Scott Leune: This podcast is sponsored by dentalmarketing.com, and they have agreed to give the listeners of this podcast a free competitive marketing analysis. This analysis is going to show you very clearly how your practice is doing compared to your competitors. It's going to give you the health of your SEO, it's going to give you a website grade, and you'll also see what your competitors are up to. This helps you know what ad strategy you should have today, how clean and effective is your marketing right now find out by getting this free and detailed analysis, text the word marketing to 4 8 6, 5 9, and you'll receive this competitive analysis from our sponsor dentalmarketing.com. So I'm going to make some people upset in this episode. I hate that, but I know it's true. There is a dirty secret in financial modeling and performance of buying practices and running them that has resulted in a couple thousand dentists giving away their practices. In my mind, I would call it for free to DSOs when they sell their practice to A DSO because of the terms of that sale. In essence, they're giving away the practice for free and we need to stop doing it. Someone needs to ring the bell, and I'm going to do it here on this episode of the Dental CEO podcast.

All right, so I don't have a whiteboard. We're not at a computer. We can't draw out math and diagrams to all understand it. We're going to have to do this in this kind of podcast format, but I think you're going to get it. I said some pretty strong words. I said, I'm going to upset people. I said, thousands of dentists have given away the practice for free to DSOs. Now, I need to explain myself, and we need to go through the math because this has been something that I had just been eating away at me for almost two decades and I'm just shocked and embarrassed, really, that we in the dental profession have not understood the realities of how a lot of these deals are structured and how damaging it is financially for a dentist selling. So let's kind of start with almost like this hypothetical situation.

Got a dentist. Dentist is wanting to sell their practice. They're towards the end of their career. They've built up their practice, they've been working it. They have gotten to a point now where they'd like to sell. They'd like to get a nice sale price, they'd like to retire this practice just for easy math. Let's just use a million in collections and I'm writing this down right in front of you right now. A million in collections is what this practice does, and a million in collections. And let's say that the practice has, if we were to kind of do the proper math, the proper calculations, this practice would have $150,000 in, let's call it ebitda. Now, some of you don't know what EBITDA is. A layman's term explanation of EBITDA would mean it's like if I own this practice as an absentee owner and I had to pay a dentist, I had to pay that seller dentist to do the dentistry and I had to pay all the other bills, how much money would be left over before I have to pay taxes and my loan payments.

So if I paid all the legitimate bills and I paid my dentist and the staff and every legitimate bill in that business, how much money's left over before I now the absentee owner am having to pay taxes and having to pay loan payments and interest payments and so forth. And when I say legitimate expenses, I mean the rent, the supplies, the lab. What I don't mean is our vacation to The Bahamas to take a CE course or running my car through the business or buying supplies for my home through my corporate Amazon account. I don't mean those illegitimate expenses, those things that some dentists do to try to minimize taxes. I mean, if we were to look at the financial statement and clean it up for this hypothetical million dollar practice and we were to only include legitimate expenses and we were to calculate what an appropriate salary is for that seller dentist in the open market, what would a dentist need to get paid to do that dentistry, we are left with $150,000 and that is what we're calling ebitda.

EBITDA is an accounting term. It stands for earnings before interest, taxes, depreciation, amortization, $150,000 of ebitda. Okay, so that's what we got. We got to practice million in collections, $150,000 of ebitda. This dentist has a couple options. They want to sell the practice. I want to compare just two options right now. They sell it to another dentist and walk away or they sell it to A DSO that has some terms where they stay. Alright, let's first talk about selling it to another dentist. What is the practice worth? Well, it's a million in collections. $150,000 in ebitda just for easy math and round numbers. We might assume that to a private dentist, this practice is worth a sale price of $750,000. Now $750,000 out of a million dollars collections, that's 75% of collections that would be reasonable in many parts of North America. But if we look at that sale price, $750,000 and instead of comparing it to collections, we compare it to ebitda.

