240: The Exit Mistakes Costing Dentists Millions in Value

Dentistry has proven time and time again to be recession proof, pandemic proof. It's a good place for private equity to put money. It's kind of a safe haven. So you are going to see a renewed amount of optimism and interest in our space from private equity investors over the next 12 months.

Hi, I'm Emmett Scott, and just like you, I've had my ups and downs in the dental industry, but times are changing. The DEO has built a map of how to succeed in one of the most challenging industries to navigate. On this show, we talk to dental industry leaders sol problems and get you the answers you need to face these challenging times and thrive. Welcome to DEO's Growth Secrets podcast for dental organizations. Now let's get started. Hello everyone, and welcome to another episode of DEO Grow Secrets. I'm your fearless host, Emmett Scott, and today I'm here with my good friend Brannon Moncrief, principal CEO of McLaren and Associates, which as you guys know, specializes in providing practice valuations and sell side advisory services to large practice owners and emerging DSOs, emerging groups. He is the man, the myth of legend. When it comes to knowing where the market's going, you are where the rubber hits the road. So, you know, one of the things we were talking about before the show is just kind of this myth that like everything's been frozen in dentistry. I, you know, when you're coming out of a frothy market, sometimes like a normal market feels like, oh my gosh, it's all, nothing's happening in the space. So I'm curious your thoughts. Like, have transactions been happening the last couple years or have you guys just been hanging out waiting for the market to get going again?

Transactions have definitely been happening. But I think you're right in the sense that DSO consolidation was moving pretty quickly. Going into Covid and then coming out of COVID 21, 22 were crazy from an activity and valuation standpoint. High watermark for our industry. But private equity globally, across all industries they were investing in and then crazy

meaning, like tons of deals were happening post Covid.

Wild amount of deals and elevated valuations. Right. Relatively steady supply of sell side opportunities, but a massive increase in demand on the buy side.

So a lot think it was like the combo of like everyone who had been through a bunch of pain. So it was like, maybe we should partner number two. Like, interest rates were low, people were flush with cash. I mean, was it just kind of like this perfect macroeconomic storm?

Yeah, it was a perfect storm. Interest rates still at historically lows along with the capital markets were wide open. Private equity was sitting on a lot of cash and had access to a lot of leverage at historically low interest rates. And a lot of the DSOs that were mid recap cycle acquiring practices leading up to Covid, they got put on pause by their lenders for six to 12 months because everybody was holding their breath trying to figure out, you know, what does the new norm look like? Is dentistry going to respond favorably after opening back up following the shutdown? And dentistry recovered as fast or faster than any other healthcare vertical. PE already loved dentistry. A lot of DSOs had been on pause for six months to a year. So now they're behind from an acquisitory standpoint to hit their goals on when they're going to reach a recap and what the return is going to look like. So that's why demand just went sky high. And when you have relatively consistent supply and a massive increase on the demand side, you know, basic economic principles, valuations are going to go up as a result. And the more competitive the marketplace, typically the cleaner the deal structures, the more cash it close. Earnouts disappear, seller notes disappear. And those deals were a combination of, you know, 60 to 80% cash and the remainder was equity, you know, either hold toe or joint venture equity. And then 2023 happened, right? And the macroeconomic environment changed pretty radically. So interest rates went up faster than they ever have in the history of the Fed, which definitely impacts private equity backed companies because they're heavily levered and the capital markets tightened up. Leverage was not as easy to access and it was more expensive. And you move into that macroeconomic environment coming off a period of time where people were buying every asset they could get their hands on at high watermark valuations and not necessarily integrating and operating the assets they were acquiring because they were acquiring them so quickly. You know, then you entered into kind of a perfect storm in 23 and 24 in more of a negative way where a lot of DSOs had to hit pause from an acquisitory standpoint. They had to retool their organization from an operational standpoint, kind of batten down the hatches and actually integrate and operate the assets they acquired in 21 and 22. So you did see valuations soften a little bit in starting and I'd say the back half of 23 up, would

