The Practice Buyer's Corner - Random Musings from the Buy-Side

The purpose of this blog is to share current, real world, experiences on the topics of practice valuation, practice transition, retirement planning, and building equity value - over time - in your dental practice.

Blog By:
seanepp

The contemporary forms of group practices (DSO, DPO, DMO, ABC, DGO, LOL) are approaching their sixth decade of operations.  As the labels and models proliferate, an increasingly common conversation is:

“So, what’s your equity story?”

Fantastic question.

I encourage anyone curious about pursuing an affiliation with a group to start with this question.  By digging into fit first, it tends to make the financial review most constructive.

Why?

It should hopefully provide insight into how that group views their role in the dental ecosystem and sets the stage for how they intend to create equity value within their platform.  

Are they a group focused on building a fundamentally sound, durable healthcare business?  These are the operators.  Or, are they a group trying to time the market and aggregate a pile of EBITDA for a quick flip?  These are the opportunists and financial engineers.  

There is nothing good or bad about either approach *and* it is critical to understand the differences.

One of the common tells of an operator is a focus on quality outcomes and a more real world, practical approach around their equity story.  Professional investors are presently targeting some of the lowest returns in sector history - largely a function of the debt markets and a highly competitive M&A market.  In today’s market, many investors are focused on simply doubling their money over the traditional 5-year hold period.  Return expectations tend to decline as businesses scale past a certain point and risk premiums abate.

One of the common tells of an opportunist or financial engineer is a rush to tell an outsized equity story on the back end.  Many groups are still trying to sell outlandish claims of cash-on-cash returns of 3x-5x on the “second bite” of a subsequent recapitalization of the platform.  While there are always exceptions, the rule in today’s market is cash-on-cash returns closer to 2x.  If anyone is suggesting higher, it is probably worth really digging into their assumptions.
For the record, minority investors don't beat "the house" a/k/a the control equity (founder or PE) - that's now how any of this works.

Common exceptions to the foregoing can include a) the initial founder(s)-to-PE transaction, or b) PE 1.0 to PE 2.0 transaction.  After the second major PE-recap, most groups have already scaled the steepest part of the curve, established their foundational systems, and the rate of valuation creation tends to slow down moving forward.  Platform valuations tend to stay high because the underlying business has become more robust and durable, better able to weather economic volatility.

Lastly, ask very direct questions about the role of rollover equity in any transaction.  

Is the equity rollover an important signal to the group from a partnership quality standpoint, or, does the group need the equity rollover to fund the transaction? The latter scenario should prompt curiosity about that group’s financial wherewithal and long-term prospects.  No surprise, this dynamic is often highly correlated with groups selling outsized equity stories.

Hope this was helpful.  Please LMK if you have any questions by DM.

Have a great day!

Sean