While the dental practice market is one of the most mature healthcare markets, it is also highly fragmented. That fragmentation means that opportunities vary widely at every valuation level. 

In this episode of The Corner Series, McGuireWoods’ Geoff Cockrell is joined by Kevin Cumbus, Founding Partner and President at TUSK Practice Sales.

Tune in as Geoff and Kevin delve into the current dental market from an investment and practice sale perspective, including where strategic buyers are focused, where the buyer market opens up, as well as some of the pressures faced by dental practices. They also address the impact of the FTC’s recent non-compete rule on the healthcare market, and tools to maximize equity alignment at every level. 

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Corner Series, a McGuire Woods series exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuire Woods partner Geoff Cockrell as he and specialists share real-world insight to help enhance your knowledge.

Thank you for joining another episode of The Corner Series. I'm your host, Geoff Cockrell, a partner at McGuire Woods. Here at The Corner Series, we bring together deal-makers, thought leaders at the intersection of healthcare and private equity discussing live issues of the day.

I'm thrilled to be joined by Kevin Cumbus from our friends over at TUSK Practice Sales. We've done a bunch of deals with TUSK. They're very active in some of the more retail-y sectors, dermatology, med spa, and then a ton in dental. And today we're going to talk about the current state of the dental market from an investment perspective and from a practice sale perspective.

But Kevin, if you could give an introduction of yourself and a little bit about TUSK before we jump into some questions.

Yeah, happy to do it. Thanks Geoff. Kevin Cumbus, president of TUSK. Really had been involved in healthcare for close to 20 years, so my background was investment banking and sales trading in New York, down here in Charlotte. Got exposed to dental M&A through my father who was selling his dental practice and since then have built and sold a dental practice, but currently am leading a group of folks who focus on sell-side M&A activity across healthcare.

We've done about a billion dollars of transactions to date and are just amazed at how deep and wide this sector is and somehow despite the top end of the market being pretty tight, deals are still getting done, unbelievable multiples, so a rich buy side, new buyers come into market and we have a lot of fun, right? When you get to work with someone who's entrusted you to sell their life's work, it's quite an honor, so I'm pleased with what we do. It's a pleasure to get to do what we do.

Kevin, the dental market more than any other one is the most mature. We're what, 10, 15 years into the whole idea of consolidation, yet it's also so expansively large that it remains still to this day largely fragmented with a lot of small players.

When you think about the current state of the market, and you alluded to it at your opening comments, how would you segment the different sizes and the level of activity that you're seeing and are there any breakpoints where maybe the market changes?

Yeah, this is a great question with respect to the size of the market and also kind of valuation splits, but today there are over 100, maybe 120 private equity-backed groups today in the market. And those businesses range anywhere from $5 million of EBITDA to 100 plus million dollars. And then there are the doctor-owned groups that are pre-private equity, and there are thousands of those and new ones being created each and every day it seems like. And then there's the individual doctor-owner out there who an individual practice or a large single location.

So with respect to the market, we look at it, we focus on the lower middle market, right? So we're working with doctors that have between $500,000 of EBITDA and south of 20 billion. And in that space valuation multiples have really held firm since 2021. It had actually gone up, which is so counterintuitive to me because the larger deals, the larger groups out there like your Dental Care Alliance, MB-II, Heartland and others that we know are out there working to go through a recapitalization, there's not capital out there. The debt capital markets are just too expensive and they can't get deals done. Let's call them the enterprise level DSOs really just can't get off the ground, whereas these lower groups, the smaller groups that we work with are still receiving multiple offers each time we take the market.

Let's segment that a little further. You see that most of the groups that you're working with are not that massive enterprise scale size, but somewhere between 500,000 and 20 million in EBITDA. That's a really wide range. If we were to stipulate that at around about $10 million of EBITDA, things change kind of significantly in valuation from the perspective of the different venues for financing and acquisition, the idea that you have to have to get to that scale, you have to have implemented a lot of system-wide elements of command and control, whether that's internal financial reporting, compliance policies that can stretch out over a whole bunch of different areas, the ability to complete acquisitions and assimilate them. A lot of things are different at, let's call it $10 million.

Can you stratify a little bit, the market below that? Because at 500,000 you may be a single location. They may not have done any acquisition. They may not have any of the centralized functions. How would you stratify the lower parts of that?

Yeah, I think that there's a large swath of practices that are south of a million dollars, right? Those are typically individual locations with one or more owners, but in that world valuation is going to be somewhere between six to seven times. Pretty simple business there.

