Ep. 88: Four Reasons DSOs May Be in Trouble
Over the last few years, there has been a ton of money flowing into corporate dentistry and a lot of talk about DSOs becoming the future of the dental industry. But if you look closely, there are some signs of trouble in paradise recently—and these trends are interesting food for thought for all dentists in private practice.
Links:
Stats on commercial loans - https://fred.stlouisfed.org/series/DRTSCILM
Stats on credit card lending - https://fred.stlouisfed.org/series/DRTSCLCC
MGE Communication & Sales Seminars - https://www.mgeonline.com/mge-communications-sales-seminars/
Online Dental Team Training - https://ddssuccess.com/
Definition of EBITDA: https://www.investopedia.com/terms/e/ebitda.asp
Free Fees & Plans Analysis - https://www.mgeonline.com/fees-and-plans-analysis/
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Questions From This Episode
Why does Jeff think many DSOs are heading into a rocky period after years of aggressive growth?
Four compounding factors: borrowing costs have risen sharply after years of historically cheap money, many DSO-acquired practices already operate on thin margins squeezed by inflation and PPO reimbursement cuts, DSOs have been paying well above the traditional valuation model for practices, and the original owner-operators most DSOs depend on for productivity are only contractually obligated to stay two to five years before many move on.
How does rising interest rates actually affect a DSO's ability to keep buying practices?
Most DSOs and the private equity or hedge fund money behind them operate heavily on debt. When the cost of borrowing that money rises, and Federal Reserve data shows a much larger share of banks tightening lending standards to mid-size and large businesses than at any point in the prior decade, it becomes more expensive and harder to keep financing new acquisitions, which is already showing up anecdotally as deals falling through over funding rather than practice quality.
Why are DSOs paying so much more for practices than the traditional 70 percent valuation model?
DSOs typically pay a multiple of EBITDA, roughly comparable to profit, often five times or more, rather than 70 percent of the prior year's collections. On a practice with 2 million dollars in collections and 600,000 dollars in profit, that can mean 3 million dollars instead of 1.4 million under the old model, in exchange for the seller staying on for several years. That's a materially higher multiple than an owner-dependent business would traditionally command, largely because DSOs can later sell their combined portfolio of practices to a larger buyer at an even higher multiple.
What happens to a DSO-acquired practice once the original owner's stay-on period ends?
It varies, but many selling doctors don't plan to stay past their contractual obligation, since selling was often their exit strategy in the first place. If that owner was the practice's primary producer, productivity can decline once they leave, which can ripple upward and affect the value of the DSO's overall portfolio, particularly if that DSO has since been sold again to another investor holding significant debt.
What should a private practice dentist actually do given all of this?
Don't panic about DSOs taking over the industry, and don't feel bad if selling to one made sense for your own situation. For those staying independent, the priorities are getting out of PPO participation given ongoing reimbursement pressure, investing in genuine sales and communication skill, and considering acquiring additional practices, since a large number of practices coming to market over the next five to eight years won't be DSO targets and represent real opportunity for private practitioners.
Episode Transcript
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No matter where you are in the dental industry, you have some awareness of the moves DSOs have made over the past several years. You might be among the roughly 10 percent of US dentists or dental team members employed by a DSO, a dental student or newer doctor being heavily recruited by one, or a dentist who has sold, or is considering selling, to one. And if none of those describe you directly, there's a good chance someone close to you fits one of them.
With all of these connections, there's a lot of information circulating, how much DSOs pay for practices, how long you're expected to stay afterward, which group pays more than another, and so on. We hear plenty of this directly through our client base at MGE, and there's also been a steady stream of industry articles speculating that DSOs are on track to take over the profession. As part of the dental industry ourselves, we've had to stay closely aware of this, if only to give informed guidance to our thousands of dentist clients.
That's the backdrop for this week's episode. You may have assumed at some point that the future of dentistry is DSOs. We don't believe that at all, in fact we think close to the opposite. Sabri, who you've heard on prior episodes, and I were recently comparing notes and independently arrived at the same conclusion: a meaningful number of these DSOs may be heading into serious trouble in the near future, meaning real growth and economic difficulty ahead.
