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Investments in the dental industry: Consolidation strategies

Nov. 1, 2019
Bart Walker, JD, and Diana Castro, JD, identify some of the challenges to dental industry consolidation and offer practical solutions for investors.

As dental services organizations, also known as dental support organizations or DSOs, continue to expand on a national level with growing footprints in the market and increased revenues, they continue to present attractive opportunities for private investment and expansion. There are now at least a couple dozen well-funded private equity–backed consolidators in the DSO space. Many of these platforms are looking to employ a rollup or consolidation strategy whereby the platform practice acquires the clinical assets of many smaller practices and the DSO acquires the nonclinical assets of the smaller targets. This acquisition strategy enables the DSO to create a much larger enterprise over which it is able to leverage a much more efficient cost structure and implement professional business management arrangements.

The traditional private equity structure employs a potent mix of equity, debt management expertise, growth, and efficiency to achieve greater investment returns. In order for this structure to work, expansion is often key. As a result, competition for deals is fierce. Simultaneously with the increased competition for dental acquisitions, dentists are graduating dental school with mountains of personal debt, often in excess of $300,000 to $400,000. The high amount of debt often means that recently graduated dentists are unable to open a practice or purchase an existing practice from a retiring dentist. In addition to the cost-prohibitive options of starting a practice or buying an existing practice, it is becoming more common for younger dentists to join an existing DSO-supported practice. The next generation of dentists have (generally) demonstrated a preference for greater predictability and control over their schedule, as opposed to engaging in the business administration portion of the dental practice, which continues to grow in complexity by the day.

Investors have long been attracted to the dental space due to the perceived insulated position it enjoys as a primarily commercial payer or cash-pay business. Placing Medicaid-based DSOs to the side for a moment (which certainly is a viable business model), most dental practices do not have any Medicare reimbursement and only limited amounts of Medicaid reimbursement. This leads to a perception that non-Medicaid-based DSOs are more insulated from a political “stroke of the pen” reimbursement rate slash. Meanwhile, the dental practice space remains highly fragmented. Anecdotally, many in the industry estimate that 80% of dental practices are still unaffiliated with DSOs, which means we have a long way to go before the industry becomes consolidated. However, consolidation of dental practices presents a number of obstacles. Our objective in this article is to identify some of the challenges to consolidation and offer practical solutions.

Corporate Practice of Dentistry doctrine

The Corporate Practice of Dentistry doctrine is state regulated, which can result in challenges to DSOs with aspirations of growing a nationwide presence. For instance, in some states, nondentists can own a dental practice directly, while in most other states, dental practices must be owned by a licensed dentist. Some states go even further to require that such licensed dentist be licensed by the dental board of the state in which the practice is located. The structures implemented to comply with these laws can be very sophisticated and somewhat esoteric. The result is that a growing DSO may need to familiarize itself with the laws of almost every state in order to grow in a compliant manner. 

One solution that some DSOs have turned to is to play to the lowest common denominator. In other words, such DSOs have chosen to comply with the laws of the most restrictive state. While this approach could mean sacrificing structural integrity or certain economics of the arrangement, some DSOs have found this to be an efficient solution to growing quickly and in a compliant manner. Alternatively, other DSOs have taken more nuanced approaches, either involving a grouping process where similarly regulated states are grouped together for structural considerations or requiring an individual state-by-state analysis and structuring. In deciding which approach to follow, DSOs have to balance perfect precision and scarcity of resources. For example, most DSOs would not want to conduct a 50-state analysis of this one issue. Fortunately, there has been enough activity in the dental space over the last 5 to 10 years that a fairly healthy body of practice has evolved, and most knowledgeable practitioners have a general understanding of the basic regulatory landscape in most states.

Need for a dedicated team or personnel to drive the transaction

The DSO management teams who are the most successful at executing a rollup strategy have dedicated teams running the acquisition process. This internal operational structure means that—in addition to the business development professionals who are responsible for identifying potential merger or acquisition targets and filling the pipeline—professionals from operations, human resources, IT, payer relations, insurance, accounting, finance, and legal all work seamlessly as a team in their own areas of expertise to drive the transaction. While outside advisors can be used for some of these tasks, in the long-term and for a large operation, it may not always be the most efficient approach.

