Dentists: What You Need to Consider Before Selling Your Practice to a DSO

Art Wiederman, CPA: Hello everyone and welcome to another edition of The Art of Dental Finance and Management with Art Wiederman, CPA. I'm your host Art Wiederman and welcome to the podcast. We're recording here in Southern California on a very sunny and cold for us. Now, you understand when I'm talking to my friends in Minnesota, when I tell them it's 60 degrees and cold, they hang the phone up on me. But it's a little chillier than normal, but it's beautiful out here.

And today, we're going to cover a topic that is getting more and more attention in the business world of dentistry. And that topic is dentists selling their practices or being approached or approaching large groups to buy their practices. And my guest today is Brannon Moncrief, who is a gentleman I've known for 20, 25 years. He was in banking, and that's where I first met him. And he is now with his company, McLerran Associates, and is, I would say, one of the national experts on what is going on in the market of DSOs, private equity, acquiring dental practices.

So we're going to give you everything the good, the bad and the ugly that you need to know to make good decisions. Because, folks, it is a jungle out there and you're dealing with really, really smart people and they can take advantage of you if you're not careful and you don't have somebody who knows what they're doing. So we will visit with Brannon in this hour of the Art of Dental Finance and Management.

I want to again thank my wonderful, wonderful excuse me, partner, Decisions in Dentistry magazine. 140 amazing continuing education courses at a very, very reasonable price. The best clinical content of any magazine in dentistry, the who's who in clinical dentistry. And I am honored and humbled that they have partnered with me for well over three years. Lorene Kent and her team are amazing. Please go to their website www.DecisionsinDentistry.com.

We have will be, you'll be hearing this podcast in early January so I guess I should say happy 2023 and I hope you all have a wonderful, successful 2023 and we're going to be here with lots of great content for you our great guests. You'll get to hear a lot of me talking about my opinions and financial planning and how you can retire and changing your relationship with people and propagating, you know, being great dentists and having wonderful lives. And that's what this podcast is about. I'm going to continue to stay on my high horse.

On the subject of the Employee Retention Tax Credit. If you have not applied for the Employee Retention Tax Credit for the year 2020, if we are airing this podcast in January, you have about six months before this opportunity goes away. If you had a greater than 50% reduction in your revenues and generally the second quarter of 2020 versus 2019, you will qualify. And we still have doctors that are coming to us to do this. We've done, I think, 125 practices, well over $5 million in refunds for doctors, all very legitimate. And if you had a 20% or more reduction in any of the three quarters of 2021, the first three compared to the first three of 2019 or the fourth quarter of 2020 versus the fourth quarter of 2019, under the lookback rule, that credit is much more robust. I do want to again warn you about companies who are predatory in going after you and telling you that if somebody on TikTok said you can get the ERC, then you can get it.

I actually got a phone call last week from a number in Texas. A very nice, engaging young woman called me and said, Hello, sir, are you a business owner? And I played along for a little while. Yes. Well, have you heard of the Employee Retention Tax Credit? It's so easy to qualify. And I went down the road a little bit but lost my patience. But I'm telling you, folks, these businesses are going after you and telling you if you had a supply chain issue or you had a social distance that you qualify for all seven, seven quarters of this credit, I am going to tell you that if you are going to apply for this credit, please go through a reputable company, CPA firm.

Our firm Eide Bailly has done hundreds of these and we are as good as it gets at it. And if someone tells you because they talk to you on the phone and you told them that your practice was down and then it came back and that's why we can qualify. I'm telling you, you are asking for trouble. The Internal Revenue Service has issued a notice to the public, basically saying that we are going to come after you and these companies who are claiming billions of dollars in ERC tax credits. So all I'm saying is, please be careful.

All right with that, folks. I want to get to my guest. I met Brannon Moncrief I'm thinking 20, 25 years ago. Brannon was with a dental lender. Two wonderful guys, Fred Truitt, and Matt Winston, who had a great, great dental lending company out of there out of Texas, I think. And they you know, we did we did stuff together and we referred business. And I met Brannon. And, you know, you can usually tell when you're dealing with people and, you know, Brannon is a stand up guy, very, very ethical as a lender. And I've gotten to know him now in his new life. I don't know how new it is. We'll find out here in a minute. As a transition specialist, helping doctors to sell their practices and evaluate their values and look at their opportunities.

And that's we're going to talk about that. We're going to talk about, you know, what's your practice worth if you just sell it to another doctor versus what's your practice worth? If you take it to a DSO that owns 100 practices or 500 practices and Brannon knows this market better than anybody that I know. And we're going to get you really educated on this because doctors, we want you to make a good decision. We are not going to talk today about don't sell to a DSO or do sell to a DSO. We're going to give you the information for you to make the right decision. So, Brannon Moncrief, welcome to the Art of Dental Finance and Management.

Brannon Moncrief: Thanks, Art. Good to see you. Thanks for having me.

Art Wiederman, CPA: How's life in Austin, Texas?

Brannon Moncrief: Life's good. Life's good. Busy little cold today, but no complaints.

Art Wiederman, CPA: Well, the Longhorns all know. Now, remember, we're doing this in November. So when you hear this two months ago and I'm a big college football fan. The Longhorns almost beat undefeated TCU last weekend, but not quite. You a football fan?

Brannon Moncrief: I am, but I'm an Aggie, so it's a sore subject.

Art Wiederman, CPA: That's a hard thing to be this year.

Brannon Moncrief: Very sore subject for me right now with everything going on around Jimbo.

Art Wiederman, CPA: Jimbo. Just I mean, I don't know. We won't go down that road, but they're, what, three and six or three and seven? And I'm sure the natives are very restless in College Station, but, you know, it is what it is. And but I did get to go I got to see USC play Texas at the Austin Stadium. I'll tell you what, I've never seen a marching band bigger than the Texas marching band. I mean, they took up half the stadium and it was a fun day. It was not fun for USC because Sam Ehlinger, who's now quarterback in the NFL, he took he dissected us. But anyway, we could talk football the whole time, I'm sure, but that's not what we're here to talk about.

Brannon is the founder, director and CEO of McLerran Associates. Basically what they do is they help you understand your options, help you find the right fit for your practice, help you determine the valuation of your dental practice if you want to take it to market. So Brannon, let's start off kind of give us a little bit. I mentioned that you started your career in lending. Tell us a little about your road and how you got to where you are today.