That's what I want to cover this week, why we think that, how it might affect you as an individual dentist, and what you can do to make the most of it. My name is Jeff Blumberg, and I'm your host.
To be clear, when I say DSOs are heading into trouble, I don't mean all of them uniformly. DSO activity first appeared in a meaningful way around 2005 or 2006, a modest number of acquisitions, nothing close to today's scale, and the growth model at that stage wasn't necessarily unsustainable. Over the last five or six years, though, things accelerated dramatically. A lot of new organizations entered this space, largely because big money got involved, specifically private equity and hedge funds.
One of our clients, who owns several practices, attended a conference about a year ago focused on setting up a management organization for multiple practices. Most of the speakers that day were attorneys. What struck him most, though, were the vendor booths outside the main hall, the majority were private equity and hedge fund representatives, not typical dental industry vendors. That's roughly when you started seeing genuinely enormous offers for practices, nothing close to what DSOs were offering fifteen years ago. Established players who've been in this space longer will likely weather what's coming better than newer entrants, who I think are facing a considerably rockier road.
We may be early in flagging this. Back in October of 2022, we put out our twelve-point recession-proofing checklist, and it wasn't a popular topic at the time, it didn't get much traction. Recession talk has picked up more broadly since then, so we might simply have been ahead of the conversation. I'm not an investment advisor, this is simply what we're observing, and you should weigh it against your own judgment and circumstances. But this is a trend we genuinely see building.
Before getting into what we'd suggest doing about it, let's walk through the four reasons we think a number of these DSOs may be in for a rocky stretch.
Reason one: money is no longer cheap. Interest rates have risen substantially, and a lot of these private equity firms and DSOs operate with significant debt. The rate that gets the most attention is the federal funds rate, the rate the Federal Reserve effectively charges banks for borrowed money, currently at 5.25 percent. When that rate rises, banks pay more to borrow, and in turn charge borrowers more, otherwise they're simply passing along Fed loans at no profit, which doesn't work as a business model.
For comparison, that rate was near 0.25 percent from March 2020 through March 2022, which is why borrowing was so cheap during that period. Going back further, it sat around 0.75 percent from 2013 to 2015, crept up modestly through 2016 to 2019, briefly touching 3 percent before dropping to 2.25 percent right before COVID began. In short, money is meaningfully more expensive to borrow today than it's been in over a decade, and a lot of the organizations acquiring dental practices are financed substantially through debt.
On top of that, add recent bank failures, Signature Bank, Silicon Valley Bank, and others. When banks fail due to how they were run, other banks tend to pull back and tighten their own lending practices in response, understandably wanting to avoid the same mistakes. The Federal Reserve actually surveys this directly through something called the Senior Loan Officer Opinion Survey, or SLOOS, which polls loan officers at domestic banks on lending conditions and tracks the results over time. I'll link the relevant charts on the episode webpage if you want to look at them directly.
One of those charts tracks the percentage of banks tightening lending standards for mid-size to large firms. That figure currently sits at 46 percent. To put that in context, that number was at or below zero, meaning banks were actually loosening standards, for most of the period from 2010 to now, aside from a brief uptick during the earliest months of COVID. In other words, credit was relatively loose for roughly thirteen years, and now nearly half of banks are actively tightening.
There's a parallel pattern in credit card lending specifically. That tightening figure hovered below zero for most of the last thirteen years, occasionally approaching 10 percent at certain points, but it's now at 30 percent of banks tightening credit card lending standards. You may have already noticed some version of this with your own patients, more conversation around interest rates, or fewer approvals on patient financing than you were seeing a couple of years ago.
Here's a practical implication worth sitting with: if a patient has 10,000 dollars available on a credit card and you present a 7,000 dollar treatment plan, financing that plan is a much smaller mental hurdle when money is essentially free. When rates are meaningfully higher, and it's worth actually checking what interest rate applies to any balance carried on your own credit statements, that same decision carries more weight for the patient. If a patient raises cost as an objection more than they used to, it may simply reflect that credit genuinely feels more expensive to them right now.
