Four Ways to Structure a Private Equity Deal

Which model makes the most sense for you?

In the world of buying and selling medical practices, Dental Support Organizations (DSOs) and Medical Support Organizations (MSOs) are independent business support centers that contract with dental and medical practices to offer a range of business management and support. They are most commonly backed by private equity partners, who have a driving interest to see a return on their investment through dental acquisition. DSOs and MSOs offer valuable business insights to help practices aggregate and gain synergy between their dental practice and revenue growth. Given that they are funded and structured in a certain way, these investment companies are usually large and driven to purchase and hold for long-term gain. Their goals tend to be compatible with a gradual and consistent growth curve.

Within the world of DSOs and selling medical practices to private equity, there are four different ways in which a deal may be structured. In this article, we outline these four versions of constructing a sale, as well as discuss their unique pros and cons.

1)   100% Sale with a Holdback

What It Is: This is a traditional model of sale in buying and selling medical practices.  You, the seller, receive 75% cash at close and a 25% earn-out. The practice valuation is fixed and the 25% earn-out is typically paid over 3-5 years, contingent upon the practice revenue being maintained.

Pros: If you’re preparing for retirement, this deal structure is helpful as a more traditional exit strategy.

Cons: In this version of a sale, there is no wealth creation opportunity because of the fixed valuation of the practice.

 

2)   100% Sale with Holding Company Investment

What It Is: This is a type of sale where you receive 75-80% cash at close, and retain a 20-25% stock in the company. The 20-25% investment incentive is based on the idea that the value of the company will increase under DSO or MSO management, and that there will be an opportunity to sell the remaining ownership at a later time.

Pros: Holding onto post-close stock in the company offers diversification and an opportunity to participate in the financial upside that the parent company is motivated to achieve. The potential range of return on the stock is typically in the range of three to five times the initial investment.  

Cons: After closing, your return on investment is largely dependent on the variables and market performance of the DSO or MSO. For example, if the the organization just finished a re-capitalization cycle, your remaining stock will have five years to grow. On the other hand, if the organization is in its fourth year before re-capitalization at the time of sale, your opportunity to grow stock before its time to cash in would be less. This could lead to a muted return on investment for you.

 

3)   Joint Venture Model

What It Is: This deal structure offers 60-70% at close, and has a 30-40% retained equity at the practice level. Instead of rolling stock into the parent company as with the 100% sale structures, this model offers distributions from your practice directly. If you choose this deal structure you’re likely entrepreneurial: looking to sell because you want to offload some of the risks, while still remaining incentivized to grow your practice.

Pros: This deal structure offers equity in a way that has the potential to create the most wealth. In retaining 30-40% of the practice, you benefit and receive the same multiples as the DSO or MSO, assuming growth. As an equity partner, you receive quarterly distributions as well as the opportunity to participate in re-capitalization events when they occur.

Cons: While this model allows you to sell your stock during re-capitalization events, there is typically a baseline of about 15-20% of required long-term equity. The deal restricts you from fully cashing in, only being able to sell the remainder of your stock to another doctor. The restriction puts limitations on your exit strategy.

 

4)   Hybrid Model

 

What It Is: This model is where you receive 70% cash at close, 15% of joint venture equity, and 15% of the equity in the holding company. There is potential to negotiate an earn-up based on the post-closing revenue growth, while also leaving room to experience benefits from both the holding company model and joint venture model.

Pros: This is the most diversified version for selling and continued investment. This deal structure offers up-front cash at close but presents the opportunity to benefit from post-close growth.  

Cons: Companies that buy dental practices and medical practices are moving toward this model when structuring deals, as it balances out the variables into mutually beneficial shares. In sharing the risk with the parent company, the cons are that the upside for you may not be as steep.

 

Summary

Choosing how to structure a deal with companies that buy dental practices or medical practices depends on variables that are personal. The factors to consider include the risk you’re willing to take, what season of life you’re in, and what perceived value the DSO or MSO is bringing to the table. When considering a dental acquisition or medical practice acquisition, reflecting on the level of entrepreneurial partnership you’re willing to play is key to understanding which model might be in your best interest.

Morgan Burrell

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