The DDSO: Equity harvesting and value-added practice acquisition opportunities

Editor’s note: This article is part two of a three-part series. Click here to read Part 1, and click here to read Part 3.

Editor's note ii: Watch the new DE's Recall Visit video with Dr. Brady Frank and Dr. Chris Salierno, as Dr. Frank elaborates further on the DDSO model. See if a DDSO is right for you and your practice by watching the video here.

I am excited to jump into the second part of this series and lay out some actionable steps that will lead to debt elimination, increased cash flow, wealth accumulation, and increased income-producing assets. These concepts are generally simple. They involve acquiring practice assets at wholesale and building them into valuable assets. After an asset has increased in value, the equity is converted to debt reduction or cash; this is called equity harvesting. Therefore, we are finding and adding value through what I call value-added practice acquisition opportunities.

I am a firm believer that most private-practice dentists have one of two goals: owning a practice or being an owner in a small group of growing practices. Truly understanding this fact will allow you to create the most desirable situation for your practice’s business model moving forward. Many dentists tightly grip the ownership or equity component of their practices, unknowingly smothering the practice’s growth potential and their own personal financial futures. With specialized knowledge, you can create ownership opportunities within your practice without losing control or diluting your financial position.

These ownership opportunities begin as what I call trial partnerships (as opposed to the more well-known term, associates). Trial partnerships provide a low-risk opportunity for new dentists with the added benefits of high-income and equity potential. For the practice owner, trial partnerships have much higher retention and success rates than hiring associates.

Here is why: An associate generally earns income or equity from one source, a percentage of production or collection. A trial partner has four sources of income or equity, including base income as a percentage of production or collections, part of the management or DDSO services revenue, a pro-rata share of pooled monthly profits, and equity or value growth in the practice. Given the choice, I think we can all quickly deduce which opportunity—associate or trial partner—a new dentist will view as the most valuable, profitable, and fulfilling.

I employed 28 associates over a seven-year period in the early 2000s. I now only offer trial partnerships leading to clinical co-ownership in all of my private groups. At the end of the 90- to 365-day recommended trial period, the vast majority of trial partners become clinical co-owners. This means that the new dentist has acquired formal bank financing and purchased an interest in the entity holding the clinical assets of the practice(s), the professional corporation (PC). This new dentist co-owner may also now be a part-owner of the business assets of the practice, the DDSO.

Some dentists want to just focus on clinical dentistry, while others desire to have a hand in the business management of the practice. The business management functions are all handled at the DDSO level (figure 1). The DDSO is a vital part of the ongoing business model because it allows for increasing business structure within the growing group, creates an avenue for dentists to earn nonclinical management income, and gives the founder the ability to maintain control, even while adding multiple co-owners. In my experience, clinical co-ownership with the DDSO model has a much higher success rate than the partnerships of old.

Figure 1: This DDSO grew from $0 in revenue to $9.2 million in revenue in six and a half years by adding equal clinical co-owners as the practice expanded from one to four locations.

In essence, this model (or family of models) provides a transition component, mixed with some of the successful business strategies that DSOs have been using for years. The result is a growing, sustainable practice that is built for dentists, by dentists. Perhaps the most important part of these practice strategies is the sharing of the wealth with other dentists via ownership. Having owned, operated, and transitioned multiple practices of my own, I have found that the partial or full sale of a practice increases net worth far more than the operation of a dental practice. In part, this is due to a much more favorable tax treatment of the goodwill portion of the sale. Let’s explore how the practice founder can have the best of both worlds via multiple sales through co-ownership and continued operational revenue.

A case study

Using a simple case study, I would like to demonstrate a value-added practice opportunity within the framework of this DDSO model. Whether you currently own a solo practice or a group of 20 or 30 practices, the empirical principles remain the same. This actual case involves a two-location practice with the founder and two associates. The founder has $1.4 million in practice debt and would like to continue growing as the founder of the practice without the financial and emotional burden of holding the debt. He also realizes that buying another practice with his existing associate model would require taking on more debt if the banks approve him for another loan. Yet there is the nagging problem of the “associate windmill”—the cycle of associates that occurs due to the fact that the average associate leaves a practice within 18 months. Of even greater concern is the fact that a third location with an associate-driven model will create even more management and administration burden for the founder. Converting to a DDSO model can solve these problems and give the founder the freedom to move forward with confidence.

Figure 2: This small DDSO converted from the associate model to the partner model, allowing for scalability and sustainability.

In this case, I personally worked with the founding dentist to convert his associates to equal 33% co-owners at the clinical PC level. The founder simultaneously formed a DDSO and gave a certain membership interest in the entity to his new co-owners, who are recent graduates paying off dental school debt (figure 2). Now the founder is entirely debt-free and has used the excess capital from the co-ownership sales to open his own funding company, similar to a private equity company, to fund the purchase of a third location. The founder is developing his multiple streams of income and earning the interest that the banks would have otherwise received. The value-added practice is acquired from the dentist in the regressive phase of the practice cycle I described in the first part of this series.

This is a recommended compensation formula and range of structure as related to both the clinical LLC and business management LLC (DDSO). These numbers may be modified based on each individual practice situation.

The founder’s DDSO managed the transition and applied a variety of practice management and marketing systems to the practice, allowing it to double in value within five months, which then created room for a trial partner to be added. At the end of the trial period, the new dentist will acquire bank financing to be an equal 25% co-owner, while the existing partners reap the benefits of dental school and practice debt reduction. This value-added practice growth allows for equity to be built, which is then converted to cash for the founder and debt reduction for the previous co-owners. This win-win transition concept is an example of equity harvesting.

In this example, the founder released more than $1.4 million in debt within six months, started his own practice-acquisition funding company, helped two new dentists become practice owners, and acquired his third practice earning interest through his own bank.

The third part of this series will explore common vertical companies that evolve within growing DDSOs. I will also help you clarify where you currently are in your practice ownership journey and determine what steps to take to map out your ideal future and begin fulfilling your vision.

Brady Frank, DDS, acquired Phasing Out Seminars in 2006. He has presented more than 36 seminars about transition strategies across the nation. Dr. Frank is also the founder of OsteoReady Implant Solutions. In 2016 Dr. Frank founded TransitionTime, which provides continuing education, consulting, and transition management coaching. Dr. Frank is the cofounder of multiple DDSOs in the United States. Email him at [email protected].