Brannon Moncrief: Thanks, Art. Yeah, absolutely. So. I have a finance degree from Texas A&M. And coming out of school, I went to work for a small finance company that you mentioned, spent almost a decade lending money to dentists all across the country to buy practices. So in that role, I was a loan underwriter for a few years, worked my way up to becoming the director of business development. I was involved in well over a thousand practice transitions from a financing standpoint. And after about ten years of of the banking world, I decided that I didn't want to leave dental, but I wanted to get out of banking, so I ended up purchasing McLerran Associates at that time it was a small practice brokerage firm based in San Antonio and Austin, and they focused really on doing doctor to doctor transactions. They were probably doing about 20 doctor to doctor transactions in the state of Texas at that point in time, grew that business significantly over the next five years.

And then about five years ago, I've been in this business a little over ten years now, but about five years into this business, we saw DSOs come into the Texas market really, really hard. We saw private equity begin to consolidate the industry at a rapid rate, particularly in Arizona, Texas, Florida. We were some of the first states that saw a lot of the consolidation and a lot of the DSOs being founded in those states. So we made a conscious decision to pivot and to add a knowledge base to our team and start to figure out a way to provide doctors with an education regarding private equity, DSOs, their options available in that marketplace, and how value is derived in that market, because it's a very, very different world than the doctor to doctor transactional world.

So we spent a couple of years going to school on that and developing a process, building a team. We still do about 60 doctor transactions a year, but only in Texas. And then myself and a part of our team focused on sell-side advisory for DSO transactions. So we help doctors that are looking at affiliating with the DSO or taking on a private equity partner, evaluate their EBITDA, evaluate their practice value, talk about options, different deal structures, different types of buyers available in the marketplace. And then if and when it makes sense for the doctor to pursue a DSO affiliation, we help them take their practice to market, create a highly competitive environment among multiple buyers, bring them multiple offers, multiple options, and help leverage that competition to maximize their outcomes. So at the end of the day, it's about. Educating doctors on what their options are and then helping them execute at a very high level. In regards to whatever transition strategy they decide to pursue.

Art Wiederman, CPA: All right. So we're going to get into all of that. I want to start let's start with some definitions, because there might be people listening to this podcast who have heard the term DSO, have heard the term private equity. Why don't you give us kind of a 35,000 foot view of, you know, what is a DSO? Why are they formed and what's their endgame? What's their structure? What's their structure are we talking about? I mean, I talk to people, they're buying up practices. I want to own 100 practices in two years. You're well, that's not going to happen. But good luck with that. And I want to sell it out for $1,000,000,000 like some of these other guys have done. And then, you know, what is private equity? So talk about you just kind of what a DSO is, what they're doing, and then talk about how private equity is involved in this whole process.

Brannon Moncrief: So a DSO is really just a legal distinction, right? A DSO could be a single location practice or a 500-location practice. It essentially means that the ownership of the practice or practices have been bifurcated into a non-dentist-owned entity and a dentist-owned entity. In most states, the dentist-owned entity has to own the clinical assets, the practice, essentially the patient records, the non-dentist-owned entity or an entity that has non-dentist partners, owns everything else. So it typically controls all the tangible assets of the practice. It's going to control the lease, the equipment. Anything outside of the patient records is owned and controlled by the DSO nonclinical entity, and that entity is essentially designed to manage the practice and pull all the profit out of the business at the end of the day.

But for most DSOs, as people refer to that we're talking about a larger multi-location practice might be focused on one state, several states or nationwide, and they're typically private equity backed or backed by a family office. So what is private equity? What is a family office? It essentially means it is a group of business professionals that raise private capital from private investors, sometimes institutional investors, if they're a large PE firm and they look for different verticals, different industries to deploy that capital to invest in, typically highly fragmented industries that are not consolidated, that are very profitable, that can benefit from economies of scale. They can benefit from, you know, multiple doctors coming together as a conglomerate and leveraging their size to negotiate better pricing with labs and dental supply companies and payers. And they can benefit from professional business advice as well as really deep pockets from a capital perspective to continue to grow and scale the business. Private equity loves dental because it checks all of those boxes. It's very profitable. It's very fragmented. Most doctors are not inherently great business people, so they can definitely benefit from the guidance of highly sophisticated business people.

Art Wiederman, CPA: Except for my listeners who are fantastic business people, just so you know.

Brannon Moncrief: Absolutely. Absolutely. They have you on their team. So. Exactly. Big benefit. And they can also benefit from capital. You know, most of the dental lenders out there will max out around $5 million in exposure. So if you're being funded by traditional conventional financing. You're going to hit your ceiling relatively quickly. Somewhere in the 5 to 10 location range, you're likely not going to be able to qualify for conventional financing. So by default, you pivot to partnering with the DSO or bringing in institutional capital, private equity capital to help you to continue to scale the business. That history has also proven to be pandemic proof. It's proven to be recession proof. So we've actually seen more private equity come in to dental following COVID then than previously. And we've also seen valuations tick up post-COVID because dentistry rebounded faster really than any other industry out there. So for all those factors that I just mentioned, dental is probably the hottest industry, the hottest vertical in the private equity world at the moment. So we've seen just a huge influx of cash, a huge influx of interest from private equity, which has caused the advent of over 250 DSOs nationwide to form and begin consolidating the industry at a rapid pace.

Art Wiederman, CPA: So private equity. So I understand and I do understand, but I just want my listeners to understand the private equity group is the money behind the DSOs. So they're going to partner with the people who are owning and operating the DSOs, and they're going to basically give them the money to buy these practices. Is that pretty much how it works?

Brannon Moncrief: Yeah. So private equity will raise a fund somewhere in the range of 10 million to $100 million, and they will deploy that fund in the dental industry. Typically by making a platform investment, they'll buy a multi-location practice in a major metro area, typically that has 2 million in EBITDA or more. They will pay a huge premium for that initial platform and then they will bolt on other acquisitions in that geography and then expand outside of that geography as they scale the business. And it's a cost average game at the end of the day, right. They might pay 10 to 12 times EBITDA for the initial acquisition and then they're going to add on practices at 5 to 7 times EBITDA. Eventually look to recapitalize that business and sell it to another institutional investor.

Art Wiederman, CPA: Well, we're going to define EBITDA in a little bit. But let's start off, Brannon, going into the weeds here is what types of practices are DSOs and private equity looking for? I don't think they're looking for a three operator, a practice that's doing $400,000 a year. What types of practices are they looking for and where are they looking for them?