EBITDA 150 grand. So the sale price of seven 50 is five times ebitda, five times EBITDA is also in today's world, a reasonable multiple that we might find on the private market for practice. So this example is, hypothetical example is a very kind of realistic situation. An older dentist wants to retire, they collect a million a year with 150,000 of ebitda. They sell to another dentist for 750 grand. Perfect. They don't have to stay. They sell. There's some sort of minimal transition period of a month or two or three and then it's sold. They go retire, they sail off in the sunset, $750,000. Alright? That's kind of option one. Let's look at option two, selling to A DSO. Before we do the math, we need to understand that there are lots of different ways that DSOs kind of structure the sale much more complex than a simple, here's 750 grand, give me the keys.

DSOs do things to minimize their risks. They do things to try to minimize their cash that they have to spend to buy a practice. These are smart things for DSOs to do in the business world. I'm going to talk about a couple examples of them. There's a whole lot of examples we could come up with if we actually sat here together on a whiteboard and started brainstorming all the different types of structures. But some common things is number one, they require the seller to stay on for three to five years, would be a relatively normal thing to see. They require the seller to stay on after the sale. So this dentist that wants to retire, if they sell their practice to A DSO, they're not going to be able to retire immediately. They're going to have to stay on for three to five years. That's one common thing.

Another common thing DSOs will do is they won't give you all of the valuation in cash upfront. They might give you two thirds in cash upfront, but they are going to hold back the other third and maybe give it to you in stock or they're getting to give it to you after you've done your three to five year time. So those are two common things that can occur and I want to talk about each one of those. But let's start with I'm the DSO. If I buy your practice, you have to stay on for five years. I'm going to try my very best in this episode. Not to name specific DSOs, but there are some DSOs that everyone in dentistry has heard of and knows about that have terms very similar to this. So I'm the big DSO, I'm going to buy your practice and I'm going to make you stay on for five years.

Let's do the math on that. Let's say, first of all, let's assume that the DSO gives us a normal valuation of five times ebitda. Just like the private dentist example, my million dollar collection practice with $150,000 ebitda, I'm going to have the DSO deal and the DSO says, we're going to pay you five times ebitda. So you get $750,000 and you have to stay on for five years, okay? And let's assume they're giving us the money upfront. They're not even holding anything back. They're giving us all the money upfront. We have to stay on for five years. Alright, let's think about what happens here. Let's compare that to not staying on for five years. Okay? If I am going to sell to A DSO and I get five times ebitda, what does that really mean? That means I get five years worth of EBITDA today.

Remember, EBITDA is the money we make by owning the company after we pay the dentists and all of our bills. It's the money we make. EBITDA is a year's worth of money we make by being owners. So if A DSO gives us five times ebitda, they're giving us upfront the next five years worth of profits or ebitda, right? The money we make being an owner. So they're going to give us five times EBITDA to value this practice at $750,000. But here's the kicker, here's the problem. They're going to make us stay for five years. So if I have to stay for five years, am I better off selling to A DSO or better off keeping it and selling after my five-year commitment if I'm going to have to stay on for five years, the DSO side says I get seven 50 upfront and then how much EBITDA do I get in year one, zero in year two, zero in year three, zero in year four zero year five zero.

What do I get during those five years? I get a salary for being a dentist. I get paid as an associate, but what I'm not getting is ebitda. I'm working for five years with no EBITDA because I sold the business. So I'm getting 750 grand upfront and then I'm getting five years worth of salary and that's what I get if I sell to A DSO. Alright, well let's compare that to not selling to A DSO, but instead just working those five years but still owning. Did you hear what I said? I said if we're going to have to work for five years as a DSO, what if we just worked five more years for ourself instead, what would that look like? Well, I wouldn't get any money upfront like the DSO paid me a sale price upfront. Well, if I don't sell, I don't get any money up front, but what do I get year one?

I get get ebitda. I get 150 grand of EBITDA plus the salary, year two, 150 grand of EBITDA plus the salary. Year three, same thing. Year four, same thing. Year five, same thing. At the end of five years, I've gotten $750,000 of EBITDA plus a salary. The exact same thing I got when I sold to A DSO when I sold to A DSO, I got that same 750,000 upfront plus a salary. But what's the difference between the two? At the end of five years, I don't own the practice the DSO does compared to working for myself at the end of five years, not only do I get the 750 grand of ebitda, and not only do I get the salary for five years, but I still own the freaking practice. You see, if our time commitment that we have to work in this business equals the multiple of EBITDA we sell for, we are in essence giving away our company for free.

