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Are you ready for a real education on dental group practice and DSO valuation and how to go to market? On this episode we get beginner and intermediate level education on valuation from the team at Logan Growth Advisors. They conduct a course on how to prepare for a dental merger or acquisition and provide insight into the M&A process. Highlights of this highly educational dental M&A podcast include:
What does good look like?
- EBITDA
- Multiples
- Terms
- Much more
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Connect with Logan Growth Advisors team – https://logangrowth.com/connect
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Full Transcript:
Bill Neumann:
I’d like to welcome everybody back to the Group Dentistry Now Show. I’m Bill Neumann, and we are over 100 episodes right now. So super stoked about that. We’re right around 40,000 downloads just with the audio, so whether you’re listening to us on Google or Apple or Spotify, we appreciate you. If you happen to be watching us on YouTube, that’s awesome too or you find us on group dentistry now.com. We certainly appreciate the five star reviews that we’ve been getting. And always learn a lot on these podcasts, so without further ado, I want to introduce the team from Logan Growth Advisors. We have Bob Winder, Kevin Khona and Daniel Stark. Guys, welcome to the Group Dentistry Now Show. Appreciate you being here today.
Bob Winder:
Good to be here. Thanks, Bill.
Bill Neumann:
And what’s interesting about this episode is instead of doing a lot of Q&A, and I think some of this has to do with Bob’s background as an educator, he thought he wanted to do a little bit, paint a picture, so focus on what’s really important to their clients right now. He’s going to mention the legs of the stool, which is really interesting. So we’re going to get really deep into what his clients are experiencing right now, what’s going on in the M&A market in dentistry in particular and what really is a great good strategy for you because there are a lot of opportunities now. And I think especially these doctor-owned, doctor-led groups, it can be a little daunting to figure out which way to go, strategic partnership, private equity investment. Maybe the banks that you’d worked with in the past aren’t necessarily lending to you anymore, and so where do you go? So again, Bob, maybe introduce yourself if you don’t mind, your background. And then, Daniel, if you want to go from there. I’d love to just get your brief bios and then Kevin.
Bob Winder:
Sounds good. Thanks, Bill. So I worked in private equity right after the recession, and we were very interested in recession-resistant assets. So, of course, healthcare was where a lot of money was going, this flight to quality. And this was towards more the beginning of the DSO consolidation phase. It had been happening for years and years before this, but it was just feeling like it was getting hot. And so this caught our eye, and we worked on a ton of dental deals. And I really fell in love with the model, growth through acquisition, finding doctors that were getting closer to retirement age and feeling like this was a good retirement strategy, so much white space. It seemed like a really, really interesting market, so we worked on a ton of different deals. And ultimately, I thought to myself, well, geez, this looks great. Why don’t I do this myself? These dentists make it look super easy. So I raised some capital on my own with a founded dentist partner and bought a group of dental practices in Texas, and low and behold, it’s not easy. And the dentist that I had worked with before made it look really easy, but it’s not. And it was a really, really difficult experience recruiting and retaining doctors, managing staff, trying to be differentiated in a huge market.
Bob Winder:
It was a couple years of my life. Probably took at least a decade off my life expectancy, but I learned a lot in the process and gained a ton of respect for those doctors that are successful and that do it and make it look easy. During that time period, I had a private equity friend of mine reach out to me and said, “Hey, Bob, I’m looking at this deal. We’re going to buy it for $20 million. It ended up being too hairy, too raw. We’re going to pass. We’re going to walk away, but maybe I could introduce you and you can help him clean things up. And we can save face a little bit.” So I said, “Well, I’m up to my eyeballs, barely making payroll with my dental gig right now,” but when your back’s against the wall, you just say yes. So I said, “Yes, let me take a look.” Sure enough, really great business, great business, six doctor partners, and they were doing some really interesting things. So I took the mandate, said, yes, let me work with you guys and get you ready to sell and work with private equity.
Bob Winder:
I knew exactly what private equity wanted. I had been on their side for a long time. I knew how difficult it was as an operator to effectuate some of those changes, so I thought I could put both of those skill sets together and run a process on the sell side and help these guys out. Well, sure enough, it was a great business. We’re able to make some tweaks, refine the financials, get the strategy in order and ended up selling it for $40 million, not two, in less than a year. And that’s when I realized, okay, this is what I need to be doing. This is partnering with doctors, helping them present themselves and get ready for a transaction and running a really great process and helping them achieve a victory like that. It’s what I’m good at and what I should be doing. So I sold my dental group, and then have been focusing on this for the past seven or eight years. In the process, I became a university professor at two universities, teaching about mergers and acquisitions and private equity, venture capital, and even more importantly, was able to find the best partners on planet Earth, Kevin and Daniel, who are incredible in their domains.
