Offers from DSOs come in all shapes and sizes and contain a wide array of terms, variables, vocabulary, and numbers. Yes, there’s typically a “headline number” or “enterprise value” near the top of the page, but the reality is that many will never realize that headline number due to the deal structure.
Structure drives the long-term value of a transaction. As I’ve said many times, I will happily buy your business for 25x, if you let me structure the deal. If you took me up on this offer and owned a business with $1M of earnings before interest, taxes, depreciation, and amortization (EBITDA—a proxy for operating free cash flow in your business after normalized owner-doctor compensation), I would offer you $25M (25 x $1M = $25M). As for the structure, I would wire you $1M of cash at closing, then put the remaining $24M in unattainable earn-outs, but you could tell all your friends that you got paid 25x for your deal. See where I'm going?
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That’s really what makes our job at TUSK so exciting. When we take a client to market, we receive offers from five or more DSOs, and they are all different. However, there are always some dollars at risk, while others are not. Below are a handful of deal terms that we have seen over the years along with potential issues with each.
Deal terms to watch for
“Cash at close” refers to the cash amount that is wired to you at closing.In some cases, DSOs will include clawbacks where the DSO can come after these dollars if revenue or EBITDA targets are not maintained postclose.
“Postsale compensation” deals with how you will be paid as a clinician or manager in the business postclose. Clinical commissions on what? Collections, net collections, production, collections less a percentage of labs? It all matters, as it drives your EBITDA and can impact valuation.
“Earn-outs” are dollars only realized when your business achieves certain revenue or EBITDA targets.Once you sell your business, you give up control of the revenue and expenses, and it can be harder to control the outcomes; the DSO is calculating the EBITDA going forward.Deals are sometimes structured to show huge earn-outs that are practically unattainable simply to boost the headline “valuation” in letters of intent.
“Equity retained in your business,” sometimes described as sub-DSO equity or joint venture (JV) equity, is equity retained in your business postclose. Most times this equity allows you to enjoy distributions based on your pro-rata share of the retained equity in your business. Management fees charged by the DSO range from 0%–20%. Some are capped at a certain dollar amount, while others are not. The one thing they all have in common is that they are paid before any distributions to equity holders.
“Equity rolled in the DSO” refers to how some DSOs offer the opportunity to roll proceeds from the sale into equity at the “hold co” level. Many will tell you that these shares are the same as or “pari passu” to the shares that the private equity guys and leadership in the DSO have; others will not be so fast to tell you where these shares live on their capitalization table. These shares don’t typically come with distributions and can return 1–5x cash-on-cash rolled. Timing is a possible issue here. When a PE group invests in a DSO, they expect to grow the business, then exit within a 60-month period. If you roll equity into the DSO at month five, your returns will likely be much higher than if you are investing in month 55. Keep in mind that some DSOs are mismanaged and over-levered and don’t make it to a recap. When this happens, their lenders take possession of the business and wash out the value of the equity holders. That’s right; it’s possible for the equity value to reach $0.
If after reading this you are still good with me structuring your deal, I am happy to pay you 25x your EBITDA today for your business. My guess is that you’re smarter than that.
TUSK Partners is among Dental Economics’ financial supporters.
This article appeared in the February 2023 print edition of Dental Economics magazine. Dentists in North America are eligible for a complimentary print subscription. Sign up here.