The Group Dentistry Now Show: The Voice Of The DSO Industry

Mike Montgomery, Vice President and Founder of the DSO Division of Live Oak Bank, joins the GDN Show to discuss group practice funding opportunities. He also discusses his recent appearance on the panel, ‘Show Me The Money’ at the DSO Leadership Summit and his outlook on the industry. If you are looking to find the best funding option for your dental group or DSO, then this podcast is for you.

Contact Mike @ mike.montgomery@liveoak.bank

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Our podcast series brings you dental support and emerging dental group practice analysis, conversation, trends, news and events. Listen to leaders in the DSO and emerging dental group space talk about their challenges, successes, and the future of group dentistry. The Group Dentistry Now Show: The Voice of the DSO Industry has listeners across North & South America, Australia, Europe, and Asia. If you like our show, tell a friend or a colleague.

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Full Transcript:

Bill Neumann:

Hey, I’d like to welcome everybody back to the Group Dentistry Now show. I’m Bill Neumann, and again, as always, thanks everyone for listening in or watching us on YouTube. Without listeners or viewers we wouldn’t have a show, and of course without great guests you wouldn’t be watching or listening. So we have a great guest here today, as always, and you may know his name. This is Mike Montgomery, he is with Live Oak Bank. Thanks for being with us, Mike.

Mike Montgomery:

Thanks, Bill. Appreciate you having us. Great to see you again in person last week. Had a blast out there in California with you guys.

Bill Neumann:

Yeah, yeah. It was a lot of fun and we’ll touch on that a little bit. And Mike wasn’t just an attendee, but he actually was on a panel discussion, which we want to talk about, because if you weren’t there, there was some really good information. Mike is the vice president and founder of the DSO division of Live Oak Bank, and they are based in Wilmington, North Carolina, one of my favorite places, at least on the East Coast.

Mike Montgomery:

That’s right.

Bill Neumann:

Yeah. So yeah, Mike talks a little bit about being out at the DSO leadership summit last week in San Francisco. We had 320 attendees, which I think is great for San Francisco. Great for being right after Labor Day, and it just worked out really well. It was a fun event. Group Dentistry Now participated with HR for Health. We had our Emerging Groups to Watch awards, which were a lot of fun, to be able to hand out awards for the first time to all the winners that were on the Emerging Groups to Watch lists for 2021. And then the next day we had pretty much an entire day chock full of great sessions. One of the sessions that Mike was a panelist in was called Show Me the Money, which I love the name. So Mike was there. We had Dr. Roshaun Pareek, or Dr. Ro a lot of people know, he was the moderator, and Ro is from Walmart health fame and had his own DSO, a Chicagoland Smile group.

Bill Neumann:

And then also Dave Pegg from DCA, Dental Care Alliance, and then we also had Mike White, who’s a CPA from CLA. So it was some good stuff. Mike, do you want to talk a little bit about, do a little recap of that session?

Mike Montgomery:

Yeah. And I love how you guys put that session together. It’s not every day you have a finance panel with that many different perspectives. And every perspective is a good perspective. There are so many different ways of tackling your financing and going through your strategy as you become a DSO. And it was refreshing to hear David Pegg speak about how DCA does things and how creating your own DSO is not for everybody. Sometimes it makes sense to, depending on what your goals are, to join forces with a strong group like them. You had Mike White involved, that he’s obviously one of the best CPAs in the DSO space. So really great influencers.

Mike Montgomery:

And it was great to hear how they look at the financing, not only from the bank side, which of course I represent, but really refreshing take on it. And I tell you, I think the content across the board in that whole day was amazing to hear some of these different speakers, and just to have some of these discussion panels. It didn’t feel like an advertisement like you sometimes feel some places. It was a really good panel of experts throughout the whole day and I think everybody got a lot out of it.

Bill Neumann:

Yeah, I totally agree. And it was a lot of fun. So maybe hat tip to Kim Fuller there at DSO Leadership Summit, HR for Health, who really put 95% of it together.

Mike Montgomery:

She did great.

Bill Neumann:

Yep.

Mike Montgomery:

Great energy.