you almost say mature up a little bit too? I mean, probably get more, a little realistic. And I think when that second perfect storm too, you had inflation set in. So now everyone's ebitda gets crushed for minutes. They're like, okay, what are we going to do with all these new labor rates? And it's not like insurance companies are moving our dollars. So we've got to reset our DSO struct structure. We've got to rethink through our acquisition strategy for us internally, all of these things. Interest rates, of course, move up. I don't think people realize when interest rates move up. One of our largest like base pool investment groups is baby boomers. They tend to go to money markets once interest rates are up because the hurdle rate moves up. And so, you know, I remember when we were at 3 trillion sitting there on the sidelines and it was like creating a frothy market. But now we're at 7 trillion sitting on the sidelines because money market rates are so much higher. And a baby boomer is like, I can just kind of live off interest right now. So it kind of leads us to a unique place because we're, you know, doing this like three days before the Fed's probably going to lower interest rates again and start a pretty, probably aggressive move. We'll see. Definitely the higher ups are putting a lot of pressure on moving interest rates back down. We saw like a job markets that was weak and all of these things. If interest rates move down, you've got private equity firms. I think Trump just said we want private equity to be able to be invested in from 401k accounts. Right. So if like they start getting new money and that 7 trillion says these market, money markets aren't good enough anymore, it's going to be interesting, you know.

Yeah, I think what you said was definitely accurate. We went through a reset that was kind of called for, right, for DSOs to get their act together, get a little bit more principle based, more discipline in regards to what they're buying, what they're paying for it, how they're structuring deals and actually integrating and operating the assets. Now we're moving into a much more favorable macroeconomic climate where, where private equity is going to have a lot more access to capital for a couple of reasons. One, just like you said, the open architecture investing of allowing 401ks to put money into alternate investments, that opens private equity up to billions of dollars of capital that was basically locked away, you know, for a long time in combination with declining interest rates, in combination with the stock market being relatively frothy and investors are now going to look for return in other investment vehicles, including real estate and alternative investments. So I think you're going to See market conditions change pretty dramatically over the next 12 months where you're going to see private equity sitting on a boatload of cash. The capital markets are going to open back up, interest rates are going to be lower. Dentistry has proven time and time again to be recession proof, pandemic proof. It's a good place for private equity to put money. It's kind of a safe haven. So you are going to see a renewed amount of optimism and interest in our space from private equity investors over the next 12 months. So I think you're going to see quite a few recapitalization events happen here, starting probably in Q1 of 2026 and ramping up through 2027 at favorable EBITDA multiples as a result, trickle down effect, the DSOs are gonna have more confidence that they can acquire, you know, whether it's one to five location, you know, platforms at possibly higher multiples than we saw over the previous 24 months. Deals definitely happened in 23 and 24. We closed more transactions in 23 and 24 than we did in 21 and 22, despite 21 and 2020 to being a frothier environment.

But that's interesting.

It is. I think it's because practice owners realize that you need to create a competitive environment for your practice and who you sell to matters. Therefore, they've gravitated more towards hiring sell side advisors that understand the marketplace, have the relationships, know who the good players are and who the bad players are and who to partner with and who not to partner with. So I think because of some of the turbulence in the marketplace that has caused astute practice owners to realize that they need representation if they're going to go down this path and look to partner with the DSO or private equity. And also, we've just been very disciplined in only taking class A assets to market. Those are the assets that traded over the past 24 months. The class B C D assets, they did not trade. So because we had a high volume of class A assets going to market, those assets traded, they traded at favorable valuations, not where they were in 21 and 22, but definitely favorable to where they were pre Covid. And also, you know, good thoughtful deal structures that create alignment both at the practice level and the holding company level. So like you said, DSOs have gotten wiser. They're only chasing class A assets and they're going to make sure that they mitigate risk through structure and creating that alignment with their doctor partners at the practice level.

If you love what Brandon's saying by the way October 9th through the 11th, he'll be out in Dallas here at the DEO event. And so we're excited to have you there, Brannon and your team. Brandon is of course a partner here in our DEO work that we're doing and we use him on all the sell side components, him and his firm, because they just see the market, they know where it's going. So it's a great resource we have for our DEO members. So I appreciate it. There's a lot I want to unpack on what you were saying. I'm curious, like in deal structure, what that has looked like and maybe some advice for someone building a practice today. Because what you're able to see is kind of how the story ends.

Right.

And I think there's some myths, and I'll throw one out there that like more locations get you a higher multiple. Right. And you and I have talked about this before. It's about profitability. It's about having a class A asset, something that's truly bringing value to the marketplace, I. E. The patients, the team, et cetera. And, and so other things you're just seeing whether that's in deal structure or in advice for someone who's building a practice today to get the highest valuation.

