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Access to Capital: Helping DSOs and Emerging Group Practices to Grow

Dentistry is evolving, creating huge opportunities for entrepreneurial dental professionals, provided they can access affordable and reasonably structured capital, writes Gareth Petsch, National Director for the Healthcare Practice Finance Division at Citi Commercial Bank.


The trend toward large group practices and Dental Support Organizations (DSOs) is not new. But it is rapidly advancing. Of the less than 200,000 dental offices in the US, just 5% are currently a group practice or DSO, according to the American Dental Association. However, experts predict that this will reach 25%-30% by 2025 and almost 50% by 2030. Dentistry will increasingly operate in a corporate environment – some companies could potentially list on the stock exchange via IPOs.

There are many drivers of the shift towards DSOs. Increased competition is encouraging the dental industry to focus on operating efficiencies and margins. In addition, patient demands and expectations are growing. The availability of information anytime via the internet and smartphones has turned dental patients into wise consumers: they expect the latest technology, access to information via patient portals, and the ability to schedule appointments by smartphone or text messaging. Meeting these demands at a time of compressing margins is challenging. Inevitably, it has prompted consolidation in the industry.

Another driver of change is the shortage of skilled clinicians, which makes it tougher for small or solo dental practices to compete – larger organizations are often perceived as offering more attractive work environments and can offer better packages to recruit new dentists.

Many FMCG players have been slow to react to these trends, not least because their higher cost base makes them less nimble than new players.

The Challenge for the Middle Market

The disruptive trends described above present an opportunity to grow a successful group practice or DSO. But one thing stands in the way of capitalizing on this consolidation: cash.

Large corporations find it relatively easy to access capital: both middle market and corporate-focused banks and private equity (PE) firms compete to offer creative banking and financing solutions. As a result, large DSOs have been able to buy multiple locations and practices. At the same time, small solo practices or those with a couple of offices can count on the support of local and national banks when they need capital to acquire or start a dental practice.

The challenge is for practices between these two extremes – middle market group practices or emerging DSOs – which find it difficult to access reasonably priced capital. These entities, which typically have 5-50 locations, are too big for the dental lenders to support yet too small for corporate-focused banks. The irony is that these practices, which represent the majority of the group practice DSO landscape, arguably offer the greatest potential for growth.

This capital shortage has caught the attention of many PE firms, which have been heavily involved in helping DSOs grow. PE involvement has prompted a change in mindset in dentistry. Less than a decade ago, few dentists would have understood how to value a practice based on a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). Now EBITDA is avidly discussed at DSO conferences.

Providing an Alternative for Middle Market Group Practices and DSOs

The shortfall of capital for emerging and middle market group practices and DSOs means they face barriers to growth. This is especially true when they are in competition for practices with cash-rich corporate DSOs; typically the larger firms will be able to pay higher multiples than a small DSO can afford or is willing to pay.

From a bank’s perspective, this type of lending is complex: most firms serving the health care sector focus on the ability of the dentist/owner to perform dentistry to generate cash flow. Loans are generally collateral light, so banks rely on cash flow to repay the loan; if the dentist/owner, who is the primary repayment source, cannot practice there is effectively no collateral. As a result, banks are often uncomfortable lending to DSOs when the dentists performing treatments are not the owners or part of the borrowing team. Such a scenario forces banks to evaluate hiring and retention arrangements.

Another complicating factor for banks, which lowers their appetite to lend, is the differing regulatory environment for the corporate practice of dentistry in each state. Lenders need significant industry expertise to understand and address these complex challenges and recognize areas where clients or potential clients have gaps in their operations, which could have risk implications for the bank.

Choosing the Right Partner

The opportunities for group practice and DSOs are great. The pace of financial innovation is accelerating as external business leaders and expertise enter the dental sector. This is freeing up dentists from management, HR, administration and re-imbursement tasks and allowing them to explore clinical breakthroughs and focus on their trade. As a result, outcomes are better for patients using these services.

However, the challenges for the middle market or emerging groups or DSOs are tangible, especially in accessing affordable and reasonably structured capital. Advice and support is needed if a DSO is to achieve its growth objectives in a financially prudent and secure way. Consequently, choosing the right financing partner is critical.

A lender must have highly specialized bankers if it is to successfully evaluate and support DSOs and group practices. These specialists must be able to understand risk and potential mitigants while having a view into the entire operation – they cannot focus on a single transaction. Middle market group practices and emerging DSOs seeking finance and support must evaluate lending partners carefully (see callout box) and prioritize those with proven thought leadership credentials. They need to work with bankers that engage with CEOs, CFOs and owners of DSOs and have the expertise and experience to be part of a DSO’s strategic planning process.

How to Evaluate a Potential Lending Partner

Do they understand the industry?

Does the bank have a dedicated team of bankers and credit officers with experience working with larger dental practices? Group practices or DSOs should not need to explain production/collection reports or why their company’s balance sheet does not look like a manufacturer with an abundance of assets and inventory. An added bonus of working with an industry leader is access not just to their broader client knowledge but also to their professional relationship network.

How do they value an enterprise?

Are they looking for hard assets to secure loans or can the lender recognize the value of an enterprise and the existence of a secondary market? Will they only support 100% doctor-owned practices or require the owner to continue to see patients? It is important to understand a bank’s requirements because even if they are not applicable when a loan is made they may become so in the future if the owner wants to move to an executive role, for example.

Do they look at leverage ratios, debt service ratios, covenants and more?

A specialized lender should evaluate the entire operation, even though they are only funding a single new location. They should take time to understand how the new location fits into a strategic plan, centralization efforts, growth plans, treatments offered and demographics. Practices should ask whether the lender assigns covenants purely on a location basis or against the entire corporation. It may be easier to service debt and comply with covenants as a corporation rather than at individual office level. Moreover, the administrative burden of measuring metrics related to covenants may be easier at the corporation rather than office level.

Will they be able to support a DSO as it grows into a larger company?

Make sure a lender has sufficient capacity to handle not just today’s business plan but also future growth. Banks have a strict debt ceiling for individual borrowers: these may range from $1 million to up to $5 million for small lenders. Larger lenders with industry expertise can generally offer deal sizes of $10-$20 million.

Are the right people within the lender accessible?

Many banks are complex organizations with many layers and significant bureaucracy. Practices should ensure they have access to a named banker and that the team they work with is empowered to make decisions. A collaborative relationship creates an environment where ideas or acquisitions can be discussed and help is on hand when making decisions. Having a clear point of contact within a bank is especially important when the business encounters challenges: a banker that fully understands a practice will be a great advocate during tough times.

Will they support the practice’s strategy after initial closing?

Whether a practice plans to grow by acquisition or via a de novo strategy, it should understand the potential appetite of a lender for further borrowing and its approach to equity. Will it ask for additional equity for every transaction? Is the lender going to provide facilities, such as a pre-approved credit facility, when the DSO is negotiating a new location or targeting a practice? This could be an important concern when competing with well-funded large corporate DSOs as it allows a faster closing.

What other solutions and advice does the bank offer?

The range of services offered by banks varies significantly. Practices should seek to work with a bank that can provide solutions that enhance their business, save time and energy, and create efficiencies as the business grows. It is especially important that a potential lending partner invests sufficiently in new technology so that the DSO can leverage the benefits of rapidly evolving innovative digital solutions.


gareth natural director of healthcare

Gareth Petsch
National Director for the Healthcare Practice Finance Division of Citi Commercial Bank