Bob Winder:
And I’ve been super fortunate to build Logan Growth Advisors. We work with dentists. We work with doctors and help them navigate the complexity of all of their strategic options. As you mentioned, that’s what we’re going to talk about a little bit more today, a lot of the strategic options that they have in front of them, what some of those could look like, what they mean and then what this whole M&A process looks like. So it’s a little bit more like one of my classes that the university, unless a specific meeting with a doctor. But we’ll field some questions, and hopefully this is useful.
Bill Neumann:
That’s great. Thanks, Bob. Daniel, how did you end up becoming a partner at Logan Growth?
Daniel Stark:
Thanks, Bill. I started my career at KPMG, which is one of the large accounting firms in the United States. And I was doing accounting and due diligence work, which means helping people like Bob look at companies to purchase back when he was in the private equity world and help evaluate them, look under the hood, find the skeletons in the closet, find all of those nitty gritty things. And I did that for eight years before my wife and I decided to have a child, and I decided to switch career paths a little bit. Similar to Bob becoming a CEO of his own dental practice, I left and became a CFO of a dental practice myself, not my creation, but one that I helped run. During that career path, I became a CFO of several different healthcare organizations but really fell in love with the dental world, the relative simplicity of D codes versus CPT codes and production versus gross charges. And I found Bob when he was looking at another healthcare company, and he needed somebody to evaluate it because anytime you’re looking at a business like that, you need to be able to evaluate it and value it and make sure that you’re paying the right price for the right assets.
Bill Neumann:
Thanks, Daniel. Kevin, you’re up. How did you get involved with Bob and his team?
Kevin Khona:
So Bob and I were actually classmates at BYU and undergrad together, so I’ve known Bob for a long, long time, almost 15 years. But I worked at multiple hedge funds where we were multi-strategy focused and also event-driven, so merger arbitrage where there’s a potential to take private a public company, and looked at not only take privates or a private equity perspective in public markets, but also publicly-traded investment holding vehicles, like BDCs and BDCs that own and operate SBICs. So I spent a lot of time on investor structures and what are different types of institutional investors, then ran a thing similar to Bob. I thought I could run a group on my own, do my own thing. I’m not good at running a group of my own thing or anything. [inaudible 00:09:17] focused roll up in the northeast, ended up winding it down with three locations and ended up working with Bob, and it’s been a ton of fun. We’ve been able to help a lot of founders achieve a successful exit. Also, worked for in corporate development for a private equity back company who was going through a recap and worked for the CFO, and really interesting to just work with the sponsor and the management team and to try to maximize the management team’s economics and the transaction and see the existing sponsor, the new sponsor, the management team and a lot of different stakeholders at the table on each deal.
Bill Neumann:
Thanks, Kevin. So before we really get into this theme that we really want to focus on and before we start to your class, Bob, Kevin and Daniel, tell me a little bit about the typical client that comes to you, the doctor-founders that you have. What tend to be the needs and wants, and is it somebody that has a single location, somebody has multisite, combination of the two?
Bob Winder:
It’s all the above, Bill. What’s interesting is most dentists today have been approached by either private equity direct or a strategic, another bigger DSO. And so they’re getting these inbound inquiries, and they’re starting to ask themselves, wow, this market seems to be consolidating really rapidly. What should I do? How do I fit in? And those are a lot of the questions that we’re getting, and even just a couple days ago, a doc with 15 practices reached out and said, “I just got an LOI from a strategic, larger DSO. It looks really interesting. What do you think?” So a lot of times, that’s what happens, is they’re hearing this. They’re either hearing it from their buddies or hearing it from conferences, podcasts, or they’re getting inbound inquiries. And usually, these doctors usually fall into three categories. So one is they’re getting a little bit older. They’re thinking about retirement. They’re not necessarily at retirement age, but they’re feeling more risk averse and starting to get these inbound inquiries and thinking, what should I do? How do I fit in? Who should I potentially partner with and when? So that may be the biggest category right now of doctors that we talk to.
Bob Winder:
Another really big category, so the second one, is a successful doctor, usually a little bit younger and started out his career being very risk tolerant, growing rapidly but now maybe he’s up to 10 or 15 practices and has some real net worth tied up in his illiquid business. So this is an illiquid asset that most of his net worth is tied up in, and he’s now transitioned from being risk tolerant to more risk averse because now he’s got something of real worth and he doesn’t want to screw it up. And so he’s less focused on rapid growth and more focused on I just don’t want to mess this up, I want to keep making money, I don’t want the wheels to fall off. What should I do? It probably makes sense to diversify, take some chips off the table, but I still want to be at the helm. I still want to have upside, but I want to make this fun again. Right now, it’s not as fun as it used to be because it’s a lot more stressful. I actually have something to lose now. And so in that scenario, maybe private equity makes more sense or even a strategic partnership.