Then you've got anything over a million to two million is interesting to me because that's where strategic buyers are really focused these days is focused on that market and at that size, what you don't see is private equity really get interested for an in inaugural investment inside of the market. They don't have the infrastructure yet. They really don't have maybe a leadership team. They could be operating on multiple practice management softwares. It's just not a mature business at that point. But north of two million, really, when you get to that three to five million, that's when the entire buyer market really opens up.

It is exponentially harder to go from a million to $2 million of even on this world. It just takes more people. It takes more time. There's more complications. The more doctors and people you have, the more complicated the business is altogether. But if you are able to get to that point, both private equity groups and existing DSOs get really interested in purchasing you, and when you open up both sides of the market there, valuation really peaks. Regularly, when we take businesses like that to market, even in today's market, we're seeing offers at nine, 10, and 11 times EBITDA. So there's just a healthy, healthy appetite for it because it's so hard to do and it's so rare.

Yeah, I have that conversation with sellers pretty regularly, and part of the way I explained it to them is that part of why a little bit larger business gets a much higher multiple is that that business has already internalized some of the costs of being a larger business, that all of those internal reporting, management, investments, all of those things enable you to grow, but they're also structurally a drag on EBITDA. So doing straight income comparisons of a smaller practice to a bigger practice is a little bit unfair to the bigger one that's getting a higher multiple because they've already absorbed some of those costs, and that sometimes makes it a little easier for a smaller practice to wrap their heads around.

Yeah, I think about it like this. If you had a leadership team, let's say you've got $500,000 of expenses in your C-suite, that individual practice or a small group doesn't have, that's even though you've got to make up somewhere else. You got to make it up through same store sales. You got to make it up through acquisitions or de novos.

And if you're doing it through acquisitions, many times there's going to be debt attached to that as well. So if you're thinking about building and scaling and growing, anybody can do it with enough debt, but keep in mind you got to pay off that debt at the closing table. It's kind of these leaps of expenses, and then you got to offset that with additional acquisitions. It is a very challenging thing to pull off.

One question I often get, and not just in dental, but in other practices, and they might even be a little bit bigger than some of the smaller ones that you're describing, but I get the question of a few practices that are historically not directly affiliated, having an ambition to join forces so they can tap into the magic of that higher multiple. How often do you see that? How often is that successful and what are some of the challenges to pulling that off?

Yeah, so it's hard. Let's just get that on the table. I would say a misperception out there that if we bring two independently operated groups together and bring them to market, that the market's going to reward that because it's additionally, right? So let's say you got two groups with a billion dollars of EBITDA. Each somehow get them connected to one another and take them to market.

There was probably a time in early 2020, 2021 when you could pull that off, but the market's gotten a lot smarter. They really just look at those as two independent businesses. We don't see a ton of accrual benefit when we are approached by groups to do that. What we will do is take them together it to market at the same time and inform buyers that we would like for them to provide us two offers.

Offer one is an offer for the individual location. Offer two is if they'd like to buy both. And some DSOs get comfortable with that, but most do not anymore. It's something that we had success with in early 2020, but really the market's just wise at the moment.

Right. It's almost better advice to say, look, if you want to be a combined business and prove that you can integrate and centralize across these historically separate businesses and across multiple locations, then do it. And if you're successful at that, give that a year. If you're able to centralize that and navigate everything that comes with that, then you may be able to get the reward of a higher multiple on that, but a completely unproven, non-integrated approach of just smushing things together. I agree, that's fallen pretty distinctly out of favor.

They want the reward without doing the work, right? And buyers look at that and go, "We're going to be the ones taking on all the operating and integration risk. We really, really don't want to pay a premium for that."

What are you seeing in some of the headwind pressures on these practices? There's still several of them that they're out there, but what would be some of the leading ones that you're encountering?

Yeah. I mean, healthcare providers really took a break, right, during COVID, and we've seen the great resignation impact the dental industry acutely. There are a lot of doctors who were working a little longer than they wanted to and all of a sudden have left the workforce altogether along with hygienists and assistants. So that great resignation led to massive wage inflation. There were points in time in early post-COVID where hygienists were making 50, 60, even $70 an hour because of lack of talent out there.

So that's normalizing a little bit, but it's going to take a long time for folks to get through hygiene school and start normalizing this down. But we've seen deterioration of EBITDA in some cases losing five points off the bottom because of increases in salaries and wages, and that's material, right, so you're doing the same amount of work this year that you were doing last year, but as an owner, you're making less.