Bill Neumann:

Yeah, for sure. Yep, that’s what made it so much fun. Yeah. And then we also, I think new Dr. Ro was kind of interesting because he had that private equity perspective. He sold his group to PE. So you got that perspective. You had your perspective, you had the PE perspective from the moderator, and then you had the CPA, and then you had the DSO there. So you’re really full circle of the options.

Mike Montgomery:

That’s right. How could I forget Dr. Ro? He’s a good friend of ours. And yeah, the fact that he’s gone through, built his own DSO, it speaks more volume coming from somebody that’s done it to the audience that you guys were representing. So it was good to hear his perspective as well.

Bill Neumann:

Yeah, absolutely. All right, so for the folks, you got the recap there, so if you missed it you got the good recap. Let’s talk a little bit about what you see, Mike, or what Live Oak Bank is seeing from current M&A. What are you seeing just from your perspective as a lender right now as we sit 3/4 of the way through the year in 2021?

Mike Montgomery:

I tell you, this is probably the busiest we’ve ever seen it, Bill. And I should probably back up a little bit and give a brief history of where we’ve been in the space just to give some context. Live Oak has been in the dental space since about 2008. We’ve lent over $2 billion in origination to dentists in all 50 states. A lot of that was in the private practice side. And then a couple of years ago we really saw the need for financing to these emerging groups. We saw that a lot of them were hitting that debt ceiling with traditional banks, and really their only other option or alternative was to go private equity at an earlier stage where they were getting a less than desired valuation. So we did a lot of research, came into the market, and really working with folks that were $2 million+ EBIDTA that are really looking at the M&A front now and need to have capital to deploy at a moment’s notice so they can go to market.

Mike Montgomery:

What we’re seeing with the market right now, obviously the fact that we’ve been in dentistry since 2008, we’ve learned a couple things. In 2008 we had the great recession. Dentistry came out resilient as ever, same for 2020 during the COVID shutdowns. Dentistry is one of the most resilient industries out there. We spent a lot of 2020 helping our current folks with PPP, making sure their payments could be made, whether it was deferring payments or whatever it was. And we found that out of our 1,000+ dental clients, not a single one suffered through any type of default or had to had to close their doors.

Bill Neumann:

That’s amazing.

Mike Montgomery:

And so the industry as a whole has really rebounded. Most groups, especially in the specialty business, did better in 2020 than they did in ’19. And the same goes for this year. So the M&A market right now is as hot as we’ve ever seen it. And more important than ever, capital needs to be easily accessible and executed. So that’s what we’re trying to help folks with. The private equity market is the hottest we’ve ever seen it. There’s more dry powder than ever. We’re seeing a lot of the existing groups that you’ve probably heard of that have done platforms in the past are going to market and then creating new platforms. You’re seeing a lot of new private equity groups coming into the space, doing a lot of research. You’re starting to see a lot more search funds. So think of a couple folks graduating from MBA school with some operational experience, they have a dentist that’s a friend, they come in and they get some financial backing through some funders.

Mike Montgomery:

And then of course you’re seeing more and more new groups forming that want to do it on their own. There are a lot of sellers out there, but I would say for every seller there’s probably three or four buyers. So it’s an extremely competitive market right now. And again, it’s important to have your ducks a row if you’re looking to continue to move forward and have your financing together so that you can deploy that and actually win those LOIs, because there’s a lot of other folks out there doing the same thing.

Bill Neumann:

Yeah. Some great points, an exciting time to be in the industry. I think things were a little bit, I would have to say, scary for all of us in March of last year, not really knowing how dentistry would react to this. And of course a lot of practices were closed down. So they reacted to it, they couldn’t react, right? They were closed down completely. So fortunately that was short-term and able to bounce back pretty quickly. And thanks to people like yourself and Live Oak Bank being able to get that PPP together, because that wasn’t necessarily the easiest thing to figure out how to apply for. So that was good you were there for your customers. Yeah, let’s talk about, from the perspective of a DSO or an emerging group, what should they be looking for? So as practices, maybe the original lender for that first practice isn’t interested in lending beyond the second or the third or the fourth. So what should they really be considering when they look at banks?