Bob Winder:
The third that we see is a little bit younger, more aggressive doc, maybe has five or 10 practices, is hitting up against this glass ceiling of debt. The traditional bank lenders that he’s using just don’t know what to do with him. He’s outside of their typical box and is causing trouble in their minds. The faster he wants to grow, the more risky it seems for the bank, and they get none of that upside. And so for them, they don’t know what to do. They ratchet back their lending. He’s already fully personally guaranteed to the loans. He’s got tons of opportunities to grow, but he just can’t get more funding to grow. So he usually thinks, hey, I need to sell. I need private equity. I need something because the lenders won’t work. Well, there’s a lot of different options for him too. Private debt is a great option and potentially bridges the gap between where he is now and maybe call it $1 million of EBITDA earnings, Daniel will define that in a minute, that’s his domain, and $3 million of pre-tax profit EBITDA, which is really where the whole world of opportunity opens up from an M&A perspective. So in that scenario, maybe private debt is a great option or a strategic partnership.
Bob Winder:
So understanding really the age, the risk tolerance and the size of the group of practices help us navigate or give advice to doctors as to what their options are and what might make the most sense. But usually, some variation of those three buckets are where most of the doctors are that we talk to.
Bill Neumann:
So what we’re going to discuss today is really how you’re helping these clients, which all are different sizes and shapes and at different stages, whether it’s the stages of their career or the stage of growth of their group, how they find a successful merger or acquisition and what that M&A landscape looks like. So it can be pretty daunting, and there’s a lot of information coming in now. Some of the big DSOs have their biz development people out there, and they’re hounding them. You’re perfect for us, so they come directly to them. Let’s talk a little bit about, as you start to set them up, what does good look like? Whether it’s a merger and acquisition or whether you continue on your own, how do you make yourself look good for a lender potentially?
Bob Winder:
That’s a great question, Bill. And as you mentioned, there’s so much information out there right now, and it’s confusing. What is important? What does good look like? You go to these DSO conferences, and everyone’s talking about multiples, right? That’s the big term today, is multiples what. Multiple did this trade at or di this sell at, or this big DSO sold for 15 times or 14 times some big multiple. So everyone’s fixated on this multiple concept, which is only one piece of the puzzle or one leg of the stool, so as we think about a holistic deal, what is a good deal, what makes a good deal, it’s really three components. The first is multiple, as I mentioned, multiple of your EBITDA or your pre-tax profit that goes into valuation. These are economic terms.
Bob Winder:
But the second is the EBITDA, so at what EBITDA are you actually using to apply that multiple to to determine your overall valuation? That is a very subjective measurement. Unfortunately, it should be very scientific, but unfortunately, it’s very subjective. And it can be negotiated. And so we’re going to have Daniel, who is our expert at establishing a defensible and aggressive EBITDA, walk us through what that looks like. And then the multiple, that is really derived from running a competitive process. That competitive tension is magic, so you as a seller or even someone looking to partner with either private equity or a strategic, another DSO having multiple parties competing to win your deal, that competitive tension is where the magic happens, and that’s Kevin’s domain. He is unbelievably good at this, and he loves it. He can’t get enough of it, so he’s going to walk us through what it looks like to create that competitive environment in order to get the best multiple.
Bob Winder:
The third leg of the stool is the terms. So you might get a great multiple on a fair, but you might have horrible terms. And so sure, you might have gotten a big multiple, but ultimately, it’s a bad deal because those are not good terms. And we all work on the terms, but I’ll go over that a little bit more as the last phase of a deal where all the terms are ultimately negotiated. And far too often I get accused of being an attorney, which that’s okay. I’m not, but we get really involved in that. And just having more knowledge about it, we go over a lot of that in our classes that we teach. Those are the three key components of a deal, and we all, us three partners, take on specialty in our domain. And we’re happy to go over that right now with you, Bill.
Bill Neumann:
That’d be great. So just to reiterate the legs of the stool, we have EBITDA, the multiple and terms. And so to your point, Bob, you used to not hear this, but now all you hear is EBITDA, right? It used to be a percentage of production, and now it’s EBITDA. So the industry’s getting a little bit more sophisticated, but that’s not the only piece because if we only had that one leg, we’d be in trouble. So I believe that’s you, Daniel, so if you want to talk a little bit about EBITDA and your knowledge about that and what that means for your clients.
