Dental practice roll-ups can help to increase value

Jeremy Booth, Dental Tribune International

Thu. 26. October 2023

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Navigating the landscape of dental practice transitions can be a complex endeavour. There is a surge in consolidation in the industry, and dental professionals must remain informed about various models of operation so that they can make informed decisions for their practices. Dental Tribune International spoke with Kyle Francis, founder and president of US dental mergers and acquisitions specialist Professional Transition Strategies (PTS). According to Francis, the concept of dental roll-ups is emerging as a popular option in practice transitions. In this interview, he sheds light on the intricacies of practice roll-ups and provides an overview of current market trends in dental practice transitions in the US.

Mr Francis, what defines a dental practice roll-up, and how does this model of operating differ from other types of transitions?
A roll-up is a mergers and acquisitions strategy in which multiple dental practices are aggregated and brought to market at the same time to maximise the scale of the earnings before interest, taxes, depreciation and amortisation (EBITDA) that is being bought.

This model does not require an overarching management structure or legal entity; however, it is good to have ties between the practices, such as shared services and procedures or similar locations and payer mixes. This helps to illustrate why they should be a marketable asset together, rather than practices grouped together just for the sake of increasing value. Often, rolled-up practices share connections. They could have the same consultants, or staff could have similar study clubs or be alumni. This helps the practice teams to have a clear idea of whom they are working for and with as they move forward.

Kyle Francis is the founder of mergers and acquisitions advisory firm Professional Transition Strategies. (Image: Professional Transition Strategies)

Are the current economic conditions leading to an increase in collective transitions such as roll-ups, and do you think these transitions can help dentists to get better value out of their practices?
So far, we have not seen signs of a slowdown in dental practice mergers and acquisitions, and roll-ups are not always driven by economic conditions. They are part of every industry consolidation life cycle, and they are a viable option for creating new platforms or substantially adding to existing entities.

To help secure their financial future, dental entrepreneurs have the opportunity to leverage the consolidation wave to their benefit. They can always consider working with one of the more than 375 existing groups who would be happy to partner with their practice. However, a roll-up can help to generate a better financial outcome compared with the sale of a practice on its own.

It is also imperative to remember that practice roll-ups can help derive value, but only if there are good reasons for the practices to be tied together. If the roll-up is a mishmash of practices, specialties, disparate locations and so on, then it will not be able to achieve a higher valuation. In fact, this strategy will chase off some likely buyers.

What are the advantages of a roll-up?
The advantages of a roll-up really boil down to increasing the value of the business. For example, if a single practice goes to market with US$400,000 of EBITDA, we would expect to get a multiple [the financial valuation ratio that measures a company’s return on investment] of around 6.5, giving the single practice a total enterprise value of US$2.6 million. However, rolling that practice together with eight other like-in-kind practices that have many similarities could bring the EBITDA to a total of US$3 million, and we would expect that practice group to trade for a higher multiple of around 8.5. If you apply that multiple to the original practice’s EBITDA of US$400,000, the value of that practice expands to US$3.4 million, purely owing to the scale and class of the asset.

What about the disadvantages, and how can they be dealt with?
In my opinion, the greatest disadvantage of this kind of deal is the perception that there is an ever-expanding multiplier tied to the amount of EBITDA, if, for example, tens or hundreds of practices are grouped together. That is just incorrect. The law of diminishing marginal returns tells us that owners will benefit from adding some scale in EBITDA, but that this benefit will flatten out and even decline if too much is added.

Another disadvantage is that there are many advisers providing incorrect information to dental entrepreneurs. They often say that the kinds of multiples that owners can expect from a roll-up would mirror what an existing dental service organisation could garner. That is also wrong, however, and can skew practice owners’ expectations. The accretive multiple is driven by scale in EBITDA as well as by corresponding scale in the services offered and by robustness of platform, value of leadership, proven trajectory and many other factors that cannot be proved in a roll-up.

“It is best for owners to join in a roll-up with people that they like and trust.”

That being said, the biggest challenge with a roll-up is that owners have to give up some autonomy when it comes to decision-making. If they go to market alone (and hopefully with the help of an experienced adviser), they have the full agency over decision-making. But when practices are rolled up, decisions must be made that are best for the group. In some circumstances, there are contractual obligations to being a part of the group (also known as options contracts), and they may even necessitate that owners transact the business if they no longer want to be a part of the group. That is why it is best for owners to join in a roll-up with people that they like and trust. This means making the right decisions together and trusting that everyone is working for the benefit of the group.

You have worked with dentists who have rolled practices together. Could you give us some insight into the process that is involved?
Definitely! I recommend dentists interested in a roll-up to start by getting a prospectus done for each practice and talking about what the desired outcomes are. That helps determine whom they want to do the roll-up with.

From there, they should figure out who they want to represent them. I highly recommend working with an experienced, dental-specific mergers and acquisitions adviser. They can act as an unbiased third party, guiding the group through the transition process.

Research conducted by the American Dental Association Health Policy Institute in 2022 showed that Dentistry in the US is transitioning away from an owner-dentist model. (Image: luis abrantes/Shutterstock)

The adviser will also help the group to determine who the ideal kind of buyer is—from both a strategic and a financial point of view—based on what kind of new entity the group wants to build and how much of a role each person will want to play in the roll-up.

The next step is to reach an agreement between the practices of what the roll-up aims to accomplish, and finally, it is all about executing the plan. It is important to keep in mind that there will likely be attrition, and it’s best to have a plan on how to deal with it.

Taking these steps helps to garner trust among the group that the practice owners are heading in the right direction.

How would you describe the current market for dental practice transitions in the US—what trends are you seeing—and any word on the risks and opportunities that lie ahead in the second half of this year?
At this point, the market is still incredibly strong, and we do not see signs of it slowing down. Instead, we have only seen steady increases in valuation methodologies and the types of structures that dentists can take advantage of.

That being said, increases do not last forever. Interest rate uncertainty is definitely a factor leading many private equity groups to source new debt rather than considering a transaction themselves. It is hard to price risk into a deal when you do not fully know the funding mechanism you would need to apply towards future successes.

Individual practice valuations have not gone down, mainly because the current debt facilities are known quantities, and the private equity funds can make good decisions on how to deploy their existing resources. It is harder for a private equity firm to write a very large cheque to buy a platform if they do not have confidence in what the debt deal might look like for add-ons to that platform.

I would also say that the major difference between the dental industry and many other consolidating industries is that dentistry is used as a hedge by fund managers and is generally considered a very safe asset. Economic uncertainties may have pushed out the time horizon for some recapitalisation events, but “buy and build” concepts are likely to continue to add on to their existing platforms if a sale does not make sense in the short term.