I think it's how do you position your practice as a class A asset? Right. Because those are always going to be valuable, they're always going to trade and they're always going to fetch a premium comparative to your colleagues that have lesser quality assets. So most DSOs are looking for assets with at least $500,000 in EBITDA, you know, up to, let's say $5 million in EBITDA, I would say there's a bit of a declining return. Once you pass about $5 million in EBITDA, you start to limit your buyer pool to only private equity investors that are looking for a platform. The strategics start to back away once EBITDA reaches a certain point. But I'd say 500,000 minimum in EBITDA all the way up to about 5 million. And EBITDA, you know, number of locations doesn't really drive demand or valuation. It's more about do you have a sustainable business that's being run in an efficient manner? Do you have the ability to recruit, train and retain staff and doctors? Do you have alignment with your primary producers in some form or fashion that might be some type of like virtual or phantom equity or some type of

profit sharing plan something?

Profit sharing plan retention bonus. If there's some type of liquidity event. DSOs have definitely gotten more sensitive about alignment at the local level with not just the founder doctors but also the primary producers. Dr. Turnover. Founder turnover is the Achilles heel of most DSOs. So if they're going to buy a large multi location platform, they're going to want to make sure that all the producers are incentivized to stay on long term. They don't want to have a mass exodus immediately following that acquisition. Because the number one way to lose money as a DSO is to have your revenue and EBITDA move backwards post sale. Especially when they go to recap, they're being judged by same store sales growth, organic growth at the practice level. So that's when we can talk about, you know, deal structures as well. One of the things that the market has definitely gravitated towards is some type of joint venture profit sharing model. The traditional private equity model is a Holdco model where they're going to buy 100% of the business, they're going to take possession of all of the EBITDA and you're going to exchange a portion of the value of your business for stock in the holding company of the DSO. That's kind of the traditional private equity DSO playbook. DSOs have gotten wise to the fact that that does potentially create a free rider problem where if I only own equity at the Holdco level following the sale of my business, I'm not that incentivized to keep my foot on the gas in my own practice.

As long as everybody else is doing good in their practice, my my stock's good.

Exactly. But if everybody adopts that same mentality that DSO is, you know, going down the drain. Right. So they want to create typically alignment at both the Holdco level and the practice level. And the way to do that is like a hybrid deal structure where a portion of the value of your business is going to be exchanged for holding company equity in the dso. So you're diversified in that way and you also care about the performance globally of the DSO because you own stock in the Holdco. But also they want you to retain equity to some degree or have some type of profits interest at the practice level so that you're incentivized to keep your foot on the gas at the practice level. VSOs are looking to buy practices that are operating at a high level but also have growth potential so they can lean into that narrative when they go to recap that they've been able to grow the assets they've acquired because in a large way that's how they're being judged by institutional investors when they go to monetize the parent company. So Definitely we've seen DSOs be more careful about evaluating key man risk provider alignment and being more thoughtful about adopting a sustainable deal structure where they have alignment with their doctor partners long term. And along those lines, the institutional investors are smarter on the back end. They're not allowing doctors typically to liquidate 100% of their equity. At recap, typically you're going to have to roll, you know, as little as 25%, as as high as 75% of your equity into the next recap cycle. Again, to create that alignment and ensure they don't have a mass exit is following a liquidity event.

You know, there was a lot of talk in the beginning of this whole consolidation process that private equity firms don't respect Dennis, and they're just going to drive quotas and all of that stuff. And one of the things that I said is, to the extent that that is true, it will not last long. You know, and I think we could all point to some bad players in the marketplace. But the reality is, everything you just said tells me that what's really happened underneath is that institutional investors, DSOs, private equity, whatever it might be, all understand one thing. The most valuable asset is the dentist taking care of the patient, right? And to the extent that that's happening, well, everything happens well. And to the point that, you know, they have patient flow, to the point that they have the team around them, et cetera. And to the extent that's not happening, well, there's lack of motivation, there's misalignment. I mean, it's just total disaster. And so you're just seeing this maturing up. And so someone might look at this and say, oh man, they're creating all these deal structure and they're expecting me to be here more. And yeah, they just respect the value that the doctor is to the practice. And anytime they haven't done that, even like some dentists, right, who bought practices and didn't fully respect the associates that they had, it just collapsed on them, it didn't work. So anyway, it's a natural maturing of the marketplace. And just like capitalism at its best here, I'm curious, as you kind of look forward next steps, where do you see the marketplace going? You got to pull in some AI here and is that going to be meaningful? Is it not going to be meaningful? Should we be thinking about that? And to what extent is a practice owner kind of overplaying that hand making too much investment there's. And to what extent does that like actually help with the valuation?

