Lessons Learned From Industries Long Consolidated

We’ve heard a lot of late about the economic environment, financing rates, interest rates,  PE funding and valuation levels. It’s a veritable cacophony of conflicting thoughts, values and guidance. Largely missing from all of these are references to industries consolidated long ago which can give us some incredibly valuable insight into where we currently are, and where the industry aggregators may be moving in the future.

PICTURE IT WITH ME: you’re enjoying a relaxing Saturday morning at home. As you sit on the front porch reading the paper, you notice that the grass needs cutting, the dead limb over the garage did not come down by itself while you were practicing dentistry all week, and although the leaves fell months ago, you still haven’t removed them from the flower beds. There’s certainly some work to do outside. Not wanting to tackle the chores today, you wander inside.

 As you walk past the fridge, you glance at the long list of honey do’s placed up there weeks ago that continues to grow. As you pour another cup of coffee and think about how to get through this mountain of work around the house, the doorbell rings.

“I want a 9X on 1.8MM in EBITDA, 80% cash at close and no earnout!”

“I want an 8X on 550k in EBITDA, 100% cash at close and a 12-month employment agreement.”

I hear this all the time. At times, I must sit back and wonder where it all comes from and how these expectations began. There are a dozen funnels of information that can find their way into the general dental population, however I believe that there is a vast chasm between expectations and reality right now that simply has to be addressed, and the fault lies everywhere.

The Mergers and Acquisitions (“M&A”) world is largely cyclical.  There are ups and downs and good times and bad to sell one’s business. Over the last 5 years, we have only seen dental practice values increase.  So, the question we are often asked is, “How much longer can they go up?”

If you spend too much time watching the news or reading the financial press, it can feel as though we are only one day away from financial ruin, but the story in the dental economy is a different one. Demand is high across all specialties and GP practices and new capital is entering the market with great regularity, keeping valuations high, for now.

As we prepare for the year ahead, I want to share a summary of conversations I’ve had in recent months with IDSO/DSO leadership nationwide, as well as our insights on the dental mergers and acquisitions (M&A) markets.

Valuations Remain High

2022 was one of our busiest years. Our clients enjoyed rich multiples and favorable deal structures with the best DSOs in the nation. We currently have more deals in the market than ever, and we’re consistently seeing bidding wars and multiple offers. Buyers are complaining that they cannot keep paying these rich multiples much longer and that they must be selective in how they spend their money, but for every buyer that bows out, two new buyers appear. There were at least 20 private equity- (PE) backed DSOs formed in 2022, and they must buy practices to grow and meet the needs of their investors. Q1 is always a fascinating time in M&A markets: fresh off the busiest M&A closing season, there are never enough sellers to meet buyer demand. Each year this results in bidding wars and premiums paid by buyers through the first four to five months of the year. The first half of 2023 will be fast-paced, resulting in excellent deals for sellers.

From Hunted to Hunter...

During my years in investment banking, I worked with a series of private equity (“PE”) backed companies across multiple industries.  Their business models were always the same: (1) buy one large platform business with adequate infrastructure and solid leadership; (2) buy additional businesses in the same industry and roll these companies into the larger one; (3) ultimately sell the business to a larger private equity company.  These PE investors made money by buying the acquisition targets at the most affordable prices possible and selling the resulting platform at the highest price possible and make money on the spread, defined as arbitrage.  Sound familiar?

I Will Buy Your Business for 25x Your EBITDA...

Offers from DSOs come in all shapes and sizes.  They contain a litany of terms, variables, vocabulary and numbers.  Yes, there is 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 structure of the deal.  Structure drives the long-term value of a transaction.  As I have 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, on a $1M EBTIDA business ($25M Enterprise Value on 25x EBITDA), I would set aside $1M of cash at close then structure the remaining $24M in unattainable earn outs, but you could tell all of your friends that you got paid 25x for your deal.  See where I am going?

I Am Not Your Friend…

For a long while, I operated on the buyside of both a smaller regional DSO, and an elite national DSO. In that time, if I could have honestly started off every single meeting I had, it would have started with the phrase “I am not your friend!”. Obviously, that would be incredibly counter-productive to my cause, so I generally just settled with “Dr. Jones, it’s wonderful to meet you! You’ve built an incredible business and my job is to make sure a partnership is a good fit for all parties involved and get you the value you’re looking to receive!” Phew, that feels better for everyone sitting at the table. Amazing how semantics can alter the focus of a conversation greatly.

But I digress, as a buyside representative, my job was to find opportunities that were a good fit for my organization, and then pay as little as possible for those opportunities, thus maximizing the arbitrage that my organization would experience at their next capital event. Rinse. Repeat. This was done through a myriad of strategies, a couple of which I’ll touch on here.

If you missed part one of this article, you may access it HERE.

3. Taking Too Much or Too Little Cash at Close

I love that dental deals these days come with so many options when it comes to the allocation of the purchase price. I also love that every DSOs equity packages are vastly different and come with different risk factors.

Some DSOs offer equity that is trapped at the DSO level, provide no distributions, and can only be monetized when their PEG sells their position. Other DSOs offer equity at the practice level that distributes profits quarterly based off EBITDA and comes with put features that enable you to put the equity back to the DSO when you choose at a pre-determined valuation. 

Almost every deal we close comes with the opportunity to roll some of your proceeds from the sale into equity at some level. And each tranche of equity comes with very specific rights, obligations, privileges, and responsibilities. We work closely with our clients to make sure that they understand the risks and the expected rewards that accompany each equity offering.

Too Much Focus on Exit Multiple / Price

I know that this may sound counter-intuitive, but price (or exit multiple) is only one component to a transaction and is not the most important. I am fond of saying, “I will pay you 25x your EBITDA, if you let me structure the deal.” 

I would argue that the deal structure is the most important feature of any transaction as the deal structure dictates how cash, equity, and cash flow from JV equity is delivered to you and your estate. In addition, today’s deals are far more complex that historical deals, with a lot of the enterprise value held in the various equity offerings of each individual seller.

Understanding what the triggers are for these equity offerings, and what exiting said offerings consist of is a critical component in realizing the full value of your deal.

Because of our extensive background in investment banking, our process mirrors that of many of the largest investment banks in the world. Each time we take a deal through a Marketed Sales Process, we receive a wide range of offers with a plethora of differing deal points and structure, including but not limited to: