Demystifying Private Equity: What are Investors Looking for in a DSO Investment? Part 2

I have been working with PE investors who are actively investing in dentistry for most of the past decade. During that time, I have seen all types of firms, personalities, ethical values and approaches to engagement with DSOs. The best investors are true partners in every sense of the word: they communicate well, constantly seek alignment, and they are humble enough to understand what they don’t yet know about managing a DSO. There are many success stories with these “best of the best” investors. In contrast, there are also many stories in circulation regarding the worst investors (the bad actors), tales of disgruntled partners, fleeing employees and investor hubris run amok.

Obviously, we all want to be a part of the successful partnerships rather than those with less than optimal results. I spend the majority of my time assisting DSOs and PE investors how to find their “diamond in the rough,” finding the right investor partner for DSOs and also the right DSO for PE investors. In this article, my goal is to share deep and clarifying insights from PE investors who are actively targeting assets in the DSO space and to assist your DSO’s preparation for bringing on an investor partner at some point in the future.

The first characteristic your DSO needs to be attractive to investors is knowing your DSO’s ‘why.’ Why does it exist beyond the how and what it does? The Why is your DSO’s reason for existence and it must animate and inspire your team to act in accordance to it, typically summed up in a DSO’s Mission, Vision and Values. If the Why is primarily motivated by financial gain to the owner(s), few dental entrepreneurs are historically successful in their endeavors. Getting your Why right and successfully leading a mission-driven organization lay the groundwork for a sustainably successful DSO, and one that PE investors may be interested to invest in. The DSO House concept (illustrated above) was discussed in a previous GDN article, ‘Building your DSO or Group Dental Practice House.’

In addition to your DSO’s ‘why,’ and the other basic concepts of The DSO House, I recently queried a diverse group of PE firms within my network and asked them a simple question: What characteristics are you looking for in a DSO investment?

The answers were varied; however, several themes emerged that will help you understand what to focus on as a pre-PE investment DSO entrepreneur. Ultimately, investors are seeking to invest in a DSO platform that is sustainable over the long term and has a high probability of continued financial growth with additional capital investment from their firm.

Platform DSOs typically will include these desirable characteristics:

Growth History and Strategy
 Enough initial scale and diversification to demonstrate an ability to be a growth platform
 Proven ability to operate multiple locations including all systems and processes
 Strong history of pre and post acquisition organic growth
 Predictable growth of de novo practices with short runways to profitability
 Tried and true integration and on-boarding processes
 Active acquisition/de novo pipelines and dentist recruiting pipelines
 Near and mid-term opportunities to expand regional presence with desirable demographics
 For some investors, ability to integrate specialty services

Leadership and Alignment
 A strong clinical leader who can drive the business and clinical vision systemically
 Full or at least partially built management team with controller/CFO in place for transaction
 Pre-transaction agreement on Board control/governance and Board members
 Full alignment on the Why (Mission/Vision/Values), operational strategy and exit strategy

Financial Performance
 A minimum of $2 million EBITDA annually
 Above industry margins or better – 18-20%+ DSO level EBITDA margin

Clinical Performance
 Quality control mechanisms and management in operation
 Limited or no malpractice/legal issues related to clinical quality
 Appropriate provider revenue per hour metrics
 Consistent patient base with high hygiene recall/recare rates of 85%+
 High rates of case acceptance
 Above average new patient numbers

Ownership and Dentist Continuity
 Dentist continuity over the mid to long term is critical
 Low dentist turnover and embedded mechanisms for long term retention of providers
 PE often requires a 20-40% retained seller ownership (most deals around 30%+ retained)
 Some investors prefer employee dentists and others prefer joint ventures with key dentists

Geographic Density
 Favorable dentist to population ratios generally above 1:2000
 Solid market position in demographically favorable markets

Treatment Mix
 No overtreatment of high dollar procedures such as crowns and implants
 Low crown or high hygiene procedures as a percentage of overall revenue is favorable
 Bread and butter dentistry is more desirable than high percentage of specialty procedures

Payer Mix
 Diversified payer mix with no single dominant payer
 No Medicaid or very limited Medicaid (below 20% total revenue)
 PPO’s are generally acceptable, assuming good overall financial performance

Regulatory Compliance
 Clean regulatory/audit history
 Minimum of an outsourced OSHA/HIPAA compliance program
 Ideally have a functional, legally vetted DSO compliance program with internal oversight

Reputation
 High customer satisfaction proven by internal surveys and online reviews
 High percentage of new patient referrals – 1/3+ is optimal
 Modern and well maintained facilities

PE investors are looking for a true turn-key business to invest in as a platform investment, not just a loose collection of practices with limited management and systems. The concepts outlined by PE investors here are sound business concepts applied to dentistry, and just about any size dental practice, dental group or DSO would do well to focus on building capacity within these functional characteristics. With an intelligent business plan/road map, the right advisors, a lot of hard work, and a little luck your DSO may just end up being the “diamond in the rough” a top PE investor is looking to partner with in the near future.

Read Part 1 – Demystifying Private Equity:
When is PE Investment Right for Me?

Written by Jeromy R. Dixson, DMD, MBA, CEO of The DSO Project and DSO Project Advising. Dr. Dixson was chosen by Group Dentistry Now as one of the ‘DSO Influencers‘ of 2019. You can contact Dr. Dixson at drdixson@dsoproject.com or connect with The DSO Project ecosystem at www.dsoproject.com and www.dsoprojectadvising.com. Read Dr. Dixson’s other article here: Building your DSO or Group Dental Practice House

 

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