based on the expected positive performance of the DSO.

Along the way, it’s best to accept venture capitalists, hedge fund operators, and investment bankers to strengthen the DSO financially and make it more attractive to investors and other dental practice owners. The various funding sources will also help the DSO format different strategies for success and potentially an initial public offering. If this is what the organizers want, it can be accomplished and the investors who brought the DSO to this point will usually leave with their profits. This will most likely leave the dentists and the management team in the DSO in charge with money for expansion or to withdraw.