Well, I think it's always important to evaluate how leveraging technology could be accretive. Right. From both operational efficiency perspective and overhead management. I know there's quite a few companies right now that are working on simplifying the tech stack. You know, it is insane. The tech stack that most especially multilocation practice owners carry. So that's a big problem that I think needs to be resolved.

So because we were sitting on this terrible practice management software that did three things right, it scheduled a patient, it allowed us to chart and allowed us to bill, but it didn't like allow us to do any other kind of communication, etc. So then we had a marketplace that said, you're right, let's go build all these plugins. And now we have all these plugins and we're kind of in the Microsoft era of like drivers and blue screens and, and you know, now it's like when's Apple going to show up?

And exactly make it all really neat. You know, that's, that's what we really need is a fully integrated platform where you don't have to have all of these plugins. So I know there's several people working on that. But the technology is currently, you know, in its infancy. So I think you should definitely evaluate technology but you don't necessarily want to be the first adopter. And please, if you were thinking about monetizing your business in the next 24 months, do not significantly modify your tech stack or switch your practice management software because technology is evolving so quickly in the space. We are seeing a lot of entrepreneurial doctors make the decision to change their practice management software or change the plugins that they're using and you know, temporarily that can cause some havoc in the production collection and financials of the practice and you do not want to do that if you are planning to go to market in relatively short order. It's no different than if you're thinking about going 100% fee for service and dropping all the PPO plans and completely changing your payer mix. You're going to need at least a year, if not two years to let that play out and stabilize in your numbers. You know, unfortunately I've had multiple clients that mid process while we were on market made the decision to change their practice management software without notifying us. And as a result it caused major problems within their P and L and their production collection over a period of time. That's critical. That's. That's going to be evaluated as part of the quality of earnings process. So I do think it's important to stay on the forefront of what's happening from a technology standpoint, but not necessarily be the first adopter of that technology. Like let it evolve, let the market kind of settle. And I think we're going to see a handful of companies emerge that are going to solve, you know, some of these issues for especially large multi site practice owners.

This is one thing I love about DEO. When you have 500 entrepreneurs and we're all in the DEO app together, everybody's kind of testing different things. So you don't have to be first adopter for everything someone else is. You're the first adopter on one of the softwares and then you're like, hey, this worked, this didn't. But man, that network effect right now that's happening as they're just like vetting through stuff really quick. You were talking about timing. I think sometimes people are like, I'm gonna call Brannon once I'm like really burned out and I'm done with this thing and I need to offload it in the next month. What is the right time to be thinking about it? Cause I think it's farther ahead than people realize. You know, they could reach out to you, for example, and just get a practice level valuation or a group, you know, practice group valuation. How soon should they be doing that and what's the pros and cons of doing that? Timing.

I think at any given time you need to know what your EBITDA is, right? Both practice level and enterprise ebitda. So I think it's important to go through that exercise. You know, every single person listening to this podcast should know exactly what their EBITDA is at a practice level and an enterprise level. So it's never too early to talk about going through that exercise. But as far as looking to monetize your business, you need to start planning, I'd say five to seven years in advance. And the reason being is again creating that alignment with founders and producers. DSOs are looking private equity is looking for a long term commitment. Even if you're not working chairside, even if your practice is not dependent upon you operationally on a day to day basis, they want to know at a local level. They have a founder that is vested long term in the success of the business. So you need to understand that they're going to want at least a three year, if not a five year commitment post sale. So you want to sell at A peak, not at a valley. You want to sell at a time when the business is operating, you know, efficiently and profitability and EBITDA margins are where they want to be. A lot of our clients are multi site platform owners that have not yet invested in a lot of centralized infrastructure, but have reached a point in their business where they're going to need to make a decision if they want to continue to scale. They've got to build out the centralized infrastructure, which hits EBITDA from a negative perspective temporarily and then they've got to grow to first get back to even and then exceed where they were, you know, at day one before they built that infrastructure from an EBITDA perspective. Or they need to take on a partner that already has that infrastructure and the capital that they can leverage to continue growing their business. So I think when you reach that inflection point, whether it happens at three locations, five locations, seven locations, 10 locations, you need to think about what it's going to take to get to the next level, to get to 15 or 20 locations. How much time are you going to have to invest, how much money you're going to have to invest, and where are you going to find the operational talent to help you get to that next level. That's a big step and in the interim it erodes the value of your business. If you're successful long term, it will exponentially increase the value of your business. But if you make that commitment and mid stride you try to pivot to monetizing your business, it's going to be problematic. And that's where we get into a very complex discussion about, you know, what do we need to dismantle and add back to the ebitda and is the market going to buy that narrative? Because DSOs and private equity are not in the business today of buying assets that they need to retool and to turn around. They want to buy healthy assets where there's simple levers that they can pull that will increase profitability in short order following the acquisition. They're not in the business of essentially buying a large multi location platform with a ebitda margin sub 10% and wrapping their arms around that and really making that a profitable business over time. It takes too much time, too much money for private equity and DSOs to do that when they can go buy a healthy asset as an alternative to buying a fixed or upper.