If I sold to the DSO, I'd have 750 grand plus five years of salary and I would not own the practice if I kept the practice and worked those same five years. Instead, I'd have the same seven 50 grand, I'd have the same salary, but I'd also still own the practice. So the reason why this happened was I sold for a five multiple and I had to stay for five years. They cancel each other out. What if I sold for a seven multiple or shoot an eight multiple? What if I sold for an eight multiple? What would that look like? Well, I do a million in collections and 150,000 in ebitda. So if I sold for an eight multiple, I would do, and I'm going to whip out a calculator, which is kind of embarrassing. I could probably do this in my head, but if I do eight times $150,000 of ebitda, my purchase price is 1.2 million.

Wow, what a wonderful purchase price. See, because when I try to sell it to a private dentist, they're only going to give me 750,000. But if I take the same practice and I sell it to A DSO for an eight times multiple, I get 1.2 million. Oh my God, what a great thing. That's more money, but they're going to make me stay on for five years. Okay, so let's do the math. Let's compare them. If I'm going to have to stay on for five years with the DSO, I'm getting 1.2 million upfront, plus I'm getting five years of salary. If I instead keep the practice and work five more years and then sell it to a private dentist for a lower price, what do I get? Well, I get five years of EBITDA for owning it for five more years, so that's seven 50 plus I sell it to a private dentist for seven 50 and so I end up with 1.5 million.

In other words, I make more money working five more years owning it and selling it to a private dentist and walking away than I do selling it to A DSO for this bigger number, but having to stay. You see when the DSO offers me eight times multiple or times EBITDA multiple, they offer me an eight, but they make me work five. The net is kind of three. If I work five and I own it, that's plus five. Excuse me. Lemme say this a different way. Lemme say this a different way. If the DSO offers me eight times EBITDA but makes me work for five years, then I kind of net three. If I instead work for five years and sell to a private dentist, I net five. So the years we have to work, cancel out the multiples in ebitda. The only way for the DSO option to give me as much or more money than selling privately is if the DSO gave me 10 times EBITDA and made me work for five years, that would equal just working for five more years and then selling to a private dentist for five times ebitda.

This is a huge issue because we've got dentists that are getting huge valuations from DSOs with this little kicker, this little fine print that says you got to work five years so I could get a nine times EBITDA multiple on this example. That would be 1.35 million offer from A DSO for my $1 million practice. And if I have to work five years, I still make more money not selling to 'em and just working five more years for myself and then selling to a private dentist for only 750,000 even though the DSO is going to offer me 1.35 million because they required me to work five more years, that burned away the value of this deal because those are five years I'm still working, but now I don't get to keep the profits if I instead just own the company for those same five more years and kept all those profits I could sell for an average sale price and still have more money.

And by the way, don't think when you sell to A DSO, life is all wonderful and easy. Now, I know that sometimes the sales pitch we get, Hey, sell to A DSO and we will run the administrative side of the practice so you can just focus on what you do best, the clinical care for patients. I know that that's the sales pitch, but think of all of the people that have lived that transition who say, no, it's not like that because that DSO may not run the practice the way you want it run that DSO may not put a regional manager in charge that you like or that is skilled. The office manager themselves may not be someone you enjoy, you may not enjoy. Now the labs you get to choose from or the types of materials or the types of decisions being made around marketing or the fact that they now roll over your missed calls to a call center that has horrible quality or now the fees have changed and the payment options have changed and your patients are complaining and they've added an associate dentist because they're trying to expand and suddenly you don't have enough patients for your own schedule and the associate dentist isn't doing good work and they've added more employees and you're losing your veterans and that whole life, that whole situation, everything I've said is highly realistic and highly stressful.

I know we want the grass to be greener on the other side, but so often the pain and the stresses we feel as an owner are just traded for other equally or more intense pain and stresses we feel as a former owner stuck in this DSO. Now, the math I did is optimistic at best on the DSO deal side because what we assumed on this was that we got all the cash upfront. What if we don't, don't get all the cash upfront. What if the DSO says, we'll pay you half cash, half in stock or two thirds cash, one third in stock. And it's highly common because what happens is for the dsso is it requires them to come up with less cash to do the deal and they're just going to take the profits of the company over the next three to five years to be able to supplement what they need to then do another deal.

