Dental Practice Management Companies: The Real Deal or the Emperors New Clothes

James Randolph Quick, DMD, JD

Once upon a time, there lived a vain emperor whose only worry in life was to dress in elegant clothes. Two scoundrels heard of the Emperor`s vanity and decided to take advantage of him. They introduced themselves at the gates of the palace with a scheme in mind.

"We are two very good tailors and, after many years of research, we have invented an extraordinary method to weave a cloth so light and fine that it looks invisible, they said. "As a matter of fact, it is invisible to anyone who is too stupid and incompetent to appreciate its quality."

The Emperor, who was taken in by the scoundrels, thought he had a win/win situation: in addition to getting a new, extraordinary suit of clothes, he would discover which of his subjects were ignorant and incompetent.

One day, the emperor told his most trusted adviser to see how the work was progressing. "I can`t see anything," the adviser thought. "But if I see nothing, that means I`m stupid ... or worse, incompetent!" Not wanting to be either, he went along with the scheme.

"Your majesty," the Prime Minister said, "we have a request for you. Many of your subjects have found out about this extraordinary new fabric, and they are anxious to see you in your new suit." The Emperor, who secretly couldn`t see the invisible fabric either, was doubtful about showing himself naked to the people, but then he abandoned his fears. After all, no one would know he was naked except for the ignorant and incompetent.

Days later, all the townspeople gathered in the main square, pushing and shoving to get a better look. Everyone said, loud enough for the others to hear: "Look at the Emperor`s new clothes. They`re beautiful!"

A child, however, who had no important job and could see things only his eyes would show him, went up to the carriage, looked at the Emperor and said, "The Emperor is naked." The boy`s remark, which had been heard by the bystanders, was repeated over and over again, until everyone heard. "The boy is right! The Emperor is naked! It`s true!"

The Emperor realized that the people were right, but he could not admit to that. He thought it better to continue the procession under the illusion that anyone who couldn`t see his clothes was either stupid or incompetent. The Emperor defiantly stood naked on his carriage, clinging to his arrogant, misguided beliefs.

Borrowing a page from this well-known Brothers Grimm fairy tale, we, as dentists, also must ask if dental practice-management companies are the real deal or if they are, in fact, the Emperor`s new clothes?

Let`s take a look at dentistry and its history with dental practice-management companies. The dental-services industry in the United States is large and highly fragmented. According to the Health Care Financing Administration, the cost of dental services is estimated to reach $59.1 billion in the year 2000. The great majority of dentists (87.7 percent) still practice alone. If you believe Wall Street and the dental practice-management companies, our industry is ripe for consolidation.

When physician and dental practice-management companies burst onto the health-care scene a few years ago, they promised to make physicians` and dentists` lives easier by boosting their income and helping them to survive - and even compete - in the new world of managed care.

But these management companies also had an interesting story to tell Wall Street: Health care was a multi-billion-dollar-a-year business, and they possessed the expertise to consolidate the industry and make those increased profits available to investors. They preached and opined that physicians and dentists were not business people, but doctors. Why not allow the business experts to manage the business aspects of the practice and let the "docs" do what they do best - treat patients? Bedazzled by the prospect of potentially lucrative stock deals, elimination of the everyday management headaches, and consolidation of the nation`s health-care system, the believing physicians, dentists, and investors alike eagerly embraced the opportunity.

So, was it the real deal or merely the Emperor`s new clothes?

Due to haste, greed, and the fickle nature of Wall Street, the luster of physician- and dental-management companies began to lose favor this year. Fueled by internal turmoil and poor financial results, it became clear that, in their haste to consolidate practices, the management companies had become greedy. They had forgotten what they were in the business to do: add value to the practices they purchased!

A little too fast

Most management companies - initially bankrolled by wealthy venture capital firms, and later, by IPO public offerings - acquired practices too fast. This made it impossible to transitionalize and build an adequate infrastructure to manage those newly acquired practices effectively. The marriage has become increasingly shaky.

In the past year, the honeymoon appears to be over. Most institutional and individual investors who initially invested in physician and dental practice-management companies have lost interest in the practice-management industry. They dumped their stocks when they discovered that many of the DPMCs and PPMs couldn`t run the practices any more efficiently than the doctors themselves. So again, I ask, is it the real deal or the Emperor`s new clothes?

False promises

In a surging development that could spell the demise of many practice-management companies, doctors are flocking to their attorneys, demanding that the management companies renegotiate their contracts. Some have instituted litigation to get out of their deals and get back their practices.

"They told us this would make us rich and profitable, and that profits would soar due to their ability to do mass purchasing, mass marketing, and managed-care contracting," said Dr. John Kaufmann, a Boca Raton family physician. "Little did we know that all management meant was that they had a Costco discount card."

It must be noted, however, that there are some public, dental practice-management companies that appear to have moved through the acquisition and operations process at an acceptable pace. They have ended up developing excellent relationships with their dentists.

The majority of physician and dentist complaints center around the management companies` failures to make good on assurances that they could apply their business acumen to dentistry. In theory, management companies were to leave doctors free to practice without having to worry about the day-to-day managerial functions of running their businesses.

The dentists understood that, in addition to the elimination of these daily administrative headaches, the management companies would not only release their bound-up equity, but develop new revenue streams, diminish and/or control overhead, and protect them from the onslaught of managed care by building managed-care contracting networks and negotiating sweeter deals. Most have not done that. So, is it the real deal or the Emperor`s new clothes?

Litigation

PhyMatrix, a West Palm Beach-based, physician practice-management company, has filed suit in West Palm Beach Circuit Court against a number of Tampa physicians who walked away from their management agreements. PhyMa-trix is demanding the return of the $3.6 million dollars that it paid for these doctors` practices.