Mike Montgomery:

Yeah, that’s a great question, Bill. Financing is a little bit segmented in the DSO space. I consider really there’s tow to three parts. The first one is that emerging stage where maybe you’re a private practitioner, you’ve added a second or third location, and you’ve been to these DEO events and maybe you’ve decided, “Okay, I want to do this. I want to continue to expand on my own and create a DSO.” That’s a major inflection point for a lot of these folks where your existing banking relationship might be comfortable lending to three, four, maybe five locations. Over a longer period of time there’s going to get to a point where those banks hit that debt ceiling. A lot of banks, all banks for that matter, have a certain cap that they’ll lend to any one individual. And so a lot of groups are running into that right now, where their bank either is willing to lend up to $5 million or maybe even $3 million.

Mike Montgomery:

On top of that, once you actually create your DSO there’s always that debate, what comes first, the chicken or the egg? Do you go ahead and put all your practices together now and then build the infrastructure, or do you build the infrastructure first? I don’t think there’s any right or wrong reason to it, but it’s a different approach to each with pros and cons. But what we typically see is, once groups get to a certain phase and they’ve established that DSO, they’ve got their management service agreements in place, a lot of the banks don’t understand where the money’s going. And typically if you’ve run out of runway with one bank, you go to another bank and you start to bootstrap, you get in a little bit of trouble with the banks where they really get concerned even though there’s really no need for concern, and the lending dries up a little bit.

Mike Montgomery:

And that’s when you’re faced with the, “Okay, what do I do now in order to grow? Do I need to go get mez funds at a higher rate so that I can continue to grow? Do I partner with private equity?” It really depends on what your model is. How fast do you want to grow? But if you want to retain all that equity on your own and continue to grow, there are several banks out there that can help you get to that next step. And that next phase of financing is where we come in. And it is very different from how you were working with your banks in the past. You might be working with a regional bank, they’re offering you very low interest rates, they are able to get some term debt for you.

Mike Montgomery:

Going forward, once you hit this, we consider you to be a lower to middle market business at this point, you’re not a small business any more, that changes a little bit. So rates are a little bit different because there is a little bit more risk involved. There are some personal guarantees sometimes that we can slowly burn off, but really what I recommend groups look for when they’re looking for a bank is, number one, does that bank understand your business and understand the industry? That’s number one. I always recommend to folks, interview your bank like you’re interviewing someone as a new hire and make sure they fit your culture, make sure they fit exactly what your goals are. We’re okay with that. We actually have just gotten through about a 12-week cycle with a new group that was vetting banking relationships to see who they wanted to go with and everybody has a perfect fit for everybody else.

Mike Montgomery:

What we were able to provide and what we recommend to a lot of groups is, it’s not about interest rate any more. Not saying we have the highest interest rates, we don’t have the lowest interest rates, but at this point what you need in a financing partner is a group that’s able to help you scale to that next step, give you the assurance that you can do that, and have that flexibility. If I’m trying to buy four practices this next year and there’s three other groups looking to buy that same practice, how quickly can you deploy that capital so that I can execute on that and have that buying power, maybe actually negotiate the purchase price a little bit more? So I think ease of capital is more important at this stage in the game. And just the ability to continue to work and partner together is key as you continue to move forward. So those are the main points I would make there.

Bill Neumann:

So what do you look for? So let’s do the flip side of that. So first the group’s looking through the banks for the opportunities, but from your perspective, what do you look for? Who do you partner with? Maybe give some tips to some of these groups so they can make themselves as viable a partner for a bank as possible. Because some of them maybe aren’t viable for any lending, right?

Mike Montgomery:

Sure. Yeah, the saying always goes, if you’ve seen one DSO you’ve seen one DSO. And it’s absolutely true. For the folks that we typically finance there’s a common denominator, and it’s a number of things. One, the culture’s intact, there’s a lot of clinical autonomy. You never want to lose that and have that corporate feel. You always want to make sure that that clinical side is intact for your clients. Number two, good track record. For us, we put our minimum requirement of EBITDA at around $2 million. We do that for a reason. That typically means, call it a, if it’s a general dental practice, maybe they’re doing $1 million per practice. If they’re doing $2 million in EBITDA, that’s usually a 20% margin. Let’s call that 10 practices. They’ve shown a track record with those acquisitions, or maybe it’s a de novo strategy or a mix of both, but they have a track record and a history that we can look at.