So dentists have really seen some compression in their EBITDA and their cashflow, and those larger DSOs that had so much debt had the decreased EBITDA, decreased cashflow coupled with rising interest rates, and that left many of them to pull out of the buy side altogether. They simply were in breach of covenants, and as a result, they had to work on operations and focus on internal growth rather than growth through acquisitions.

So that's been a big, big issue. And as you know, there's so many of these practices that rely on PPOs for reimbursement. Well, the PPO market doesn't respond quickly. They don't like to increase their reimbursement rates, so dentists on the balance really don't have that much control over pricing, so they can't increase their revenues. They're renegotiating with PPOs and they're losing it on the expense side as well.

Additionally, with this most recent data breach and hack, there had been delays in payments to all sorts of healthcare providers, but right now we have clients who have months of accounts receivable that they're waiting on to be paid back. So there's a couple headwinds out there for sure.

If you think of a local market where a strategic has entered that market, they have some choices, right? They could expand through acquisition in that market or they could expand through de novo in that market and expanding through a de novo has some upsides to that. Namely, you don't have the upfront purchase price if you have a certain amount of density in a market, you can staff that de novo from other locations to a point. You can staff it through other locations and use a bit of a hub and spoke or something like that where you take a little pressure off of the labor market there. How are you seeing those dynamics of strategic behaving as a de novo expander versus an acquisitive expander?

That's a great question. Really, two camps out there. I'll tell you, I worked for Affordable Dentures for about four years, and they were at that time primarily a de novo business, and their thinking was they wanted to control the culture, they wanted to control the team. They didn't want to buy anybody's products. They knew they could get these businesses up and running and profitable extremely quickly.

Others look at that as a major challenge. Although you don't have the upfront purchase price when you build versus buy, it takes a long time to get a return on investment there. And private equity companies are typically in the business of getting into and out of these investments as quickly as possible, targeting five years, what we're seeing them get faster and faster, and some of them we're in and out now in three years.

If the plan is to make a healthy risk adjusted return in the shortest period of time possible, the most lucrative way to do that and the fastest way to grow a business in preparation for an exit is through acquisitions. So I would say 90, 95% of the groups out there really are doing it through acquisitions, not de novos.

That said, there was a group that traded at the end of last year, and they were primarily an acquisition business. I was speaking to the CEO after his trade had closed. I said, "Look, now that you guys are backing that capital, we'll start showing you more deals." He said, "Actually, don't do that. We're only going to grow our business through de novos on a go forward basis."

They shifted their strategy completely. They're building 20, 30 operatory practices and really trying to keep everything in house, right, so it'll be a complete model for all specialties inside of this one super practice, and they feel like that's the way that they want to continue to grow going forward. So again, it's an evolution I think as people think about what strategy they want to partake, but mostly the DSOs out there are playing the acquisition.

It would seem that there's also a different market runway on that growth strategy. If you're principally growing through acquisition, you can see the fragmented market and its size and you've got a pretty long runway of being able to grow through consolidation and that if you are trying to grow through de novo, it would seem like the boundaries are kind of almost like physical saturation in a market.

Do you have any sense that the market for de novos is nearing any level of saturation? I think around here around Chicago, there's lots of shiny new locations with clearly private equity backed chains, and they're pretty cool and they have a lot of technology, and the patient experience may be fantastic, but there are limits from a saturation perspective. How would you describe that dynamic in markets?

I think when you talk about a place like Chicago or New York where we're seeing some of these newer models like [inaudible 00:15:18] pop up where they're trying to be elevated or different, you got to cut through the noise and be very different. Just opening up another dental practice is not going to get you there.

We're seeing ... It's funny, you're in this industry and you drive out around Houston or you drive around Dallas, there are dental practices everywhere. I mean, everywhere you look. So it feels like if you're going to be in the de novo space, you have to be dramatically different than everybody else out there.

An additional pressure that we're seeing across to healthcare is in the regulatory environment around non-competes. Obviously the recent FTC rule is putting some pressure on that. How are you seeing people respond to that new rule?

Yeah, we're seeing a lot of posts from folks like you guys on webinars, right? "Hey, we're going to help you unpack this and understand it." I'm curious, Geoff, what your employment team is saying about this and how big of an issue is this really going to be for those who employ hundreds of dentists or those who are thinking about building groups through acquisition?

Yeah, I mean, a couple things. One is that the rule does make an allowance for continuation of non-competes that are directly connected to a sale of business. So the specter of writing a check to a group of sellers and then having them kind of walk away again with the business, there'll still be some protections there.