The doctors` attorneys are relying on a Florida Board of Medicine ruling that compels the doctors to terminate their management contracts. That Board of Medicine ruling stated that PPMs could not receive an arbitrary percentage of the practice`s income in return for referrals. The total must have a rational relationship to the amount of services provided. If not, it would constitute the illegal activity of fee-splitting, and the physicians would be subject to revocation of their licenses. The doctors` arguments are receiving additional support from the federal government.

According to a recent advisory opinion issued by the Office of the Inspector General of the Health Care Financing Administration, the question of percentage-fee arrangements has the potential to be in violation of the federal anti-kickback law. In this case, the long-term, administrative-services arrangements negotiated between doctors and the management companies could be avoidable. That ruling is now on appeal before the First District Court of Appeals in Tallahassee. How this affects the corporate practice of medicine and dentistry remains to be seen. Is it the real deal or the Emperor`s new clothes?

Nuts and bolts

Dental-management companies consolidate and manage dental practices. They do everything from providing minimal consulting services to total management of the entire practice. The structure and degree of ownership varies. Some dentists appear to be in total control of their practices; in others, they control only direct patient treatment.

The most common dental practice-management contracts begin with the purchase of all tangible assets of a practice from the dentist/owner. The management company and the dentist enter into a long-term management contract (usually 25-40 years), enumerating the management services to be provided. The management company hires and trains all support staff and manages all aspects of the practice`s operation (except the treatment of patients). By employing effective management procedures, the management goal hopefully is achieved by increasing practice efficiency. In addition, the management team attempts to increase the practice`s patient flow through aggressive marketing, advertising, and solicitation of managed-care contracts.

Next, a company designates and/or controls a professional association (PA), owned by a licensed dentist, and purchases all the intangible assets of the practice, usually consisting of the patient records and goodwill of the practice. The selling dentist then enters into an employment contract with the controlling PA, with compensation usually consisting of a base salary plus bonus. Is it the real deal or the Emperor`s new clothes?

Making an informed decision

"We neither encourage nor discourage dentists from signing on with practice-management firms," says ADA attorney Wendy Wils, director of the association`s Contract Analysis Service. "But, it is important that dentists learn all they can about these new businesses to make an educated decision as to what is best for them."

Dentists should think long and hard about whether they want to give up ownership of their practices to become an employee. Selling dentists will want to be comfortable with compensation terms, which should be carefully spelled out, including whether a bonus will be paid in addition to a salary and what the conditions are to earn a bonus. If selling your practice is your exit strategy to retire, remember: DPMCs probably are not for you! Generally, DPMCs want the selling doctor to remain under an employment contract for three to five years. If that`s your goal, fine. If not, explore other avenues. Most sales result in the dentist giving up some income in exchange for a contribution of stock and notes, so carefully compare the cash flow now to the cash flow after the sale.

Accordingly, if a dentist is entering into an employment agreement, the details of that contract will need to be carefully reviewed by the dentist and his/her personal attorney before it is signed. Is it the real deal or the Emperor`s new clothes?

Legal and tax advice

A dentist/business owner selling his or her practice to a management company will have the same tax consequences as selling to another dentist. Legal representation is critical. In addition to a lawyer, dentists also should have a tax specialist and a financial consultant.

The contracts that make up the sale between a dentist and a DPMC are lengthy and complex. Because of their profound and long-lasting consequences, good legal advice is crucial. It is imperative that the attorney you select be familiar with the sale and purchase of dental practices. Since most sales of dental practices are taxable transactions, dentists/owners will want input from a tax specialist and a financial consultant. With an asset-sale transaction, a seller corporation could be subject to ordinary income tax. With a stock-for-stock exchange transaction, the shareholders will be subject to capital-gains tax on the sale of their interests. This is a big difference in tax rates (20-39%), so consultation with a tax specialist for presale planning is critical.

Dentists who enter into employment agreements with another dentist-owned PA need to be comfortable with the compensation package. The terms must be carefully spelled out and analyzed, including the conditions by which a bonus can be earned. Nonsolicitation and noncompete restrictive covenants will be included in the asset-purchase, employment, or other agreements. Dentists must consider the geographic and time constraints of any such restrictions carefully, as well as restricted activities that are covered.

Inasmuch as the dentist then becomes an employee, rather than the owner of the practice, he or she should think long and hard about whether the terms of the employment are agreeable. Once more ... is it the real deal or the Emperor?s new clothes?

Going forward

If, after careful consultation with your advisers, you, here are some steps to consider.

E Get to know the company you?re dealing with. You and your advisers should carefully analyze the company. Is it already public? Or is it still private, but telling you it?s going to go public soon. Be careful; the most risk is with these Onot yet publicO companies. There is almost no public information available to perform an adequate examination of these companies. If you are dealing with an established, publicly held company, review its financials, business plan, and existing infrastructure. You should attempt to get a feel for the company?s business philosophy by calling other dentists who have sold their practices. (This is public information that you easily can obtain on the Internet.)

E Meet with an attorney and, together, line by line, carefully analyze the offer. Do not sign anything without consulting your attorney. Remember, you are selling your livelihood. Take your time; this is very important. Don?t allow yourself to be Ofast-talked.O The most reputable public companies want to develop a long-term relationship with you, and will not pressure or rush you. If you feel pressured, let your attorney handle it. That?s what he or she gets paid to do.

I Do some real soul-searching to see if you?re really going to be happy giving up most of your autonomy to practice in a corporate-structured environment. Some dentists adapt very easily; some do not. Remember, seek legal counsel at all stages. Then, armed with all the diligently acquired information needed to make an informed decision, ask yourself the question only you can answer:

Are dental practice-management companies the real deal or are they the Emperor?s new clothes?

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