Mike Montgomery:

How did they go by buying these practices? What was the process? What was the onboarding process? What did they learn from those? And then what were the financial trends? What’s the organic growth of those? How much have they grown the top line? How much have they grown the bottom line? It tells a full story. So we want to have several years of track record there. The next thing is, as you continue to grow and scale you need to build out that non-clinical team. It doesn’t have to be perfect. I think there’s no perfect recipe to it. It really comes down to, where’s your comfort level as you’re continuing to grow? Once you get about five locations or so you probably need a regional manager or an operating manager, probably need to have some type of bookkeeper and slowly advance to a controller.

Mike Montgomery:

And we’ve got some groups that they don’t have a CFO yet, and that’s fine. They might be outsourcing one, but really have that non-clinical team in place to be able to help promote that growth and be able to really track the financials. And probably one of the most important, Bill, is really having more sophisticated financials. That’s probably the biggest. We’ve seen a lot of groups that are almost ready for the next step but their books are a mess. They might have 20+ locations, they’re not consolidated, you ask for a financial report and they send you 20 different spreadsheets. How can you run a business like that successfully if it’s not consolidated into one where you can really look at one page and see that financial picture? So having a good CPA that understands the business, just like having a bank, is of utmost importance.

Mike Montgomery:

There’s a lot of great CPAs out there in this space. Having them come in, consolidate everything, make sure you’re tracking KPIs. There’s a lot of debate of when you need to go from cash to accrual accounting, obviously accrual is preferred. There’s reviewed financials versus audited financials, and we can get into that a little bit later. Typically reviewed is fine up to a certain loan level, but after that we have to move to the audited. But really at the end of the day, having that good track record, having a good plan in place, having those sophisticated financials, and really having that plan for growth in the future and have a philosophy of how you’re going to continue to execute is important to us. So that’s really what sticks out to us of the ideal DSO that we’re looking to partner with.

Bill Neumann:

Excellent. Yeah, so let’s talk a little bit more, you mentioned it earlier in the podcast, personal guarantee. So give the listeners, the people viewing, some expectations around that.

Mike Montgomery:

Sure. That’s always a hot topic, right? You’ve had a personal guarantee before when you’re working with those regional banks on those term loans. A lot of folks expect that now that they’re a larger business and they’ve built out this platform, there shouldn’t be a need for personal guarantees. The banks look at every loan as a type of risk. And any way they can mitigate that risk gets them more comfortable with lending to that group. We understand that as groups grow there’s going to be a point where that personal guarantee probably doesn’t matter as much any more. There is such a thing as being, you can still be big and still fail, but by doing these different things that we’re discussing is really going to mitigate that and gets us a lot better comfort level.

Mike Montgomery:

Typically a non-recourse loan or having a line with no personal guarantee is always going to be common when there is an equity sponsor. If it’s just a, let’s call it a 50/50 owned two-doctor platform, typically personal guarantees are going to be required, at least for a little bit. Our philosophy is, once you get to a certain stage we can actually do a burn-off on those personal guarantees. Typically $5 million in EBITDA is where our comfort level is. That’s coupled with, we do covenant compliance testing, which is a way of really seeing the health of these groups and giving us the ability to continue to lend to them. We look at a leverage ratio covenant as well as a debt service coverage. Try to keep it pretty basic, but as long as that group can not only obtain that $5 million mark, as long as they can stay in compliance with those covenants over a certain period, then there is the path to be able to remove those personal guarantees. So we’re definitely willing to work with you.

Bill Neumann:

That’s good. I think that’ll alleviate some fears wrapped around that. So what about, we hear a lot of talk about EBITDA. And so I think the sophistication level of even some of the solos out there, they understand EBITDA to a degree, but why is it really so important?

Mike Montgomery:

Yeah, EBITDA is important for a number of different reasons. One, that tells you where your business is and how it can compare to others. It also is the indicator of how you can value your enterprise. Any time you hear that somebody sold for 5X or 7X or whatever it is, or some of these bigger platforms that are at $25 million in EBITDA are saying, “We sold for 12, 14X,” that’s X of EBITDA. And so EBITDA is the indicator of profitability for us, and really for the banks that’s how we gauge how much we can lend to you. We look at it from a leverage position, where you’re looking at your debt to EBITDA, how much debt do you have in relation to that profit? Most of the banks out there right now, you’re seeing some of them post-COVID that won’t go more than 2.5 or 2.75 in some cases.