It's highly advantageous for A DSO in so many ways to buy you out in part cash, part stock instead of all cash. Now, the sales pitch for that though because they got to sell it sales pitch is, Hey, if we pay you in cash, excuse me, if we pay you in stock, our stock is value is going to go up a lot. It's going to be a much higher multiple. You're going to get this multiple arbitrage and whenever we recap, whenever we sell, you're going to get this big payout and they're going to tell you sometimes the payout when we sell is going to be equal or more than the payout you got from your practice. In other words, they'll say you get to double dip, you get two transactions. That's the pitch. And of course, theoretically that is possible. Of course it is, but it's also theoretically highly plausible that that doesn't happen.

I spoke to an attorney, a dental attorney yesterday, I'm not going to mention any names, but I said, Hey, how's it doing? And this is a litigation attorney and he said, I have never been so busy. And I'm like, really? You've never been so busy? What's going on? He said, well, here's the thing. All these DSOs over the last five years have been doing a lot more stock deals. They've been buying practices with part cash, part stock. And so these dentists have been given this sales pitch of, Hey, we're not going to give you all the money for your practice. We're going to give you some of it, but we're going to give you the stock and someday soon, every three or five years, we expect to sell our DSO to the next private equity group and you're going to get this big cash out potentially.

Well, what's happened is due to a variety of reasons right now in the economy, the DSO world has frozen up a lot over the last 18 months. There have been interest rate increases, there have been inflationary pressures and increases on the cost to run a practice. So what happened was these DSOs, which had a ton of leverage, a ton of debt put on them, their profit margins went down and they had a hard time making debt payments and they wanted to try to refinance the debt to make it easier to make these debt payments and they couldn't refinance them. Well, because interest rates have gone up and this kind of pressure cooker of a situation caused some DSOs to shut down practices, some DSOs to stop doing as many startups or stop acquiring practices so quickly it got DSOs focused heavily, a lot, heavily more on if we're going to buy a practice at better cash flow because we need the cash.

And it got dsso saying, Hey, if we can buy more practices without so much cash, let's give 'em stock. That'll put less debt pressure on us. And when all this happened, it kind of looks like it's not a bubble popping, but it's definitely kind of a pause in the growth, almost like a correction that's happening where the DSOs were under financial pressures. Now it wasn't the same frothy easy market as it used to be. And so what happened is this DSOs weren't recapping, meaning they weren't selling themselves to new buyers so often at such high valuations so soon as what maybe the little dentists in their organization with a little bit of stock from selling their practice thought would happen. And so my attorney friend said, what's happening now is all these private dentists that have stock and they can't sell their stock, they're starting to make all these negative claims about the DSOs and they're trying to sue the DSOs and he's involved in a whole lot of litigation now between dentists who sold practices to DSOs and the DSOs, they're in lawsuits together.

Now, this is not a podcast episode about lawsuits or about putting blame on one party or the other or anything like that. I'm just mentioning this as another symptom of what happens when we make assumptions that aren't met. The assumption was I sell my practice to A DSO and I get stock and the stock is going to be worth a whole lot of money someday soon. What actually happens with some of those doctors is they take their million dollar collection practice, they sell it for some bigger number, like 1.3, but of the 1.36 50 is cash and six 50 is stock and now they're required to work five years and at the end of five years, they still haven't been able to sell their stock and they remember they were used to having EBITDA fund their lifestyle. See, that's the other thing. You're used to living off of your salary and your EBITDA from being an owner when you quit having EBITDA and you get a sale price, but you don't completely shrink your lifestyle, you're just going to eat away the sale price to live.

So these doctors they sold and five years later, their mandatory time, they got to put in. Five years later, the money they got from the sale is gone because it went to taxes and it went to living, and now they're holding onto stock that can't be turned into money and they're getting pissed and some of 'em are getting in lawsuits again. When we say yes to a deal, a multiple, and we agreed to stay, the time that we have to put in is chipping away at the value of the deal. In addition to that, if we don't even get cash, all the cash upfront, but we're getting part cash upfront and part stock, we are opting into added risk, added risk that we can't liquidate the stock at the time we want and the value we want. It's a gamble. We're not in control anymore.