Don't, don't overcomplicate it. One of the things I love that I know a lot of our D O coaches are doing with our Members is getting in front of you early because one, you guys will do a practice level valuation, which is really like this incredible health check of saying, hey, if you were going to sell it today, here's your weak points. Well, that just feeds right into DEO coaching. Right. Because then we just work through those weak points. And if I understand correctly, Brannon, like, once somebody's done that practice valuation with you, if 12 months, 24 months from now, they come back and say, hey, I lost a bunch of weight. You know, I've gotten healthier there, got some muscle on me now. Can you redo my physical? You guys just include that kind of as an evergreen checkup. Right. So they can really start testing the deltas there. Of like, here's where I was a year ago, two years ago when we first talked and I had you do the valuation. Here's my updated info. Am I. Am I in a better place? Right. And then maybe even get additional like, okay, now go tweak these things, et cetera. I just think it's super valuable, right, to have that outside real market valuation that they can benchmark off of.

Yeah. Especially collaborating with the DEO coach. Right. Identifying the strengths and weaknesses of the business and then talking about, you know, what your timeframe looks like and talking about the levers we need to pull to reverse engineer the outcome that you ultimately want to achieve. Whether you're looking to sell a year from now, five years from now, 10 years from now, that's an extremely healthy exercise and I encourage every DO member to consider going through that.

Awesome. All right, anything else? As you think about what's coming down the pipe, people should be thinking about, I mean, this has been extremely valuable. I think we're entering in another very interesting market time. I think if you're an entrepreneur, you should be really thoughtful about the next year or so and prepping for that year. And as you said, if you're at one of those inflection points, where is it? Am I going to go big or am I going to partner big? Right. Am I going to persevere and push through this or should I partner to the next level? I think these are all big decisions that could have financially kind of life changing opportunities. You don't want to mess those up.

So, yeah, absolutely. I would encourage, you know, everybody listens to this podcast to reach out, at least schedule a discovery call just to get to know each other and then talk about, you know, does it make sense to do a deep dive to do an EBIT analysis, do that SWOT analysis and then figure out, you know, where are you at? Where do you want to be a year from now, three years from now, five years from now? And let's create a game plan to get you there. And like I said before, the good news is that there's a lot of optimism, you know, entering our space. We're kind of that the fog is starting to clear that DSO World has been in over the past 24 months. And we're really excited about what the next 24 months are going to look like for a lot of different reasons, but especially given what we think is about to happen from a macroeconomic environment perspective. So awesome time to own a successful dental practice and be of the mindset that you potentially want to monetize it and take some chips off the table at some point in the relatively near future.

What's the best way for someone to reach out to you?

Brian I always give out my cell phone. People think I'm crazy. But you can text me or shoot me an email. That's the best way to get a discovery call scheduled. My cell is 512-660-8505. My email is brannon br a n n o n dental transitions.com yeah, please reach out. I'd love to schedule a 30 minute call just to get to know you, you know, get to understand a little bit about your business, who you are, where you're at in life, personally, professionally, and talk about what's next and how we can help.

Awesome. And if you're a D.O. member at the event in Dallas October 9th through 11th, you can talk to Brandon directly or any of his team members. Brandon, thank you so much. Appreciate it, my friend.

Thanks, Emma. See you in Dallas.

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