Brannon Moncrief: So it's a great question. And we get this question a lot. Most DSOs are looking for and this is this is a generality, you know, because we're talking to a broad audience base. Most DSOs are looking for practices located within, let's say, 60 miles of a major metro area. Five plus operators because they'd prefer to have multiple providers there, either now or at some point in the future. Seven plus eight plus operators is ideal annual revenue ballpark 1.2 million baseline, ideally 1.5 million in revenue or higher. And the reason being is because what they're really acquiring, what drives value from a DSO private equity perspective is EBITDA right is profit. How much, as an absentee owner are they going to make by owning that practice once all the bills are paid and the doctors are paid? So EBITDA is the driving force behind value in the DSO private equity world, and it's very difficult to generate substantial EBITDA with revenue of less than 1.2 to 1.5 million.

Art Wiederman, CPA: All right. So we've been talking about this EBITDA thing. It's not a human being. It's an actual term. As a CPA, I am required by law to give definitions on accounting terms. And this is actually an accounting term, folks. EBITDA stands for earnings before interest, depreciation, taxes and amortization. Did I get that right, Brannon. Yep. Okay. Would you define EBITDA for purposes?

So we have a dentist who is thinking about selling his or her practice to a larger group. Let's just call a larger group, whether it's private equity and they have a DSO or a big you know, they're going to sell it to these folks. And you're going to say, well, we need to calculate the valuation. And the first thing we do is figure out EBITDA. Now, you and I have had conversations about how many people don't calculate EBITDA. Right, but from a very high level. How do you calculate EBITDA?

Brannon Moncrief: It's very simple. You're right. A lot of people screw this up, but. But it should be completely objective and very simple. You take top-line revenue minus real overhead expenses, right? So get out all the fluff, your auto, your meals and entertainment. If you remodel the office, any non-recurring expenses, let's remove all that. Let's talk about the real operating overhead of the business. So revenue minus overhead, minus doctor compensation and you typically have to factor in a fair market comp rate for the doctor. If we're talking about general dentistry, let's just say it's 30% of doctor collections and what's left over after you back out overhead and doctor compensation is essentially EBITDA. So if you look at it from the standpoint of if I'm going to be an absentee owner of that dental practice, I'm gonna have to pay the overhead. I have to pay the doctor to do all the production. What do I have left at the end of the day, as the investor in that dental practice where most people screw up is they forget to back out the doctor compensation.

You know, we get calls all the time, hey, I've got a practice with $1,000,000 in revenue in my evidence, 400,000. And I'm like, whoa, whoa, whoa. Nope. Did you pay yourself? No, I didn't pay myself. Oh, I need to do that. I need to take that out. Yes. You know, your wage would be $250,000 to do that, $800,000 in dentistry that you're doing in that practice. Therefore, you're if it is 150,000, not 400,000, you can imagine the valuation delta when the but there's such a big difference in this to.

Art Wiederman, CPA: Huge, huge difference. So here's what happens. I'm at the dental convention. I'm giving a talk and I get a client calls, says I talk to this DSO group and they're going to give me 12 times EBITDA. And the first question I ask is, oh 12, what is your EBITDA? Well, I don't know. They just said they'll give me 12 times EBITDA. So in the world of, you know, that you live in, how do we determine, you know, if I sell a dental practice, okay. And I've always talked Brannon nationwide and it's been this way since the 1980s when I started in this business. Dental practices nationwide, with the exception of areas of the Northeast, including Manhattan and Southern California, are valued at somewhere between 60 and 80% of one year's gross or two and two and a half times true net. Now, the EBITDA, we don't usually use I don't use EBITDA in calculating a valuation of a practice that I'm selling from one doctor to one doctor.

Okay, your EBITDA calculation. And I and that's based on my net profit. And I add back the doctor's salary because a buyer of a single practice is going to be able to earn that salary, whereas in your situation, an investor is still going to have to pay that selling doctor or someone else, and it's probably going to be that selling doctor to operate and do that production. So how many times EBITDA okay. That's what everybody's waiting to hear on this podcast. So how many times EBITDA are we talking about for let's start with general and maybe chat a little bit about specialty.

Brannon Moncrief: So before we go there, I want to make a point that everybody's so focused on the EBITDA multiple. What multiple did you get? Oh, I got a seven multiple. I got a nine multiple. I got a ten multiple. A multiple of a what? As I said before, EBITDA should be objective. But I will tell you that DSOs and private equity to some degree are predatory and they play games with EBITDA. You've got to control the narrative regarding the EBITDA of your practice when you're looking at and evaluating going the DSO route. If you don't control that narrative, they're going to hit your EBITDA for four different types of adjustments that are going to impact your value substantially if we're talking about a7x multiple. Every dollar of EBITDA is worth $7 in value. So the EBITDA actually moves the valuation far more than the multiple does. So you got to make sure, one, that your EBITDA analysis is accurate and defensible and not allow DSOs private equity to play games with your EBITDA, or it's going to have a massive impact on your value.

Art Wiederman, CPA: So how does this work, Brannon? In other words, I mean, doctors go to come to DSOs and private equity in several different ways. They could get a call from a DSO, says, listen, we like your location. We want to buy you. And then they calculate the EBITDA because the buy the selling dentist doesn't know how to do that. Or they could come through someone like you. So is it the, you know, let's say you're representing a practice and you take it out to different DSOs. You do your own valuation and then do you wait to see what the DSO offers and you kind of how does that work?

Brannon Moncrief: So we do our with every client, we start with an analysis, an evaluation, and that's a private conversation between us and the client. We only represent sellers. So we dial in on what is the true EBITDA of the business, what is the multiple that we think will fetch in the open market? And if and when it makes sense for us to take the practice to market, we put it out in a bid process. So we give the buyers our EBITDA analysis and say, Hey, we're controlling the narrative. Here's the EBITDA number that you need to work off of. And it. And then we allow them to tell us what they think the practice is worth from there. We've already had a private conversation with the doctor and set kind of a baseline expectation on the value that we expect to fetch. But by putting it out in a bid process and creating a highly competitive environment, we find that we get a much better outcome than we would if we price the practice. So the key is doing your homework upfront. Building a case for evidence, making all your adjustments defensible, and controlling that narrative throughout the process. And then creating a highly competitive environment to keep the buyers honest, make sure they put their best foot forward, and pay you the full value of your practice. And after LOI, once it goes into due diligence, right? And once it goes in quality of earnings and the buyer is really digging into the numbers. They're not going to play games if they know that there were five, six, seven offers on the table. And they were the winner in the LOI stage if they start to play games, when they start to evaluate the EBITDA we're going to bounce, right?