It is out of our control. What happens to our nest egg of a retirement fund in this kind of valuation that's tied up in stock? So often what leads dentists to wanting to sell are actually pain points in the practice and they tell themselves, I'm just really stressed. It's difficult. I'm not making as much money as I want to want to retire here over the next five or 10 years. So let me sell now. I'll still work, but at least I can sell now and I'm free of these pain points and I get all this money upfront. That's kind of the thinking, and when you hear me say it, it sounds very logical, but that's not actually mathematically the right thing to do. You see, if we plan on working another five or 10 years and we sell today for five years or eight years or whatever it is of profit, after five or eight years of living, all that money's gone actually shorter than that because we had to pay taxes on it.

It's gone. If we don't want to retire and drop the handpiece and sail off to Cabo, if we're not actually ready to stop so often, it's better to not sell yet. But to just fix the pain points, you will make more money and spend less money bringing on a coach or consultant to dive in and help you understand how to fix the pain points, help you understand how to drop back clinical days even if you only want to work one or two days a week, you can build and own a company that gives you EBITDA only working one or two days a week and have that EBITDA for those last five or 10 years. You plan on practicing before you then sell, and when you sell, you want to sell and walk away. That maximizes typically the net value of the deal. If the sale requires you to stay for years on end to work, it's better off almost always to just own the company for those next years.

You were going to agree to work anyway before you then do a deal where you can walk away. And yes, when you do a deal where you walk away, you get less money, less money at the sale price, not less money in your life, less money at the sale price. If you stay, of course you're going to get more money because every year you stay is a year you're giving them profit. So I hope I'm making sense. I'm worried that those visual learners on this podcast episode may not be grasping it, especially if you're not totally paying attention. If that's you, I really encourage you to listen to this. Again, sit down and really listen it. Write down numbers as I say 'em, but those of you auditory learners that can do a little bit of math and understand a little bit of business, I hope you realize what this means.

This means that if you're wanting to sell and make the most amount of money you can hardly ever, does it make sense in today's market to sell with an employment commitment? I say hardly ever. Of course, there's extreme situations. Of course, you can get this massive multiple of EBITDA with a minimal time commitment, and that net deal makes a ton of sense. That just rarely happens. But of course it can happen, but that just rarely happens. The way I would look at this is you need to work as long as you're willing to work and then you need to sell and walk away. Usually that's the most money you make. Now, if you're presented with a deal that has a time commitment to it, then you need to subtract the multiple of, excuse me, you need to subtract the time commitment from the multiple of EBITDA and tell me what's the net number If you're offered an eight multiple, but you got to work five years, the net is three.

How does that net compare to what you would get on the open selling your practice and walking away? Today in the open market, you can get five to seven times ebitda. So if you're going to have to stay for five years in the DSO, you're going to need to get a 10 to 12 times multiple to equate just keeping it working for five more years and then selling for a five to seven. This is how some of the largest DSOs in the world have been able to get practices with very little risk practically for free. They've said, we'll buy your practice even at a frothy valuation, but we're going to make you stay for five years so that we're going to use your own profit to pay you. Oh, and by the way, we're not even going to give you all the money upfront. We're just going to give you stock that keeps, by the way, getting diluted over and over and over again that you have no control of.

And you can't sell on open market. You can't go sell your stock off a E-Trade. It's a privately held company. It's stock that's just tied up. You don't have control over it. You see, they've been using your own profits to pay you your sale price to in essence get your practice like I like to call it for free. And they're not even maybe giving you all the cash upfront. And now you have this assumption that the stock is going to be worth a ton of money and you're going to sell it soon. And that doesn't necessarily happen. And you've got this assumption that under new management, your practice is going to be less stressful for you. And so often, so often all you're doing is trading one set of problems for another set of problems of equal stress. So often. But see, now you've lost control.

When there's a problem with the office manager, you can't go replace 'em when there's a problem with the marketing, you can't change that decision when there's a problem with how the phones are being answered by some call center. You can't fire the call center. You've traded stresses for new ones and you've lost control. And when that practice grows and becomes more profitable, if it even does, you don't get the profit. They're using your own profit to pay you. I don't know how else to say it, but this is embarrassing that so many practices have been sold this way. And in dentistry, I think it's safe to say that a lot of times when dentists make errors, many times they'll never know they did. They're living in la la land, they don't understand the reality of the situation. They truly, honestly, to their soul believe that it was the right thing to do.