Daniel Stark:
Okay, absolutely. Thanks, Bill. EBITDA, you probably heard it pronounced EBITDA, EBITDA or 100 different ways. I pronounce it EBITDA, but it stands for earnings before interest, taxes, depreciation and amortization. That is a very boring accounting way of saying, how much money does it make? Because in reality, that’s what an investor’s interested in. What is the profitability of a business? And it’s not the same as net income or even taxable income because there’s all sorts of funky accounting things that we accountants, we love to throw in there, like depreciation and amortization. What it tries to be is a proxy for cash flow, so for how much cash a given company or an asset is generating. And there’s another term that some people use called sellers discretionary income, or SDI, which is not generally used by the larger DSOs. What SDI is is if you take away all of the operator-owner’s wages and all of their health insurance and all of their benefits and et cetera, et cetera, how much cash flow is it making?
Daniel Stark:
And it’s largely irrelevant unless it’s a single-owner practice. That’s generally the owner is checking out. He’s retiring and wants to sell that practice to another single owner operator so that owner operator understands what are they generating. So I’ll focus on EBITDA for the larger DSOs, which would include all of the owner compensation, would include all of the dentist compensation. A lot of companies look at EBITDA, and they get concerned because there are bumps along the road. During COVID, for example, I think every dental practice in the country was closed from about mid-March through mid-May of 2020. We ran into a lot of founder-owners who were very wary about trying to sell in June or July of 2020 or even early 2021 because the key focus of EBITDA is your last 12 months, what does an annual EBITDA look like? What does a year’s worth of EBITDA look like?
Daniel Stark:
But if you had COVID, then your EBITDA is down, so what do you do in those circumstances? Well, you pave over those potholes. Everybody knows COVID existed. Everyone knows COVID happened. And so you can say, well, had COVID not happened, what does the company look like? What did the last six months look like? What do the six months after COVID and the six months prior to COVID look like? What does that surrounding area, et cetera, et cetera. Or there’s some of these one-time or non-recurring events or initiatives that you’re doing. We ran into a client who had just recently hired a prosthodontist, and a prosthodontist will generate a lot of new revenue for a DSO. But the prosthodontist had only been working for three months, so their question was, do we need to wait nine more months before we can look at and figure out what EBITDA. The answer is no.
Daniel Stark:
When you perform something called a quality of earnings, what it does is it looks at what is reported EBITDA and adjusts those numbers so that the reader can understand at a normalized basis what kind of profitability is this asset generating. It gives a real feel for what it’s generating and even though there’s noise, even though there’s bumps, even though there’s different things, a good provider will identify those, smooth it out so that you can come to a certain number. So I’m going to share an example quality of earnings on my screen. I think those of you are listening at home, Bill, correct me if I’m wrong, but they could probably go to the website to download this.
Bill Neumann:
Yeah, they absolutely should. Yeah. So if you’re interested in seeing what a Q of E looks like, you’re going to have to go to our website. In the audio show notes, we’ll put a link to this.
Daniel Stark:
So what this shows, this reported revenue and EBITDA for an example company, and for the last 12 months of this, the revenue was $7.7 million and EBITDA was $514,000. Great, those are your reported numbers, but your reported numbers don’t mean a whole lot until you’ve beaten them up and figured out, well, what is behind the numbers? So one of the items that we do and typically one of the most interesting things you can do is what’s called a cash to [inaudible 00:23:59] conversion. Most dental companies out there, you receive $1 million in a month, you record $1 million of revenue, and you move on. If you’re a Medicaid practice, I know that Medicaid pays on Tuesdays and Thursdays. If you had only four Tuesdays and Thursdays in a month, well, it doesn’t look like a great month, whereas the next month you might have five Tuesdays and Thursdays and it looks like a great month. Or you might be growing, and as we all know, production can take 45, 60, 75 days until you start seeing that in your bank account.
Daniel Stark:
So the biggest thing that we do or that any advisor does is they take a look at that production, they took a look at those collections and they give you credit for the work that you’ve done, not only the cash that you’ve collected. So in this example here, there are positive adjustments that fall to the bottom line. For the last 12 months here, $173,000 of revenue in EBITDA are generated that just haven’t come in yet just simply based on when the timing occurred. The other things that we’ll do is we’ll look at personal expenses. Your advisor is not the IRS. If you have your spouse on your payroll, you have dinners that you expense through the business or if you have your personal automobile through the business, make sure to tell your advisor because you get credit for those things.