Art Wiederman, CPA: Yeah. Yeah. It's just like if you're selling a house and someone and there's ten offers on the house and the first guy says, Well, I don't think it's worth. Fine. Go jump in lake, I'll go to the next nine offers. That's how it works in this life, right?

Brannon Moncrief: Exactly. It keeps them honest. It makes them behave in a genuine fashion. And look, they're not all bad actors, but there are some bad actors out there. And there are people that are opportunistic. And if you haven't created a highly competitive environment, if you don't have somebody like me at the table with you, there's a high likelihood that you get could get taken advantage of. So let's get back to the magic bullet, the big question, right? What is my practice going to trade for from an even a multiple perspective? So I'll just give you some ranges. I will tell you that it's very situational. That's why we put it out in a bid process. I will tell you that valuations coming out of covid were all over the place. Some people were being more aggressive than ever. Some people were being conservative. And we're seeing the same thing again, right?

Coming out of covid, we had rapid, rapidly changing market conditions. Currently, we're in an environment with rapidly changing market conditions. Inflation, the labor market is a mess. You've got a looming recession. You've got banks starting to tighten up. So valuations are starting to be impacted from some degree for some buyers. Some buyers are so flush with cash and being very, very aggressive, while others are starting to pull back a little bit because they see storm clouds on the horizon. So that's why it's so important to utilize a bid process because it's very situational and offers will vary greatly from buyer to buyer, especially in the current environment. As a general rule practices with EBITDA of let's say half a million dollars. So that's likely going to be a practice doing 1.8 to 2 and a half million dollars a year in top line revenue, $500,000 in EBITDA. They're going to trade in in a. All if all market conditions are fairly attractive for that practice, somewhere in the range of five and a half to six and a half times that, sometimes situationally 7 to 7 and a half times over that's a substantial increase from where we were a couple of years ago. Those practices were trading for four and a half to max five and a half times over.

Art Wiederman, CPA: So let's throw some numbers to that again. I am required by law to do that. So let's just say let's make the numbers easy. A $2 million practice with a 500,000 or EBITDA, that's 25%. That's in your wheelhouse because you've taught me 20 to 25% EBITDA is a good place to be, right?

Brannon Moncrief: Right. Absolutely.

Art Wiederman, CPA: Okay. So if I get a six multiple, so six times 500,000 EBITDA is 3 million. So I'm getting one and a half times my gross. Now, if you as a broker go to sell to another doctor just a one on one transaction, you're not going to get one and a half. The banks aren't going to finance that. Nobody's going to pay that. They might pay 80%, 90%, maybe. Maybe. But now we can go into the next conversation, which is the different types of transactions you run into. Okay. So let's say we take my $2 million seller. He you know, he wants to retire. I'm not he wants to retire, you want to work three or five more years. We're going to talk about what they're looking for and that end in a second. And now we say, okay, how does this what does this look like? In other words, what's the format of this? Are they just going to basically give this guy $3 million of cash and say, here you go, buddy, go home? Or how does that work?

Brannon Moncrief: Yeah, absolutely. So one thing to touch on, obviously, there are huge delta between the private buyer valuation and the DSO valuation. And the example we just looked at, the delta is somewhere between a million and a million and a half dollars, right? Private buyer world is worth 15 to 18 DSO world. It's worth somewhere probably 3 million to 3 and a half million dollars double right in the DSO world. What it's worth in the private buyer world, that's why a lot of doctors are looking to sell to a DSO. Just the economics are incredible compared to the more traditional option.

Art Wiederman, CPA: But you got to peel the onion back, right?

Brannon Moncrief: You got to peel the onion back. Right. So valuation again, it's kind of like the conversation about EBITDA, multiple versus EBITDA, right? When you start to talk about enterprise value, I would argue that the fit, right? So which DSO you choose as well as the deal structure is equally important, sometimes more important than the economic implications. At the end of the day, the conversation always starts with why first of all.? Why did you look to sell your practice to DSO in the first place?

Art Wiederman, CPA: And let's go down that road. The advantages and so a doctor we got a doctor who's 67 years old. He's built a big practice. Maybe he wants to work a couple more years, but he's getting tired of the management. I mean that, you know, maybe he's got two or three associates. They don't want to buy the practice. I mean, that is a perfect scenario, right?

Brannon Moncrief: That is a perfect scenario. Going back to what are DSOs looking for, they want the seller and all providers to stay on long-term post close. So somewhere in that 3 to 5 year window, you've got to have some runway left post-sale in order for a DSO to be interested. So they want you and your associates, all the providers, to stay on long term. So the situation that you just described, multi-doctor practice associates either don't want to or can't afford to buy the practice. It's a large practice that's worth, you know, easily two times in the DSO world, what it's worth in the private buyer world. It starts to become a pretty compelling story economically.

But then what are you trying to accomplish? Are you trying to alleviate the management burden or is it solely an economic consideration? If you want to really offload the management burden, then you need to affiliate with the DSO that's got robust infrastructure, right? That's got the ability to support you, not kind of this faux DSO model where they don't really have any infrastructure. It's solely an economic play. And really they're going to buy you, let you take some chips off the table and leave you alone. For some people, that's music to their ears. They're like, Hey, this is economic. I want to take some chips off the table in a favor evaluation. I want to get access to some of the wealth creation, the equity opportunities that DSOs and private equity offer, whereas other people, the main motivation is, Hey, I'm drowning from a management perspective, I'm miserable. I don't get to see my wife enough, my kids enough, I want to travel more, whatever it may be. That's the pull rather than the economics. Well, then you got to make sure that you partner with the DSO that can help you solve for why you decided to go that route in the first place.

Art Wiederman, CPA: Now, Brannon, again, I've been a dental CPA for 38 years. You've been in the dental industry for 20 plus years. We know that. You know, one of the great things about working with dentists that I've learned is that they are kind human beings as a group. Okay. You've got you know, you've got all kinds of people in all kinds of groups, but dentists are very kind people and they generally, in many cases, they treat their staff like their family. And so now that dentist is going to go to an unknown group and they're going to say, by the way, I'm selling and now you're working for this group, and they're going to change a lot of things because don't DSOs generally come in and change stuff in the practice or do they not?

