The prevalence of dental support organizations (DSOs) and the competitive purchase prices they offer, has led many dentists and dental practice owners to decide to sell their practice. As this consolidation trend will likely continue for the foreseeable future, it is in the best interests of private practice owners to understand what to expect when selling to a DSO. This process can be broken down into four phases, each of which is critical. Setting the appropriate expectations and goals private practice owners should have for each phase of the transaction can enable them to position themselves for success when selling their practice.
Phase 1: Non-Disclosure Agreements and Letters of Intent
Prior to beginning negotiations and disclosing confidential information, private practice owners should execute a non-disclosure agreement (NDA) to ensure the confidentiality of information exchanged between the parties. Proprietary data, such as the practice’s financials, client/patient list, supplier information, and employee information can be crucial to a potential buyer in assessing the acquisition. However, if this information fell into a competitor’s hands, it would be detrimental to the seller. With an NDA in place, sellers should feel more comfortable sharing information with a prospective buyer.
After an NDA is executed, the parties will negotiate a Letter of Intent (LOI). The LOI is a non-binding offer to buy a practice that is often negotiated by the parties prior to drafting purchase contracts. It sets out the key terms of a proposed business transaction and is non-binding, which means the parties are not obligated to complete the proposed transaction. The purpose of an LOI is to ensure that the parties agree on important terms such as purchase price, payment terms, employment terms following the sale, due diligence, and closing contingencies before investing further resources negotiating the deal. Signing an LOI signals the parties’ willingness to negotiate exclusively for a set period as they work to finalize the deal. Since the expectations for the sale are defined in the LOI, private practice owners should raise any concerns or unique requirements for the deal during this phase of the transaction. By way of example, if the seller has more than one practice but is only selling one to the DSO, a carve out for the practice not being sold should be included in the LOI so there is no confusion as to the assets being sold or the restrictive covenants that will apply.
Phase 2: Due Diligence
The phrase “due diligence” refers to a buyer’s careful assessment of the benefits and liabilities of a proposed acquisition, which entails inquiring into all relevant aspects of the past, present and future of the target practice. Due diligence occurs after an LOI is signed and may be limited to an agreed-upon period or may continue through the closing date. By way of example, due diligence can include running lien and judgment searches on the practice, which can reveal unpaid taxes, debts, or legal judgments; financial due diligence, which includes a deep dive into the seller’s financial statements; and legal diligence, which includes an exhaustive review of seller’s contracts, governmental permits, professional licenses, insurance coverage, employee data, litigation, corporate formation documents and ownership, employee benefits, along with a host of other issues.
When selling to a DSO, due diligence will also include a quality of earnings (QofE) assessment. The QofE is meant to uncover the exact EBITDA (earnings before interest, taxes, depreciation, and amortization) value of the practice. This process, which is designed to help potential buyers investigate what a practice earns and its potential for increased profitability, can be overwhelming for sellers. A good legal team will mentally prepare both parties for this phase of the transaction, as it often leads to “deal fatigue.” This is because due diligence is tedious, may feel repetitive, and often seems to last a long time. This response is normal and expected. However, in the end a thorough due diligence process is in both parties’ best interests. A buyer does not want to overpay for the practice or inherit an unexpected liability or problem, and the seller does not want to indemnify the buyer for violations or inaccuracies in the representations and warranties the seller makes when selling the practice.
Phase 3: Contract Negotiation
The next phase of a DSO transaction is contract negotiation. The documents prepared in connection with a transaction may vary based on the circumstances. However, the following key documents will generally be included:
- Asset Purchase Agreement(s)
As most transactions are structured as a sale of a practice’s assets, the asset purchase agreement (APA) is the primary sale document. There are often two APAs: one for non-clinical assets, such as physical assets and goodwill, and one for clinical assets e.g., patient lists and records. Most of the agreed-upon terms in the LOI will be incorporated into the APA and expanded upon in greater detail. By way of example, the APA will include a detailed description of assets, directions for completing work-in-progress, and closing contingencies, to name a few.
- Partnership Agreement for Rollover Equity
Every business partnership between two or more individuals or entities will require a partnership agreement to govern the relationship between the owners and the entity. Contrary to the general legal use of the term “partnership,” which refers to a type of business entity e.g., partnership, corporation, limited liability company, etc., here the phrase “partnership agreement” refers generally to the agreement made between business owners. Further, if a seller will receive rollover equity as part of the consideration in a transaction – meaning that the seller will have an equity ownership in the buying entity post closing – that equity and the terms that govern its ownership will be based on the express terms of a partnership agreement. Notably, this partnership agreement is typically non-negotiable since many DSOs are unwilling to alter the contract. However, it is possible to request changes to the partnership agreement in a “side letter agreement.” Important terms such as ownership rights and obligations, managers’ responsibilities, as well as allocation of net profits are all usually incorporated in a partnership agreement. Consequently, the seller must understand that investing in the buyer’s business also means becoming legally bound by the terms of a partnership agreement. Therefore, it is important to review this agreement carefully.
- Management Services Agreement
A management services agreement is a contract between a DSO and the practice they are buying that details the non-clinical management and administrative services the DSO will provide, and what the practice will pay for such services. These agreements differ among DSOs, but they all include the following basic commitments: to develop a growth strategy and marketing brand; prepare budgets and financial reports; provide administrative services; lease non-professional support personnel to the practice; and lease equipment and the office location to the practice. The management services agreement also makes clear that the practice remains responsible for providing clinical dental services, and ensuring that the practice and each dentist hold all necessary licenses, permits and approvals.
- Post-closing Employment Agreement(s)
Following the sale of a practice, the selling doctor is typically required to continue working at the practice for a certain amount of time. Hence, they must sign a post-closing employment agreement. Other associates in the practice may also need to sign new employment agreements if the DSO chooses not to assume their current contracts. Some of the more important terms of an employment agreement include the length of the term, termination policies, as well details concerning salary and benefits. Finally, it is also critical for the seller to work with the DSO transition team to create a timeline for informing staff about the sale, and in order to smoothly transition retained employees.
Phase 4: Closing
Closings are the culmination of all previously completed work for a transaction. Throughout this phase and the overall transaction, the seller’s attorney will be there to guide them through the process. While closings were previously treated as momentous occasions, they presently tend to be anticlimactic. It is now common to close “on the papers,” meaning that attorneys distribute documents for the transaction electronically and they are held in escrow until the closing date. On the closing date, the buyer, seller, and attorneys have a short closing call in which the respective parties agree that all closing contingencies have been met. Once this occurs, the net proceeds are sent to the seller, commonly through a wire transfer, and the transaction is complete.
For personalized guidance and questions regarding your dental practice, contact the National Dental Law Group at Mandelbaum Barrett PC. For further insight into the DSO business model, please read The DSO Decision: Winning Answers From Every Angle by William Barrett and Casey Gocel.