How Small Shifts in DSO Funding will Transform the Future of our Industry

As is often the case, the ending of a year — especially this year — brings with it a chance to step back, reflect, and observe the developing market through a different lens.

What will the “dental industry of the future” look like? What’s the next phase of growth? Will the dental industry thrive? Evolve? Merge into something else? Die out altogether? And how do those of us confined to the “here and now” anticipate, pivot, and redirect?

All of us in the DSO space are in a race against time. We’re trying to reinvent the space, abjugate ourselves from long-held predispositions, and nurture organizations that will survive and thrive through the next round of changes – all before the industry shifts so thoroughly that it’s unrecognizable.

But where are we headed?

I believe that we are on the precipice of a new dawn in the space. We’ve survived industry-iterations that have tested the sacred boundaries to which clinicians swear when taking their licensing vows. We have outlived PE-backed monstrosities hellbent on profit, even at the cost of patient care.

Sure, those types of “profit-crazed” entities will always be a part of our reality — no different, really, than the presence of fast-food joints in the annals of cuisine. But organizations that are so focused on the dollar that they’ve become blind to the patient are rapidly going out of style, letting their reputations usher them toward an inevitable fate. That fate? To simply be bought and sold like cattle with every succeeding 5–7-year term, management team, and funding source. To be forever squeezed for every last drop, like some dry (and very tired) lemon.

Look no further than a slew of recent large-scale acquisitions across the DSO landscape — paying special attention to their corresponding multiples — to see how the dilution of quality (relative to patient care) results in the dilution of value (relative to the organization as a whole.)

That isn’t to say that all external funding sources are bad. Quite the opposite, in fact. And that’s precisely where I’m heading with all of this.

A NEW (FUNDING) REALITY

One of the largest developments in the dental/DSO space is the expansion of funding sources that are willing to involve themselves with profitable entities at a rapidly decreasing operational impact. In layman’s terms? You can obtain capital without giving up the farm — or control of your baby.

It would take too long to submit a comprehensive list of all the options available, but to cut it down to size, here’s a quick overview of some types of funding sources that are lining up to invest in the dental space.

LOCAL BANKS / NATIONAL BANKS

Long considered too small or too restrictive to handle a major market expansion, local and national banks have begun to lend at levels that eclipse their historic limits. Though they’ve been traditionally pegged in the 10MM range for a single group/signer, we’re now seeing these funding sources move well into the 20MM range.

This, of course, allows for significantly more leverage within an organization, and more expansion opportunities within a market. Generally set at a prime+ rate, this capital is affordable and allows the entity’s owners to retain full control of the business. (Bonus: real estate is often considered a valuable asset for these banks, so in this case, holding the real estate can be a significant plus.)

FAMILY-RUN VC and/or SMALL PE FIRMS

These smaller funding sources are, with increasing regularity, looking to dip their toes in dental investment. Oftentimes, these groups don’t have the infrastructure to really manage a business, which leads many of them to trade that management oversight for the equity in the business.

What does this actually mean? It means that rather than taking a piece of the business, this funding source could instead set a reasonable return rate (or “coupon” annual return) and allow the businesses to scale and expand while paying that coupon.

In most cases, these rates are driven by family trusts and similar entities looking for a solid annual return on their money. For the group practices that have access to this capital, this setup provides the best of both worlds: attractive rates (if slightly higher than current lending levels) and the ability to avoid giving up control of the entity. A win/win for all parties involved.

And voila – we have the makings of a new dawn in the group practice and DSO space.

RE: THE NAYSAYERS

There are those who want to downplay this development. There are observers who continue to demonize the group practice and DSO space, decrying any and all developments as the downfall of patient care and the corporatization of medical provision. These arguments were launched at the outset of DSO legal creation and have continued to this day — despite consistently positive growth, evolution, and satisfaction surveys (from both patients and employees) illustrating the efficacy, efficiency, and longevity inherent in this model.

Meanwhile, the new influx of capital sources has allowed for timeless ideals to be maintained, bold ideas to be realized, and influential legacies to be created. (Relevant side note: legacies tend to be most powerful when the organization doesn’t fall apart directly following the owner’s departure, but can instead be grown and expanded for years to come.)

ON THE HORIZON

As we see a resurgence of the mid-tier DSO, we need not hold onto past fears, assuming the “inevitable” sidestepping of clinical and ethical standards. Rather, we can look at each organization’s founding principles, seek to understand the respective markets they serve and begin to realize that we can indeed “have it both ways.”

We are, at this point in the industry’s evolution, truly able to build organizations that thrive in the current climate, utilize the latest and greatest technologies, and operate as successful businesses — all while upholding culture, maintaining employee morale, and sacrificing nothing when it comes to patient care.

So where do we go from here? Back to the beginning: vision, values, culture, clinical prowess. Now more than ever, these core pillars – along with financial intelligence and a genuine understanding of the specific market served – are essential keys to building a successful entity.

Those who can honor these concepts and properly serve patient constituencies will be able to build organizations – and legacies – that will last for a very long time to come. Those who are not able to be disciplined in their construction process will end up being fodder for the next massive national DSO simply looking to gobble up EBITDA in preparation for their next turn. No longer do I see this as an inevitability for all group practice owners, but rather as a choice. And, as with all decision-making processes, discipline will win.

I plan to win.

Written by:
Josh Swearingen
Chief Executive Officer
Vesper Alliance, LLC
www.vesperalliance.com
josh@vesperalliance.com
614.595.7600 – Cell

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