Brannon Moncrief: Not much. So the reason that we made a conscious decision to pivot our business into the DSO space was because DSOs have really learned how to stay in their lane. Right? They have learned to treat doctors with respect, to treat them like partners and to in many cases, make them partners, have them retain equity or roll equity into the parent company. And they offer a huge amount of clinical autonomy as well as operational autonomy. So most DSOs look to buy really successful practices and not screw them up. I will say this is kind of DSO 2.0, the current iteration of DSOs. Back in the late eighties, in the nineties, the first iteration of DSOs, a lot of de novo models, a lot of buy practices, tear them apart and put them back together. The business guys thought they were way smarter than the dentist and knew how to do dentistry better than they did. They thought they knew how to provide a better experience, both operationally and clinically than the practitioner did.

DSO 2.0 does not believe that. DSO 2.0 believes that the clinician is, you know, the master of that domain behind the front office. They can help provide value at the front office level from an operational perspective, and they stay out of the dentist way from a clinical perspective. Some DSOs are completely hands off others, especially if they're large and they're not a joint venture type model where you're actually a partner in retaining equity. They have to be somewhat homogenous from practice to practice, right? If I own 500 offices, I can't have them all operating on a different practice management software and being run completely differently. Right. So they're going to want they're going to have a little bit heavier hand from a management standpoint. They'll probably be a little bit more change in if you sell to a DSO that's buying 100% of the practice and is very large. But that's a big part of what you need to do when you take your practice to market is to vet these buyers. You got to ask, you don't know what questions to ask, right?

Art Wiederman, CPA: That was going to be. Yeah. Maybe for our listeners who are either in discussions on their own or thinking about talking to DSO X-Y-Z Company. What are some good questions that they should ask?

Brannon Moncrief: We've got to ask one what you just said. What do you what are you going to change about my practice? Why do you like my practice? Are you going to retain my staff? Are they going to still have the same benefits? And what type of benefits am I going to have? What is my shares going to look like? Are you going to sign me up on insurance plans that I'm not currently on? You know. Are you going to change my hours or are you going to change my chair side schedule? You need to know what changes to expect. Are you going to change my practice management software and what impact is that going to have on my staff and morale? And then you need to ask the questions regarding what's the history of your DSO like? How did you get here? Who are your other partners and why did you decide to partner with them? Can I speak to those doctors so that I can get some firsthand feedback from your equity partner. When was your last recapitalization of BET? What was the return at that event? What's your deal structure? If I'm retaining equity in the practice if and when can I liquidate that equity? And at what multiple if I'm buying stock in the parent company, at what price am I buying that stock? When is the next recap expected to occur? What's the projected return on that equity? There are literally about 100 questions you should be asking every single day so that you talk with. And each one is going to have a slightly different answer to each of those questions.

Art Wiederman, CPA: Yeah. So folks, again, I bring the best on to this podcast, nothing less. If I were going to sell my practice or think about investigating it, you got to I think you got to have a guy like Brannon. And Brannon is not the only one that does this work around the country. But Brannon, I mean, he knows this stuff really well. You've got to have somebody who can educate you and who can ask because he's you're going to ask the questions of those DSOs and a lot of them. You know them, right?

Brannon Moncrief: Absolutely. And we provide our clients with a list of discussion topics and questions. And we set up the process so that just as much as buyers who are doing diligence on our clients and their practices, our clients are doing an equal amount of diligence on the buyers so they can find the one that's the best fit.

Art Wiederman, CPA: So if somebody is thinking about this, somebody is in discussions with somebody on their own. Can they give you a call and just say, hey, listen, I'm talking to X, Y, Z, so and they're offering me this. Can you give me some advice? Can you help them with that? Or at least, you know, give me a little time on the phone because I want you to give out your phone number for people who have questions.

Brannon Moncrief: Yeah, absolutely. I mean, we're a resource and our job is to disseminate accurate information and help educate doctors and then if we provide value and they trust us, you know, hire us to go execute at a high level. I would say about half of our DSO private equity clients that engage us as their sell-side advisor already have an offer on the table from a DSO because DSOs have built marketing machines designed to try to get in the door of your practice. Before I walk in the door and start a discussion with you that you think is just a laid-back discussion that very quickly turns into a potential transaction. So they knock on doors, they send a lot of email and direct mail, and they have big business development teams that are, you know, their sole job is to get your attention, start a conversation that over time leads to you selling them your practice without representation or discount. I mean, that's, that's ultimately what happens.

So we get involved all the time with clients that already have an offer too on the table. And then we say, Hey, let's pull back. Right? Tell them, hey, pleasure meeting you. I'll be back in touch with you shortly. But I'm going to engage an advisor, and we're going to pull back. We're going to do an urban analysis. We're going to reset the stage, and we're going to take that practice to market, put it back in front of the buyers that were already at the table, but also introduce it to several other buyers and let everybody know, Hey, you're no longer the only one at the table. It's time to put your best foot forward. Here's the evidence. Here's our expectation. Here's our why. Are you the right group to help us solve it?

Art Wiederman, CPA: So, guys, if you have a question for Brannon, you're thinking about it. You've got an offer on the table, you've gotten a phone call. Your buddy in the dental society said, Oh, I just saw my practice to X, Y, Z, and I got 47 times EBITDA, whatever they got, you know, just call time out. Give Brannon a call. Brannon, how do they get a hold you?

Brannon Moncrief: They can reach me on my cell 512.660.8505 or via email. Email's Brannon@DentalTransitions.com. Our website also has a ton of resources about this topic on it. Articles, podcast. The website is www.DentalTransitions.com. I encourage you to go there and read up about the transactions.

Art Wiederman, CPA: All right, so let's get into. I wish I had 3 hours to talk to you, Brannon, but I don't. So let's talk about the different actual structures. Okay? So we know that they're not just going to hand this doctor in our example, $3 million cash and let him leave and go away. It doesn't work that way. So the first structure is an outright sale, which might involve a hold back, right? Yeah. So how does that work?