I guess philosophically, I'm more of the mind that alignment ultimately needs to have more carrot than stick, and there's certainly markets where, for example, California non-competes in the employment context have been disallowed for quite a while, yet the market still thrives on more carrots than sticks. I think people are going to rethink a number of elements of alignment as they think about implementing more carrots than sticks.

But as an initial matter, there's going to be quite a bit of legal hang up on this rule. It's an open question as to whether or not this rulemaking is exceeding the authority of the FTC. There's lots of venues where you can challenge that and you only need to win once and get a national injunction. So I think the smart money is that this is going to take a little bit longer to play out, and by the time this is airing, it may already be in an injunction.

So I think it's going to take a little bit of time to see where the dust ultimately settles. And it's also an open question whether this sweeping change through regulation process is ideal in the sense that if you have a change in administration, all of those decisions can get reversed and to have broad sweeping policy ideas swinging dramatically based on changes in administration, I'm not sure how healthy that is. So early innings, but to me, the main upshot is that the restrictions on competition in the context of a sale, those are going to earlhold together. The rest of it, there'll be ways to think through alignment and if it'll still hold together.

Yeah, we've seen DSOs get smarter and smarter about this alignment. [inaudible 00:18:09] your concept of carrots and sticks. In almost every deal we do, the buyer really wants the clinicians and the key people inside of the business to be equity holders on a go-forward basis. They've been using equity as a tool for alignment now for five, six years, and it has really come into vogue, and every group we're working with now, except for one, really wants that to be a piece of their acquisition structure.

Sometimes they're asking our client to carve out a little bit of equity for associates out of their pool of money and willingness to do that as an owner really does help improve the relationship with the buyer and can enhance valuation if you lead with that as a concept as the owner of the business. So there are some great tools out there right now for alignment with equity at either the joint venture level, right, at the practice level or at the hold co slash DSO level.

Yeah. Let's dive into that just a little bit more. So you mentioned, obviously the equity alignment can happen up at the macro level of the entire enterprise, or it may be at some sub-level where the equity connects to some subset, either small or larger, but some subset of the overall business.

When you're talking with doctors, two things. One is, do you encounter a pretty distinct philosophical approach to that, and how are you advising folks as they think about where the rollover equity should reside?

Great question. So first things first, when we work with someone, we want to make sure that the sale of their business is going to secure them financial independence, and we know that portion of the enterprise base going to be in cash. So we want to be crystal clear with them that cash is theirs. There's no callbacks on that, and they need to make sure that that cash it closes enough for them to achieve financial independence because they're selling that cash flow for good.

So once we have that piece solved, we then talk with the doctors about their risk profile. What are they most interested in? If they're interested in rolling the dice and hoping that their rolled equity receives a return on investment of two, three, four, five times, then they want to be in hold cup. We also remind them that that is equity in a privately held business that can go to zero. So for those who believe in the business, believe in the leadership and believe there's a lot of upside there, that's a great place for them to invest.

Alternatively, if they're looking for cash flow from the investment, many times investment at the practice level in some JV equity structure does allow for distributions after a management fee has been paid. And for younger doctors who are looking to continue to grow their personal income, that's a great place to retain some equity, especially if there's a mechanism for that joint venture equity to convert into hold co or there's some puts and calls associated with that hold co where you know it actually has a value at some period of time.

The risk is enrolling in JV equity, sometimes less sophisticated DSOs have mechanisms for liquidation, and it just lives on that balance sheet in perpetuity until the doctor retires, and then it's simply retired. So you got to be careful with the JV equity.

And as the lawyer who has to draft those things, the JV equity down at kind of like a sub-MSO level, the complexity can make your head spin. So I'm generally a believer in simplicity is your friend over time. The JV model is certainly very popular.

Kevin, I think we could talk for quite a while on these things, but let's wrap it up there. Really appreciate you coming on the show, and we certainly encounter you guys in the market a lot and your presence in the areas that you have scoped out. You guys have done a great job, but thanks for joining.

Thanks, Geoff. It was a pleasure.

Thank you for joining us on this installment of The Corner Series. To learn more about today's discussion, please email host Geoff Cockrell at gcockrell@mcguirewoods.com. We look forward to hearing from you.

This series was recorded and is being made available by McGuire Woods for informational purposes only. By accessing this series, you acknowledge that McGuire Woods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment.

The views, information, or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuire Woods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.