Daniel Stark:
I remember on one transaction that I was working on that initially the client would sit back, fold their shoulders, just go, “Nope, nope, no personal expenses.” And I started digging in, and turns out they have a yacht captain on their payroll. And obviously, that’s personal in nature, and as your advisors, the advisors need to know that so that they can what’s called add that back and get you credit for that. So on here, we have a couple of different adjustments. The out of period compensation, that was somebody was paid in the wrong month, and so we shifted that out from one month and into another. The owner is an absentee owner. The owner is collecting funds above and beyond what an operating dentist would take, so we add those back. And then they had some other personal expenses. They bought some new furniture for their house. They had personal purchases through Amazon, so we go ahead and we add all of that back to make sure that we get credit and give credit to the company so that the reader acknowledges that that’s there.
Daniel Stark:
And then there’s called proforma adjustments. The proforma adjustments here take a look at things like COVID. As you can see on the screen or if you’ve pulled it up, we’ve paved over for 2020. This company created a new facility that had just opened about six months prior to me looking at this. We paved over that. We take a look at what has it actually done in those six months, and we give credit for had it been open for a full year. There was a snowstorm here in Texas back in 2021. You probably read about it all over the news. The entire state was shut down for a week, so we make sure and give credit for that. And then the last adjustment here is that when you start a new facility, look, I get it, you’re not profitable right away. You’re burning money in advertising. You’re burning money in hiring front desk and DAs and training them prior to the first patient even walking through the door.
Daniel Stark:
So making sure that you go through all of that and understand each of those items so that your advisor can give you credit for it, you come down to here where we started with $514,000 of EBITDA. And with all these adjustments we’re at nearly $1.3 million of EBITDA, and getting that right number of EBITDA is important. If you go to market at EBITDA that’s lower than the 1.3 million here, for example, let’s say you went to market at $1 million, well, when somebody puts an offer on your business, they’re going to dig in the same way that a good advisor would have done so prior to going to market.
Daniel Stark:
If you’re too low on your EBITDA, they’re never going to come up in the purchase price. They won’t tell you, so you don’t want to go too low. But if we went out, for example, at $2 million of EBITDA in this company, then as they start digging in and find out, wait, there’s not $2 million of EBITDA, there’s only $1.2 or $1.3 here, well, then you have some awkward conversations with the investor. Do they still want to do the deal at a new price? Does this seller want to do the deal the same price? Does the deal going to die? And these three to six months that we’ve spent negotiating and talking, are we going to have to go through all of that process again? So it’s important to get to the right EBITDA, and it’s important to have somebody who understands and has the experience to identify are the meals personal or business. If it’s an office party, there’s pizza for the billers that are working late to make sure to get all those claims in, no, that’s not personal. Now, if it’s the owner taking their spouse out to a fancy steak dinner, yeah, that’s probably personal, but you need a good advisor to be able to tell the difference and be able to get through all of the noise to come up with a good, solid and, most importantly, defensible EBITDA so that you can get the correct valuation.
Bob Winder:
And, Daniel, in our early days we, used to do a lot of Q of Es for the buyers, for the DSOs or investors. In your experience doing that, how many times did you see EBITDA inflated that ultimately killed the deal, or what were some of the adjustments that just don’t work?
Daniel Stark:
Yeah. And thanks, Bob. And some of the adjustments that I’ve seen that have killed the deals are people trying to take credit for things that haven’t happened yet or might happen in the future. Or if you buy this and you have your own accounting department, for example, you’re not going to need our accountants, so we’re going to take credit for that. And that’s not how Q of E is designed to be. A Q of E is designed to establish what is that baseline of EBITDA. What is that number that everything else can be built off of? We came up with in this example $1.3 million. Now, if a strategic investor comes in there and looks at, okay, dental supplies are 8% of revenue, our standard is 6% because we know Henry Shine really well and have really good rates, so we’re going to save 2%. We had a transaction where somebody was at 20%. They were doing implants and moved it to the industry standard. And for those of you on the phone or those of you on audio only, I’m putting my fingers in quotes, moved the 20% down to 6%. And those of you who do implants realized that the cost of implants are a very significant part of your revenue. That transaction fell apart.
Daniel Stark:
So it’s the inexperience in the dental industry or in the specialties or the inexperience in not performing solid analyses of these companies to identify those one time non-recurring events or those personal expenses to establish that good, solid, accurate EBITDA.
Bill Neumann:
That’s great information, so that was our EBITDA lesson. And then also, you got an opportunity, and again, if you’re listening, you’ve got to jump on the video and actually see what that quality of earnings looks like because I think it’s important to take a look at that. So thanks, Daniel. That’s great. Now, as we move on to Kevin and we talk about what everybody talks about now, the multiples and these crazy multiples, at least it seems that way, that we see some 14, 15X and people throwing, “What did you get, and what did you get,” at these DSO meetings, right? So, Kevin, can you talk a little bit about multiples and where we are right now and how to maximize that? EBITDA is obviously tied to multiple, right? So you could have an EBITDA that maybe wasn’t calculated the best way, and you might get a better multiple. Or maybe you don’t, right? Maybe they go, here’s an opportunity for us to give you what looks like a good multiple on an EBITDA that maybe wasn’t calculated like it should’ve been.
Kevin Khona:
I’ve been on the other side, putting term sheets out to individual locations and seeing what would stick with a really low offer, and that’s just really common and commercial from a lot of strategics. And there are definitely high multiples out there, but it’s on what EBITDA? Is it TTM? Is it 2021? Is it 2020? What are the growth prospects? The same EBITDA could trade at a lot of different multiples. First, I would say as the biggest takeaway, if I’m an individual doctor own some clinics, the private equity market is much more robust for individual clinics that have stable and growing revenue and EBITDA, multiple providers, $1.5 plus in revenue. That market is extremely liquid compared to anything that doesn’t have those characteristics, so the vast majority of clinicians are much less than that. And that’s normal.
Kevin Khona:
So maybe a typical clinic that’s 700 or 800K in revenue, my best advice would be come up with a plan on who can you merge with, how can you get beyond five operators, how can you prep for a sale that you can get a much higher multiple because the business is better. What I would say is the acquisition market, those three buckets like Bob talked about, I would say you have the strategic bucket that we all know in the different flavors in that market, the private equity or financial sponsor market for buying a majority of the business and then also the private debt market. Or syndicated bank debt I’d almost put in that same bucket because most smaller founders might not be used to that yet. And that market’s dynamic, so 10,000 plus players in the US and Canada. Same deal six months ago today, six months from now, who is interested in that is totally different. So strategic maybe have just been acquired by a different sponsor. They’re digesting that acquisition. You talked to them a year ago, and today, they’re not interested in doing a deal. And also, individual lenders and individual funds may have a portfolio constraint where they say, Man, I’d love to do this deal. I love your business, but we are already at capacity in dental in our portfolio concentration for this fund. Come talk to us next year, in two years or 18 months.
Kevin Khona:
So being able to be broad and concentrated and targeted at the same time is really important. What I would call is how to maximize your multiple is, first, run a wonderful business that has great doctors that provide phenomenal clinical care that consistently are working for you, that you have low doctor churn and you have lots of great providers and your patients are happy with you. So that’s number one and phenomenal clinical leadership, which is going to show through in all numbers. Before going to market and having looked through the Q of E and understanding where EBITDA is and understanding the business characteristics, then you can reasonably say, here’s a range of multiples that you could expect in today’s market given, first, your EBITDA on size. Walk me through your providers. Walk me through your geography. Let me show you a few other characteristics just that we talked through in some of our materials.
Bill Neumann:
Again, for everybody on audio, you’re going to have to jump on the video to see this.
Kevin Khona:
So what is the geography? Are you a single state or multi-state? What is your payer mix? How much do you have Medicaid, Medicare? Are there Medicare, Medicare for multiple states, private payers? What is the procedure mix? How consistent is your financial performance? We joke up hopefully up and to the right, where your both revenue and EBITDA are growing. How’s your doctor retention? When you open a new location, do you have a track record of being able to open de novos, or do you have an acquisition strategy? At what multiple are you able to complete acquisitions? If you can complete acquisitions at a lower multiple, then your platform could be more valuable.
Kevin Khona:
The market also has some tiers that it’s really important to understand that really the institutional market tends to start at about $1 million or $1.5 million of EBITDA. You have a lot more liquid market at which would be the traditional lower middle market that starts at $3 million. Another layer of investors that become very interested at 5 million. $10 million is really where the middle market starts to dip down and you’re at the tippy of the lower middle market. What I would say is true middle market at about $20 million in EBITDA. And then at $50 million you’ve really got the potential to potentially go public, at least via SPAC transaction. And the lenders are across those sizes, so really institutional lenders where there’s not a personal guarantee tend to start at $1 million, $1.5 million half in EBITDA. More flexibility, more access to capital at $3 million. At $5 to $10 million, you could potentially start to have syndicated bank debt or even more flexible debt with higher leverage. So those are all points.
Kevin Khona:
In terms of the what is your procedure mix, is the procedure mixed reasonable? Do you have integrated specialty services in your clinic assuming it’s a GP practice? If it’s a specialty clinic, how are your referral parties? Are you integrated with other specialists in your group? Just how are the margins generally? How are your staff? Are things in line with the market? And where are you playing geographically? So are you multi-state? Are you rural? Are you urban? Who are your competitors? And doctor churn, which is really important, how many providers do you have? Are they competitive? I’ll give you an example. I talked to a sponsor yesterday. They only want clinics where the owner doctor is less than 30% of production. Doesn’t matter if it’s $100 million in EBITDA. Well, that’s what their LPs want. Another sponsor, they own a great group. It’s growing very well a year or two ago, and we talked this morning. They’re not. They weren’t really interested in another dental platform today. They’re actively looking in other geographies, so that dynamic changes.
Kevin Khona:
And then in terms of who fits in each of those buckets, when you look at strategics, you have founder-owned strategic groups that they don’t have a capital or institutional capital partner yet, so maybe they’re three to 200 practices but not backed by private equity. You have private equity light groups maybe, where they have a minority investment from private equity or private lender, which could be pretty interesting. Private-equity backed groups where a private equity firm owns a majority stake. And you do have one publicly-traded dental group in North America. We’d love to take to market the next one, but I’d say that the SPACs are very actively looking at dental groups, which could happen in the next few years with the US group. And then on sponsors or financial sponsors, you have a wide array of what I call nontraditional investors, especially in the lower-middle market. So in lower-middle market, you could think of $1 to $10 million in EBITDA, from a clinician perspective, 1 to 30 clinics or 1 to 50 clinics.
Kevin Khona:
Traditionally, you would have funded private equity firms. They raise a fund that lasts for 10 years. Those groups are still very active, whether they’re healthcare-focused funds or generalist funds that have a pocket for healthcare. But then you have family offices that are directly investing into private deals. You have [inaudible 00:42:25] equity groups, where they’re looking at both the debt and equity, which can be really interesting. Also, distribution-focused groups, which are different flavor, where you can receive monthly or quarterly distributions on your rollover equity. Royalty groups, just independent sponsors search funds, there’s a lot, and those buyers change all the time. There’s new groups, and the groups from six months ago or a year ago might not be investing today. And then on the private debt front, USBIC funds, BDCs, larger regional banks that have dental-focused lending who also may be willing to start to syndicate alone to allow you to continue to grow. Then you have almost non-traditional private lenders, whether they’re investing directly off the balance sheet of a publicly-traded company or of a large private company or just some other structure. So those are a little bit of the buyers and the factors on multiple, but ultimately, bringing groups together who are appropriate for the deal, having that competitive tension and having multiple bidders in a deal drives price higher. A lot of the academic research shows it’s typically 20% to 25% higher on the same transaction.
Bill Neumann:
Well, just from what Kevin said there about the different buyers, if you’ve got a strategic coming to you, which a lot of the listeners, that might be ultimately the best option for you, but it may not be right. So it’s good to look at all of your options, and there are quite a few out there, some that I wasn’t even aware of. And again, getting back to what we initially talked about, how daunting it can be for somebody that is a dentist that has found themselves with a business that they’ve grown 5, 10, 15 locations and then they’re looking to make the right move. And there’s so many options now, and there’s so much information. So thanks Kevin. That was really, really great information. And then let’s finish up with Bob because then there’s the final piece, which nobody really talks much about, are the terms, right?
Bob Winder:
The terms, which are probably the most important. So it’s really easy to talk about multiple. That’s super fun to talk about. EBITDA is a lot harder, but people generally understand what that means. But the terms is just this nebulous black box that you just want the attorneys to sit in a room and figure out, and hopefully it works out okay. But the terms are what make it all work or what make or break a deal. So you think about the first general bucket of terms, the economic terms, you might get a big multiple on a nice EBITDA, but what are the economic terms of those payments? How much of that is cash at close versus contingent consideration or earn-out versus a seller note or rollover equity? Not all of those are treated the same, and they’re not all worth the same. Money today, cash in your pocket is worth more than any of the rest of those. Generally, cash is king, but there’s a lot of times when reinvesting some of your proceeds into whether it’s a DSO, a strategic that’s partnering with you or a financial private equity because you believe in the upside in the future, what else are you going to do with your money?
Bob Winder:
You might as well put it in your own investment to go forward and make a great return on that, so there’s a lot of rationale to reinvest and have a lot of proceeds go to continued ownership. But at what terms? A lot of times what we find is that that reinvestment isn’t treated the same based on the type of deal. So a lot of times, you have a strategic approach you, and they say, “Hey, listen.” And I’ve heard pitch multiple times. Listen, we can buy you practice for three or four times because that’s the market rate, but we’re only going to buy 70%. You reinvest 30%, and we’re trading it 13 or 14 times. So you’re immediately making multiples more working with us. You’ve probably heard that same pitch, Bill, and it sounds like a compelling pitch. But if you think about it, all right, I’m being bought at three or four times, and then I’m taking some of my proceeds. And now I’m buying in at 13 times, so I’m immediately being diluted. And the only way for me to make money is if the enterprise value of the global corporation continues to grow, which we all hope it should. But me as an individual dentist, I don’t have hardly any influence on that.