Brannon Moncrief: The outright sales, kind of the traditional DSO model, it was kind of pioneered by Heartland. They were the only game in town for a long time. And that is where I'm buying 100% of your practice for a predefined value. Let's say it's $3 million. Like we said before, I'm going to give you $2 million, cash it close, and then I'm going to put you on a three year employment agreement, work back. And I'm going to put that remaining million dollars on a holdback payable in three annual installments contingent on you continuing to work at the practice and maintain the revenue with the practice post-closing So if you leave prematurely or the practice moves backwards from a revenue perspective, your money is at risk. So that's kind of the traditional DSO model where they're buying 100% of the practice. But the combination of cash and earn out, hold back whatever you want to call it.

Art Wiederman, CPA: Okay. So then we have the next model. I call it the mothership. I mean, I keep thinking Star Wars, it's the mothership. So and this is a lot of what I'm seeing and I'm sure a lot of what you're seeing is so my $2 million doctor who's going to get a valuation of 3 million, he might get 2.2 million in cash and he would get equity in. And again, I'll call it the mothership, but it's the DSO entity that is valued at $800,000. That's another type of transaction, right?

Brannon Moncrief: Right. We call that the holding company model.

Art Wiederman, CPA: So talk about that one.

Brannon Moncrief: I'm going to buy 100% of your practice. I'm going to give you, let's say, 75% cash it close. And the other 25% you're going to invest in stock in my DSO. The question that you have to ask is, what am I paying for that stock? Right. Because as the DSO begins to move through their recap cycle, they're typically on a five year recap cycle. Where.

Art Wiederman, CPA: Talk about what a recap is. There might be folks listening that don't know what that means.

Brannon Moncrief: A recapitalization event essentially means that the private equity firm that owns the DSO is going to sell that DSO to the next investor, whether that be another private equity firm, whether it be an institutional investor, family office, what have you. So upon sale of the DSO, if you're holding equity in that DSO, you have the opportunity to liquidate typically somewhere between 50 to 100% of the equity you're holding. So a recapitalization event is a liquidity event for the private equity firm that owns the DSO. The management of that DSO and the doctors that own equity in the DSO.

Art Wiederman, CPA: And the whole hook for getting a doctor to sell the practice is. So I get that 2.75%, $2,250,000. I get $750,000 as stock or a partnership interest or however they hold it, LLC interest. And then the hook is right that five years from now or three years from now, this group that you're selling to is going to have another, like you say, recapitalization event and you're going to be able to take that 750,000 and double or triple or quadruple it. Right. Isn't that kind of what we're hoping for?

Brannon Moncrief: That's correct. That piece of your valuation is pitched as a wealth creation opportunity. I can take that 750 invested in the DSO and the DSO. You know, while you might be worth six times EBITDA at your practice level when the DSO trades, it's going to trade for somewhere in the 13 to 15 times EBITDA range currently. So and the DSOs typically highly leveraged, which increases returns. So you could see if you hold that equity for the full recap cycle, you know, anywhere from a 3 to 5 X return on capital. So you could turn that 715 to, you know, anywhere from 2 million to 3 and a half million dollars over the course of the recap cycle.

Art Wiederman, CPA: Okay. So a couple things I want to make clear to our listeners and we'll get to the other type of the hybrid in a minute. Number one, this is by far not a guarantee. Absolutely not. It's very risky. And what I tell people and Brannon, you tell me if you agree with me, is if you get that 2,250,000, 75%, that's probably reasonably close to what you would have received in cash. If you sold it to a single buyer. You might have gotten a little more, you might have got less. And that this mothership investment is 750,000 of equity that might turn into two, three, four times that amount would be gravy. Is that kind of the way you look at it?

Brannon Moncrief: Yeah. I mean, you need to be careful about who you partner with, right? You know, partner with somebody that's got the pedigree to get to the recap of that and at least return your money, hopefully with a handsome return. There is risk involved. There's risk involved in any private equity investment. And it's the risk is inherently higher than bonds or equities, and therefore the return should be significantly higher. So with a larger practice, you're going to get far more in cash a close than you would have got selling the entire practice to a private buyer. Right. And then this is yeah, I mean, this is gravy. This is potentially a substantial premium and wealth creation opportunity on top of an already good economic outcome for most as well.

Art Wiederman, CPA: And you know, the advantage and again, I don't we are now four years into this podcast. So my listeners know me very well and I don't promote my guests because I promote them. I get nothing from any of them other than having a great discussion. But the fact of the matter is, is that when you go to the table with a DSO, they know, Oh crap, Brannon is involved. Brannon is involved so we're not going to offer a stupid amount of money that is too low because Brannon is going to so say, really? I don't think so. So that's one advantage of working with a broker who knows the market like Brannon or someone else.

One of things I want to cover here, Brannon, so a doctor who's making $400,000 in their practice as compensation and they're running through their car and their trips. And we have client, a client who once told me they have a business account, a combination of business and personal. They call it business. I love that. Right. So they have a business account. So now they sell. Aren't they going to make less money as a salary? Because how is that DSO or private equity group going to be able to pay if they're paying all this money and then they get to pay the owner the same amount? How does that work?

Brannon Moncrief: Yeah. So there's no way to monetize the value of your business when it's a dental practice and not damage your annual personal income. Right. So you're going to take a step back from a personal income perspective to take those chips off the table. There's no way to have both. So you've got to understand that. And along those lines, the longer your runway. So unless this is solely an economic decision you have, you're not fed up with the management. You have no plans to relocate. You have no plans to retire your runways really long, 15, 20 years until you retire and you plan to retire in this practice that you currently own. The DSO option. It is much less compelling than somebody that is five years away from retirement or three years away from retirement or that plans on relocating, you know, once their kids graduate from high school or is fed up with the management of the practice and just can't be an owner anymore. So the longer your runway, the less compelling this argument is because of that erosion of your annual personal income. And I think everybody has to understand and we approach every client like this, the first option that's always available is do nothing. You don't have to sell. Right. And the best time to be a seller is when you're not a seller.

Art Wiederman, CPA: I have told doctors for years, no matter what you're doing, any business negotiation doctors that you are in, you have to first look at what your leverage is. If you are a dentist who is disabled and you cannot pick up another handpiece again, you have very little leverage in selling your practice. If you are 45 years old, healthier than a horse, your practice is growing. Yeah, you're a little tired of the management and the DSO comes knocking or two of them come knocking. Your leverage is you don't have to do anything. Remember that. That's really, really important. So let's do the math on the example you just gave. So my guy or my lady that's selling this $3 million practice, two and a quarter million cash, 750,000. They want to work another 20 years. Okay. But they're going to take a $100,000 a year pay cut to do that. They're giving up $2 million. Now, you have to take present value in an account, but your point is very well taken. That as opposed to my 67, 68 year old doctor who is three years away, he'd like to continue to work, he'd like to supplement, he'd like to take some chips off the table. He wants a guaranteed, you know, a nice chunk of change. Now, that doctor is only going to lose income for two or three years. So that's really important. Let's go to the combination of cash equity in the mothership and maybe keeping a part ownership in the practice that happens to. Right.

Brannon Moncrief: Yeah. Before we get to hybrid, that's the joint venture structure. So we okay, let's talk about all the options we've covered. Okay. First of all, you don't have to do anything right. You don't have to sell your practice. That's number one, 100% sale, kind of the old school traditional DSO model, 70% cash on close and a 30% earn out pullback. We talked about the holding company model, sell 100%, take 75%, cash at close roll 25% in the holding company equity at the parent company DSO level. Now, let's talk about the joint venture model. The joint venture model is where you're selling, let's say, 60 to 70% of your practice and you're retaining the remaining 30 to 40% at the practice level within your own four walls. So you're truly a partner in your practice post-closing and you will continue to get your pro rated share of the EBITDA less the management fee that the DSO is going to charge on an ongoing basis. So a lot of younger doctors tend to gravitate towards a joint venture model because they don't take as big of a hit from an annual revenue annual personal compensation standpoint because they still get to share in the EBITDA the profit of the business post close.

Art Wiederman, CPA: So let's talk about have we covered all the different models now?

Brannon Moncrief: The last model is the hybrid model.

Art Wiederman, CPA: So go into the hybrid model then.

Brannon Moncrief: So the hybrid model is where? You're going to take, say, 60% cash at close, and then the remaining 40% is going to be bifurcated into holding company equity, equity at the DSO level and then joint venture equity at the practice level. So now you've got multiple different buckets, you've got cash flows, you've got the holding company equity component and you've got the retained equity component. So that's basically we call it a hybrid because it's a combination of what you call the mothership, the holding company model and the joint venture model.

Art Wiederman, CPA: I get several other things and not a lot of time to cover. Let's talk about the team that my prospective seller needs to have. If they're going to work with someone like you, they need an attorney. And there are attorney that specialize in this in this space. Right.

Brannon Moncrief: Right. Every single client. We want to have several people on the team.

Art Wiederman, CPA: Yeah, who's on the team?

Brannon Moncrief: One, we want to make sure your spouse is on board. Right. Have that.

Art Wiederman, CPA: That's the most important one.

Brannon Moncrief: The market? Yeah. Make sure you both swim in the same direction. You need to have a dental CPA, right? So that they can help you evaluate the offers. They know your personal financial situation and tax situation better than anybody. You need to have a really strong dental attorney, somebody that is well-versed in DSO transactions, not just dental law. They need to be well-versed in dental and DSO, private equity transactions. And then if a financial advisor is going to weigh in, you know, because they're managing your money, managing your retirement, if they're going to weigh in with their opinion. I'd much rather than weigh in during the valuation and discovery process then on the back end of the deal, when they find out, you know, two weeks before close that you're about to sell the goose. Right. You want to make sure that you've got all the advisors that you need on your on the bus there from really the beginning so that everybody can play their role, stay in their lane and be with you throughout the process from start to finish.

Art Wiederman, CPA: I'll give you an example Brannon We had a client who came to us and said, We're talking to X, and I said, Do you want to meet with someone? No, we're talking to X that's who we're going to do our deal with. I said great. Okay, let's talk to X. So I brought in a tax attorney because folks, there's one thing you need to know. If we do the model where you get 75% cash and 25% equity in the mothership, you have got to, from a tax standpoint, read that contract. If that contract says we are selling you, you are buying I'm sorry, you are selling your practice to group X, Y, Z for $3 million, two and a quarter in cash and 750,000 in stock. That contract, if an IRS agent looks at it, he says, you got value in a company that had a valuation of $750,000. You have taxable income with no money to pay the taxes. So you have to be careful about that. So what we like to see sometimes is either you, doctor, an evaluation should be done. You are contributing in order to obtain that mothership entity, that's equity $750,000, you're contributing your personal goodwill that you created yourself under the Norwalk versus United States case, which is how we can allocate goodwill to individuals and not to companies, because Brannon goodwill in your business is with you. Goodwill in my CPA firm that I owned by myself and when my partner Pam was with me, Goodwill in Microsoft is with the name Microsoft. So we have to be very careful to read these contracts so you don't have a surprise.

And then there's issues having to do with section 83 elections, which we're not getting into, I promise, today. But the bottom line is you need someone. We at Eide Bailly know how to do this. We have tax experts that are as good as there are in the Dental Academy, a dental CPA group. We know that, you know, they know what they're doing. I mean, you need to find somebody Brannon and I can certainly refer you to attorneys that specialize in this space.

So we're about it at the end Brannon I don't know if there's something we missed, but I want to cover let's talk to the young dentists who are now working. You know, maybe they're working and they want to go to work for one of these days. So there's large and small. What should they be looking at and can they end up getting equity down the road if they end up going to work for one of these big DSOs? Because these DSOs need associate dentists, right?

Brannon Moncrief: Yeah. I mean, DSOs need a constant supply of labor, especially from the doctor perspective, I mean, doctor turnover, is that really the Achilles heel? And, you know, I want to make the point that I am not necessarily an advocate for selling your practice to a DSO. I built my career in the doctor space and we still do a ton of doctor transactions. But for some people, it's a very, very compelling option, just as it is for docs coming out of school. You know, it's not a bad idea to go to work in a busy, you know, quote unquote corporate environment, DSO owned practice to get your hands beat up and to learn about who you do and don't want to be as a dentist and as a business owner. I would still encourage you at some point to pursue practice ownership. Dentistry is not under duress. I mean, we have plenty of private practice owners that are doing phenomenally well. And those are a lot of. But only because they've done so well and they've created so much value in their practice. So a lot of the kids are going to work for DSOs because those are the jobs that are available, you know, readily available in the marketplace.

Art Wiederman, CPA: And they got to pay their student loan debt.

