Unless you are a finance aficionado, the term “arbitrage” may not be part of your daily vernacular. However, in the private-equity-backed DSO world, it is the ultimate driving force behind consolidation. At its most fundamental level, arbitrage is the process of buying up assets or securities (aka dental practices), increasing their value through economies of scale and synergies, and offloading that portfolio at a much higher value. In other words: buy low and sell high. We see this across all commerce, industries and markets, and thus, dentistry is no different. Private equity folks are hip to the realization that if they can purchase a practice for 5-6x Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), add it to a platform of other acquired practices, and sell it to the next buyer at a multiple of 11-12x, this is a major win for shareholders. As such, arbitrage is the driving factor behind the DSO consolidation wave. Now, this does not mean that the dental providers who worked so hard to build their practices are nothing more than a pawn in a Wall Street game of chess. Rather, a provider can participate in, and benefit from, these arbitrage efforts in three distinct ways.
Increased Practice Value
In order for financial arbitrage to work, buyers need to acquire strong assets. The stronger the portfolio of assets acquired, the higher the likelihood of exponential bottom line growth as the platform changes hands. Think about it. Perhaps you have negotiated some pretty good reimbursement rates from third-party payers or with your supply vendors. Now imagine what happens when, instead of a single practice location approaching them, a group of 10, 100, or even 1,000 practices approach those same payers or vendors for enterprise-level pricing. The increased reimbursement revenue or expense savings, respectively, is game-changing for the practices involved. This means increased profitability, a stronger EBITDA and a spike in value upon a sale of the entire group.
You may be thinking: "That sounds great, but what value does that add to my practice today?" Well, if you have built a practice with say, $1,000,000 of EBITDA (not a hard and fast requirement, just as an example), you are going to catch the attention of very strong PE buyers and they are going to pay a premium to get your practice onboard. These are intelligent folks and already know that if they buy you for a bit higher than originally hoped, they can tweak the model and still hit their arbitrage goals when scaling and exiting later on. You have the ability – within reason – to negotiate the purchase price and key terms of your practice sale and need to remember that as you go through the process of selling.
A word to the wise – it is easy to get greedy! Remember this is a long-term play. Work closely with your advisors to maximize value, but don’t lose sight of the even bigger wins that may follow. If you need a great law firm referral to help with negotiations, we know people :).
Rolling Equity into the DSO
In addition to a strong purchase price, most DSO buyers will offer some form of equity in their growing organization. Some refer to this as “getting another bite at the apple”; meaning that the seller is paid upon closing the sale of their own practice and then gets to realize another windfall when the buyer goes on to recapitalize or sell the portfolio (of which you are now an equity holder). In fact, in some scenarios, dental providers can realize multiple paydays as these groups of practices are sold again and again, each time to a bigger buyer…the gift that keeps on giving! Of course, there are no guarantees. Some DSOs will move too fast, be unable to manage operations and implode. Others may be well-intended, but their acquisitions are not able to perform at the level they anticipated. However, others will deliver. A seller must carefully analyze the strength of the buyer, review its long-term investment strategy and exit objectives, and think beyond just the initial purchase price to give themselves the best change of obtaining generational wealth for themselves and their families.
Equity Arbitrage
In this video, Professional Transition Strategies founder, Kyle Francis, does a far superior job of defining equity arbitrage than we could do justice. What is important to note is that the arbitrage game does not just have to be played at later subsequent exits, or be a mere hope that such recapitalization events will even occur. Rather, savvy brokers and advisors may be able to roll your practice into another seller pool and, as Kyle articulates through his example, obtain a significantly higher valuation than a single practice might obtain on its own. In this way, the seller is maximizing their value at the first exit in addition to the subsequent exits. Talk about a win-win!
At Marti Law Group, our goal is to serve as your trusted legal partner. We aim to help our clients – both buyers and sellers alike – maximize value. As discussed above, the benefits of financial arbitrage do not have to be limited just to PE/DSO shareholders. Let us be your jump off point in understanding options as you think about entering the marketplace. We maintain strong broker and financial advisor referral partners and will to be by your side throughout the entire process. Call us at (860) 552-7770 or email info@martilawgroup.com.
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