And they unfortunately become these big fans and loud people saying, yes, I did it. I sold you should too. It's wonderful. They don't understand that it's actually really bad. I see that in dentistry. I also see in dentistry that problems, mistakes, bad performance, things that we're not proud of get hidden. They don't get talked about. We just stay silent. We pretend, we act. And it's unfortunate because it's the challenges, the problems where all the lessons are for all of us. And the pressure from those challenges gets to mold us into this diamond. It gets to sharpen us. And so in dentistry, I see both of those things happening. We hide all the problems and people are ignorant to the facts of a situation. They're blindly thinking that they had a wonderful situation and that combines to form this kind of culture and dentistry that says, Hey, this is a good opportunity.

This is a good deal. And maybe I'm crazy. I don't know. Maybe I'm the one that's blind. Maybe I don't know what I don't know. Maybe I'm doing the math wrong, maybe I don't understand. But from my very limited point of view in my experiences, this is not a good thing for the vast majority of people selling practices, and it is given rise to, one of the things is given rise to the DSOs because they're getting practices for very little cash and very little risk. Had we never sold a practice this way, let's go back to the caveman days of the Dsso world. The ground zero of DSOs. Had we never accepted deals that said we have to stay and had we never accepted deals that weren't cash upfront, I think the DSO market would be a fraction of the size it is today. And I believe that a lot of the DSOs would've been forced to, number one, become better operators, and number two would've been forced into a model that more partners with dentists as opposed to buys dentists.

And if you think about that having less DSOs and the only ones left are either really good operators or partnering with private dentists, that would've been really good for dentistry I believe. But what we've done in our financial kind of ignorance is we've said yes, yes to these deals that I deem unfair to the seller, but the seller doesn't know any better. And it's made it so easy for DSOs to get a lot of debt with a little bit of money and raise this fund and then go buy practices with less cash at terms that in essence has the practice pay its own purchase price. What a sweetheart deal. Can you sell me your practice for that? Please sign me up.

I'll buy a whole lot of different kind of businesses with that kind of deal. So I to, so I'm going to go buy this, whatever, let's just call it, I don't know, dry cleaning business and the guy that creates all the value that runs the dry cleaning business that wants to retire. No, you know what? You got to stay for five years. I'm going to give you five years of profit right now, but you got to stay for five years. So the company will have five years of profit to pay me back for what you just got. And then I get to have it after that. And so I get five years to figure out how to replace you and I get to control it. And basically your own profits are paying your own purchase price and you're locked into this deal. What a sweetheart deal for me, the buyer.

What a terrible deal for Mr. Dry cleaner. And that's what we've done in dentistry. We've given away practice for free. It's embarrassing. We need to be more financially literate. I'm sorry if I'm upsetting anyone. Of course. Let me also state, there's so many nuances to deals and structures, and of course there's so many different life situations people are in. I don't mean to come across like all deals are bad for all people, but what I am trying to say is there's a big chunk in the middle that's not an outlying situation where these deals are not good, not good for that middle, and that is a majority I believe. So I hope this got you thinking. This is the kind of stuff that we talk a lot about in our side of the world, in our side of the company. We have a multi-location seminar, teach two days long to teach how to buy, how to start practice, how to merge 'em, how to build multiple locations, how to sell to DSOs, how to become a DSO.

And this kind of financial literacy is really, man, it should be mandatory in dental school. We say that so often about so many things, but it should be mandatory for you. The person who's hundreds of thousands of dollars in debt from school and hundreds of thousands of dollars or millions in debt from a practice whose livelihood depends on big financial decisions. You should also become financially literate so that you see the world a little bit differently and you get to spot good versus bad. You get to spot opportunity versus mistake. You get to spot the thing you should focus on instead of the distraction. You get to have the knowledge to give you the strength and confidence to not be swayed by other people's words so easily. That is my kind of take home message to you today. Thank you so much for listening. I hope this was interesting for some of y'all. Until next time, my name's Scott Leune, and this is the Dental CEO podcast.