Bob Winder:
So a lot of times, we’ve helped founders come up with structures so they don’t have to reinvest at that big diluting multiple. They can keep their equity at a joint venture level or a practice level, and then when that bigger company, the big DSO, trades again to the next private equity, they can then contribute their equity up and take advantage of that bigger multiple. So that’s a huge consideration that rarely gets talked about, at what multiple buying in at. A lot of times, you’re immediately getting diluted, or if you’re partnering with private equity, what does their equity look like compared to yours? Do they have preferred equity? Is it convertible preferred or participating preferred? If it’s participating, that means their equity gets put in front of yours and that once theirs gets all paid off, then they get to work with you pari-passu. So theirs gets double counted, pari-passu meaning equal, versus hey, we’re just in this together. We’re equal partners. Our equity gets treated the same. So there’s a lot of different flavors of how their equity can be treated or paid off versus your reinvested equity that hardly ever gets discussed. Or an equity group will come in and say, “Oh, participating preferred, that’s the market norm. Believe me. You can trust me.” And so then their equity gets double counted, and yours gets diluted.
Bob Winder:
Another one that we love to work on is what’s called working capital. So this is a nebulous term that effectively means that you’re selling your business and the accounts receivable and the accounts payable are going with the business as is. It sounds simple, but it turns out to be a train wreck always in these transactions where their calculation of what’s necessary and normal amount of working capital is almost always way elevated versus what it should be, and so it ends up being a reduction of purchase price. And so this takes a lot of accounting wizardry, and Daniel and I go to war and beat our heads against the wall. And it’s always a horrible negotiation, but it’s just another lever that the… And I call them equity groups, but it’s the same decision-makers, the private equity versus strategic. The private equity guys usually own the strategic, so they’re the ones calling the shots anyways. So we’re dealing with virtually the same negotiation regardless of the buyer. So working capital is always a big one, is always a huge negotiation, and I’ve lost years of my life negotiating that.
Bob Winder:
Indemnification terms, so this is how risk is allocated post close, how a buyer can claw back economics after the fact based on various things that could happen. And the attorneys love to go wild with this. They’ll run through what I’ve heard termed as the parade of horrors. They’ll go through all the worst case impossible scenarios and scare everybody to death and sometimes try to kill the deal because of all the crazy scenarios they can come up with in this indemnification bucket of how risk gets allocated. But it is extremely important, and there’s a lot of negotiations that happen to try to come up with a fair allocation of that risk. So incredibly important. Need to be very detailed on that.
Bob Winder:
Non-competes, doctors are always allergic to non-competes, and that’s always a point of discussion. Future employment and future obligations, that’s a huge piece of this too and contingent payments. How much of that 15 times multiple is contingent on performance over the next five years? As a buyer, I’ll happily give a 15 times multiple if you guarantee 20% EBITDA growth for the next 20 years. I’m all about that. That sounds great, right? One of my favorite attorney friends, he puts it in these terms. He says, “I’ll agree to be hanged in the town square as long as I get to pick the date, which, of course, is going to be 150 years from today.” You can agree to the price if I get to agree to the terms. The terms are just as important as the price, and, of course, price is made up of EBITDA and the multiple. But all of these make up the legs of the stool. They’re all equally important. And any one of those, if it’s not done correctly, can really make or break your deal.
Bill Neumann:
So we got the three legs of the stool there, and I think I initially said that we were getting a dental M&A 101, but I feel like this was like 101 and 201, and maybe with a third leg of the stool, it was 301. So we got our freshman, sophomore and junior education on dental M&A today. Thanks, guys. This was great. So, Bob, Kevin, Daniel, appreciate your time. Bob, if somebody that’s listening or hopefully watching with all the great information that you shared with the Q&A and some of the information that you shared, Kevin, if somebody’s watching this and they want to get in touch with you, Bob, or somebody on your team or just find out more about Logan Growth Advisors, how do they do that?
Bob Winder:
Email me, bwinder@logangrowth.com. Go to our website, logangrowth.com. Love to hear from you. One of our favorite things to do is a whiteboard session, so we’ll pull up a whiteboard, put on my professor hat or an Excel spreadsheet and just walk through economic scenarios of these potential arrangements and what they could look like for you to help inform better decisions because people get approached by strategics and private equity with offers, with terms. Just to put that in perspective, what does that look like compared to what are other options out there just to help inform people to make better decisions. We love that, so would love to help out in that way or any way we can. Bwinder@logangrowth.com.
Bill Neumann:
Okay. Well, thanks, Bob, Daniel, Kevin, and thank you, everybody, for watching us today. We appreciate it. Until next time, I’m Bill Neumann, and this is the Group Dentistry Now Show.