Brannon Moncrief: They got to pay the student loan debt. I will say that young girls in particular are more transient than ever. They tend to move around a lot more. So planting a flag, you know, straight out of dental school and opening or buying a practice is daunting to them because they don't know if they want to live in Austin today, in Denver tomorrow and spend two years in New York or L.A., that the world is a much smaller place for young people than it was for docs that got out of school in the seventies and eighties, planting a flag and stayed there for 40 years. So I think it's healthy for docs coming out of dental school unless they absolutely know they want to spend the rest of their life in a particular geography to go to work for a couple of years, whether it's in a corporate environment or in a private practice environment. If you can ideally find a good spot to land and learn and get your skills developed, get your hands beat up, get your confidence, and then go out and decide what you want to do next.

Art Wiederman, CPA: So I want to say something to my audience, Brannon. And by the way, this is just absolutely amazing information. I can't thank you enough for taking the time to share it with my thousands of listeners on this podcast. But we have always been ones my, you know, one of the guys in our Academy of Dental CPA group, he's Paul Woody, he's out of Oklahoma. He's now looking up in Maine. And he is he's kind of the one of the father figure. I guess I'm now one of the father figures, too, but he's one of the father figures of our group. And he has always encouraged doctors when he would lecture at the University of Oklahoma to really become entrepreneurs, and that we want to help our doctors, to be entrepreneurs and to own their own practice and doctors. I think what 25% of dentistry is now group practice, give or take. That sounds about right to you.

Brannon Moncrief: Nobody knows exactly what the number is. I can tell you the concentration is higher in certain states than others, and the West Coast is just now starting to see the consolidation while the East Coast is already very consolidated. So overall, we're probably 20%.

Art Wiederman, CPA: Right? So that means 80% of dentistry is single doctors. And both Brannon and I sell dental practices. I do it in California. He does it in Texas. He sells dental practices. Single doctor to single doctor very successfully. There are lots of people who want to own their own practice, call their own shots or doctors. If you want to call your own shots and you don't want a corporate entity telling you anything that you need to do whatever it is, then you should own your own practice. I have lots of doctors who have practiced for 30, 40 years. They've made a great living, they've had a great life. They coach their kids and baseball and basketball. They take trips, they have great teams and they do what they do. But this DSO model, neither Brannon nor I are absolutely saying, Oh my God, you have to do this or else you're crazy. Absolutely not like anything else in this life. Brannon, a doctor selling to a DSO is a personal decision and it's not right for everybody, right?

Brannon Moncrief: Absolutely. And yeah. If and when that DSO owned practice offers you an equity opportunity, because most of the time that's golden handcuffs, it's faux equity, it doesn't have a lot of value. It's much more compelling to be the large practice on or selling to a DSO for a huge premium than it is to be the young associate buying equity in a DSO own practice.

Art Wiederman, CPA: Yep. Last question. Biggest mistakes dentists have made in dealing with these private equity and DSO groups. And then we'll let you give out your information one more time and we'll call it a podcast.

Brannon Moncrief: Great question. So first and foremost, responding to an unsolicited offer, right. You know, taking one of those phone calls, taking a meeting with a DSO, you know, your buddy recommended them or you got something in the mail and you didn't get educated about your options, your EBITDA, your value, and you didn't create a competitive environment. Hundred percent of the time you left optionality and money on the table, period. I think that's the biggest mistake, is not shopping around, not being educated about the options that were available to you and leaving money on the table, you know, not having the right advisors, you know, even if you have advisors, if they're not the right advisors, if they're not well educated in this space, if they have loyalties to one company or the other and try to push you in a certain direction, that's a problem. I will say getting involved in a gimmick. You know, some of these roll-up concepts that are out there right now. Hey, join our collective. And we're going to take 200 practices and, you know, independently owned practices and sell them for a crazy multiple simultaneously. That's snake oil.

Art Wiederman, CPA: You can and you can retire the day that you sell and you don't have to work back.

Brannon Moncrief: Right. You're going to get a ten x multiple and you don't have to work back. And by the way, we're going to help you form a trust and protect all the, you know, assets from taxation. There's a lot of people selling snake oil in this market. Any time you're in an environment where there's a lot of cash, a lot of money flowing in to an industry, you're going to have predatory people enter the industry and try to figure out how to make a dollar off of your hard work. Be very, very careful about who you align yourself with and what advisors you have at the table with you.

Art Wiederman, CPA: So, Brannon Moncrief, owner, founder, and as my late mother used to say, chief, chief owner and bottle washer of the company of McLarren & Associates from Austin, Texas. Thank you for your wonderful, wonderful insight today. And this is invaluable information. And one more time, if anybody listening to this podcast has a question for you, what's the best way to get a hold of you and also give out your website with a lot of great information for them to read?

Brannon Moncrief: Yep. You can reach me anytime. 512.660.8505 or email Brannon@DentalTransitions.com. Website is www.DentalTransitions.com. Got a lot of information about DSO transactions on it as well as doctor transactions. And I'm a resource for your audience. If you have an offer on the table, you're talking with a particular DSO or you're interested in just having a conversation about your options, I'd love the opportunity to chat with you.

Art Wiederman, CPA: Brannon, I appreciate having you as a resource that I can pick up the phone and say, Hey, my doctor was approached with this and you've always been very, very cordial and helpful and honest, which is the most important thing. You know, the players. So if you would hang on until I take the podcast out, that would be great.

So, ladies and gentlemen, again, thank you for the honor and privilege of your time. Our podcast has thousands of listeners every single month coming to our website. It's been for years or years that I've done this. I can't believe time flies when you're having fun. And I've had all the best people in dentistry, like today with Brannon on my podcast, and I thank you for listening and I thank you for all the kind words. Do go on to our partner www.DecisionsinDentistry.com website great clinical content and 140 fantastic continuing education classes. That are absolutely wonderful for a very, very low price.

If you are looking for a dental-specific CPA, we at Eide Bailly are here to help you. We're always taking new clients. You have to be nice. If you're not nice, we're not interested. But we take on nice people that we take world-class care of. My email is Art Wiederman awiederman@EideBailly.com. Or call me at 657.279.3243. My mothership that I helped form 22 years ago is the Academy of Dental CPA s. It has 25 CPA firms that represent over 10,000 dentists. Look at www.ADCPA.org and we are one of the founding members here in Southern California. Brannon Moncrief, thank you so much for your time and your expertise.

Brannon Moncrief: Thanks, Art.

Art Wiederman, CPA: All right, folks. And with that, I want to thank you again for listening. Please tell your friends, please subscribe to the podcast. And with that said, this is Art Wiederman for the Art of Dental Finance and Management with Art Wiederman, CPA. We'll see you next time.