Mike Montgomery:

We can do more than that, it’s really a case by case. Typically for us it’s a three to a 3 1/4, sometimes we can do a little bit more, especially depending on if it’s a private equity backed or something else. But what we’ll do is take that EBITDA number and we’ll do a couple different leverage ratios. We do a senior debt to EBITDA, which is all the money, say if you’re a client of Live Oak’s, it’s all the money that Live Oak has out to you. So we look at that ratio and then we look at a total debt to EBITDA ratio as a total leverage. So that’s the debt with us plus any other subordinated debt. So think seller notes, equipment loans, anything like that, real estate loans not included.

Mike Montgomery:

But that’s how we come up with these leverage ratios where we’ll say, “Okay, you’re at $2 million EBITDA today. We’re willing to lend up to 3X based on these new acquisitions. We’ll include the EBITDA of those acquisitions. The bank is willing to go senior leverage debt to EBITDA three times, and we can go up to four times on that all remaining debt.” So EBITDA is really an indicator of a couple things. And again, that’s what all the banks go by, that’s what private equity goes by. When you’re being valued, EBITDA is the cornerstone of how that’s gauged. And you want to make sure EBITDA is accurate as well. And we’ll talk a little bit about Q of Es here in a second, which I find are very important, especially if you’re still up and coming and you’re not audited yet. But a couple of things I’ve noticed with some of the upcoming groups that you want to be careful about with EBITDA. If you’re not selling your business and you’re looking to continue to grow your enterprise, you don’t want to include those offer compensations. That’s not part of the EBITDA calculation.

Mike Montgomery:

So a lot of groups, they might have five practices or so come to us and they say, “Mike, we’ve got $2 million in EBITDA.” And we look at it and then we see that offer compensation has been included, and we have to subtract that out and they’re at $750,000 in EBITDA. It’s a big difference and can make that leverage ratio and your debt service coverage change quite a bit. So be wary of that. And then a recent one that we’ve seen, and we actually wrote an article for Group Dentistry Now a couple months ago about EBITDA that’s worth taking a glance at, of how we define EBITDA. Just like we can add back non-reoccurring expenses, say you set up your DSO in 2020 and paid quite a bit in legal costs to get that set up, we can add that cost back.

Mike Montgomery:

However, with PPP and CARES Act last year, there was a lot of money that was forgiven. And a lot of times that loan was added to the revenue and dropped to the bottom line, or just like one-time expenses, that’s one-time income. That’s a non-reoccurring income. So we can’t include that in the EBITDA calculation. So that’s another thing we’ve seen, where groups have come to us and we’ve had to back that out, which has changed those ratios quite a bit. So keep that in mind too when you’re calculating your EBITDA. I think it’s a good exercise every group should do, is to go and look at what that is right now and continue to track that on a monthly basis.

Bill Neumann:

Yeah, that’s a great explanation. And I was going to hold it off until the end, but you did mention the article that you wrote. I think it was right back in May, so it’s really current, but it was called EBITDA: A Deeper Understanding. And we’ll make sure we drop a link in the show notes and you’ll be able to access it. If you just want to go to our website, you can just type in search bar Live Oak, and you’ll find all the articles that Mike Montgomery has put together there. But yeah, really concise article, give you a deep understanding of what EBITDA is and how to make sure it’s accurate. So you talked about quality of earnings. So let’s talk about, we talked about the importance of EBITDA. Let’s talk about the importance of Q of E.

Mike Montgomery:

Yeah. So a quality of earnings is essentially a test of the EBITDA and a number of other things. It’s looking at the balance sheet, it’s looking at your accounts receivables. Any time there’s a major transaction, especially with private equity, they’re going to conduct a quality of earnings on that entity. We do the same thing when we’re entering a relationship on the front end. We want to make sure that that EBITDA is tested and proven. And so we do what’s called a limited scope quality of earnings report, where essentially if you’re on reviewed financials and you haven’t moved to audited yet, you need to have a third party really look at that and determine what that actually is. So it’s really a litmus test for the bank. It’s something that you’ll want to have down the road for if you do have an equity event.