The DSOs that we have seen execute the most effective growth strategies by acquisition or de novo development are the ones with the best and most disciplined development and acquisition teams. Of critical importance is defining the responsibilities of each department or group involved in the process, setting specific expectations on timing and deliverables, and clearly defining the scope of each person or group’s work. From a legal and documentation perspective, it is very important to move quickly to a set of template documents from which there is very little departure. While the majority of DSOs have a business development person or team chasing deals, in our experience, not all of them have a full acquisition team that will help ensure that deals move quickly from letter of intent through due diligence and ending with closing as quickly and efficiently as possible.

Third-party billing and coding audit

Billing and coding audits have become commonplace, if not required, for these types of dental transactions. Billing and coding audits include a chart review, which is a random sampling or a targeted sampling of a certain statistically significant number of claims filed. The charts are analyzed for compliance with federal and state law and payer reimbursement requirements. If there are deficiencies found, they are noted and potential remedies cited. Sometimes significant issues are uncovered during the billing and coding audit early in the process, which in turn informs the business decision about whether to proceed with the transaction. Some buyers have started conducting a payer analysis or a reimbursement market analysis, which is an analysis separate and distinct from a billing and coding audit. We typically recommend that buyers engage billing and coding experts to conduct audits early in the process, given that the issues that are often uncovered go to the heart of the economics of the business and, as a result, of the deal. Keep in mind that the issues uncovered could relate to the business model going forward in addition to the historical liabilities or business risks.


We often see smaller practices that do not have a robust compliance program in place. This is commonplace and rarely fatal. In fact, many acquirers view this as an opportunity to implement standardized best practices across their entire platform. DSOs would do well to be able to distinguish between truly material compliance failures on the one hand and formalistic noncompliance or immaterial deficiencies on the other. It is also important to gauge the practice’s culture of compliance. Specifically, during the diligence process, it is crucial for DSOs to assess how seriously a practice takes compliance and how receptive the doctor and staff are to advice when an issue has been identified. In other words, is the practice proactively engaged in finding a solution, or did the practice resist change merely for the sake of resisting change?

The laws governing the health-care industry are complex. Many business practices that are benign in any other industry in the country are problematic in the health-care context. Many smaller practices and even some multisite practices are simply unaware of the complexity. This is a delicate process that needs to be undertaken in an intelligent yet practical way. In addition to federal and state corporate practice of dentistry, self-referral, antikickback, and fraud and abuse laws, a whole host of other laws govern these businesses—covering matters such as patient privacy and security, marketing, consumer finance and fair lending practices, employment (which governs employees, independent contractors, and restrictive covenants), patient notification, and more.

Valuation expectations

Over the past few years, we have seen a growing disparity between the pricing expectations of buyers and sellers in the dental market. For example, many smaller dental practices see the multiples commanded by much larger platforms and try to apply the same valuation principles to their own practices. Specifically, while some of the largest DSOs in the country have traded at multiples of EBITDA as high as thirteen or fourteen, a small practice or even a moderately sized multilocation practice would be hard-pressed to obtain that kind of evaluation. This wide range in the valuation of dental practices can be challenging for a DSO to explain. Furthermore, given the highly regulated nature of the health-care industry, there are limited tools available to try to bridge this gap in expectation evaluation, such as by offering certain compensation incentives postclosing.


Finally, attracting and retaining talented dentists and executives remains a bottleneck to consolidation. There is a clear shortage of both, and there will likely continue to be such a shortage for some time. This is especially true in rural or underserved areas. Accordingly, recruiting is taking up a greater and greater share of resources in today’s DSO world.  

Bart Walker, JD, is a partner in the nationally recognized health-care practice at McGuireWoods LLP. A leading lawyer in the dental and DSO space, he advises health-care providers as well as equity sponsors and lenders to the health-care industry. He also works with providers, including DSOs, on regulatory and transactional matters.

Diana Castro, JD, is an associate at McGuireWoods LLP. She advises clients on mergers, acquisitions, private equity transactions, and health-care regulatory compliance matters. She represents health-care providers, sponsors, and lenders to the health-care industry. She also works with hospitals, ambulatory surgery centers, DSOs, and large physician group practices on regulatory and transactional matters.

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