Mike Montgomery:

And it’s really something that, depending on the size of an acquisition that you make, you can’t always trust the financials of a seller. You want to trust but definitely go in and make sure that that’s actually what it is. So Q of Es are really important. We typically will on the front end ask for a Q of E before close. It really falls in line with the closing process. So you have a third party CPA firm, a group like Mike Weitz can do it. Mark Rudolph’s team at Elliot Davis is another one. There’s a number of groups out there that can do it, and we can give you some resources if you want. That’s one indicator that we’ve seen too this year, of just a really hot market in 2021, is Q of Es are taking a little bit longer right now. In a typical world it can usually be done in about 30 days or so, but just like everybody else they’re busy right now. They’re hiring up to meet that demand. We’re hearing as much as 10 weeks right now in some circumstances.

Mike Montgomery:

So I would say anybody that is looking to transact in the next quarter or so, start looking at the Q of Es now and ask your bank what exactly they’re going to be looking for. We all look for something a little bit different. Again, I mentioned we do a very limited scope. It’s a fraction of the cost of these other ones, but that just gives us and our credit folks that comfort level of being able to work together, and then moving forward, once you move the audited financials and things like that we’ve got a good base to go by. And as you’re acquiring these new locations, we can include that EBITDA of those locations. And depending on how big those locations are, there might need to be a single Q of E done on each of those acquisitions. But again, Q of E is something really important. It’s something that, depending on how much you’re looking to borrow, that’s going to be a requirement by banks. It’s going to be a requirement of all private equity. So it’s universal across the board.

Bill Neumann:

Excellent. So as we wind this podcast down here, do you have any recommendations for a group to really become bank ready or make themselves as ready as possible and as optimized so they can get the best rate possible, the best terms possible? What do you recommend?

Mike Montgomery:

Yeah, I’d say number one, know your business, know your numbers. Know what your process is and what your goals are, and have that mission statement. It’s okay if it changes a little bit, but to have to have a plan in place and to be able to deliver that to the bank is really important so that we know that story. Yeah, know the business, know the numbers, and then make sure you’re partnering with the right people, both internally and externally. Your CPA, your attorney, your bank, everybody should be an extension of you and should be a true partnership and all be on the same page to make sure that you’re successful. So make sure you’re working with the right folks. And then I can’t emphasize enough on the financials, make sure you’ve got all your ducks in a row there. You’ve got consolidated financials, you’re tracking that monthly, you’re tracking KPIs. And if you do that, the rest should fall together pretty well.

Mike Montgomery:

But again, a business is where you spend most of your life. It’s like your child. We know our children in and out, we want to make sure you know your business. And if you do that, then we’re happy to be a part of it.

Bill Neumann:

That’s great. Mike, what’s your email address for anybody that might be listening in so they can shoot you a quick email to find out more?

Mike Montgomery:

Sure thing, it’s mike.montgomery@liveoak.bank.

Bill Neumann:

That’s pretty simple. And we’ll have that email address in the show notes. And also Mike mentioned one of the articles that he did earlier, not too much earlier, just a couple months back, EBITDA: A Deeper Understanding, which is on the groupdentistrynow.com website. Did another one earlier in the year, which is a great read called DSO Lending Landscape 2021 and Beyond. So those are two articles, we’ll link to those, both articles, in the show notes as well, or you can just go to our website and search Live Oak Bank, and you’ll find both of them. But well, it’s been great, Mike, I know I learned a lot on this podcast, and really appreciated seeing you in person. And for the folks that weren’t able to do that, at least they get to either listen to your voice or watch you on the video portion of this.

Mike Montgomery:

Well, thanks, Bill, I appreciate you having us last week and hosting us today. And again, if anybody needs anything, feel free to email me. Happy to have a conversation with anybody out there, and looking forward to talking to you all soon.

Bill Neumann:

That’s excellent. Well, thanks again to Mike Montgomery of Live Oak Bank, and thanks to all the people watching and listening to the Group Dentistry Now show. I’m Bill Neumann, and see you all next time.