None of this changes a patient's actual oral health, they either have a dental problem or they don't, regardless of interest rates. What it does mean is that communicating value effectively matters even more in this environment, which is exactly why practices with strong sales and communication skills weathered prior downturns, including 2008 and 2009, without major disruption. If improving that skill is something you want to work on, the MGE Communication and Sales Seminars and our sales training on DDS Success both cover this in depth, links on the episode page.
So you have tightening credit, rising interest rates, and a couple of high-profile bank failures reinforcing that tightening further. Since a lot of DSO and private equity capital is debt-financed, these organizations are having to be considerably more careful about where and how they deploy both borrowed money and cash on hand. Anecdotally, we've seen this firsthand, and heard it from doctors outside our own client base too, DSO deals that were mid-process falling apart recently, not because of anything wrong with the practice itself, but because the DSO's financing fell through. We don't yet know if this is an isolated blip or the beginning of a broader trend, but it's worth watching closely.
Reason two combines a few related pressures: inflation, heavy managed care participation, and already-thin profit margins. I covered this in detail in last week's episode, but briefly, compounded inflation has run around 17 percent from March 2020 through March 2023, while many PPO plans are producing write-offs in the 40 to 50 percent range on a lot of procedures. Even a DSO benefiting from real economies of scale, better lab pricing, marginally improved payer negotiations, isn't going to close that entire gap. Fees exist at certain levels because that's genuinely what it costs to operate.
So you already have organizations running on thin margins, and if inflation keeps compounding while PPO reimbursement keeps compressing, the math gets increasingly difficult. Layer onto that the typical DSO acquisition structure: the original owner is usually asked to stay on for two to five years post-sale. That owner was frequently the primary driver of the practice's overall productivity, having genuine skin in the game in a way an employed associate simply doesn't. Once that commitment period ends and the original owner departs, replacing that same level of intention and investment isn't guaranteed, and productivity can decline as a result. On top of that, scaling smaller practices simply isn't the DSO business model, they're typically acquiring already-productive practices, generally at least 1.2 to 2 million dollars a year in collections, adding specialists or additional payer participation, not building a modest practice up from the ground the way an individual owner-operator would.
Reason three: DSOs are, in our view, overpaying for practices. The traditional dental valuation model, in place for decades, has been roughly 70 percent of the prior year's collections, adjusted somewhat for equipment condition or practice age. A practice collecting 500,000 dollars a year would traditionally sell for around 350,000 dollars under this model.
Most DSOs instead use what's called a captured DSO model. Since dental practice ownership laws vary by state, most states require a licensed dentist to own the actual dental practice and patient charts, while a small number of states, I believe Pennsylvania and Arizona among them, allow non-dentist ownership, worth checking your own state's dental practice act directly if this matters to you. Under the captured model, the DSO purchases all the non-clinical assets, equipment, staff, physical infrastructure, while a dentist retains ownership of the clinical charts and patient care decisions, since a non-dental corporation generally can't exert direct control over clinical treatment.
Rather than the traditional 70 percent model, DSOs typically pay a multiple of EBITDA, earnings before interest, taxes, depreciation, and amortization, essentially an alternate measure of a business's cash profitability, similar in spirit to net profit but calculated somewhat differently. Take a practice collecting 2 million dollars a year with 600,000 dollars in annual profit. Under the traditional model, that's a 1.4 million dollar sale. Under a DSO's five-times-EBITDA offer, that same practice sells for 3 million dollars, in exchange for the seller staying on, often for five years.
From a purely economic standpoint, given a choice between 1.4 million dollars and 3 million dollars, most people would reasonably choose the larger number, especially with a defined multi-year plan already in place. DSOs commonly structure this by paying out a majority upfront, say 80 percent, or 2.4 million dollars in this example, with the seller retaining a 20 percent ownership stake that gets bought out at the end of the commitment period, assuming the practice's numbers hold steady or improve.
So why do we think DSOs are overpaying? That 70 percent model worked reliably for decades for good reason, and one major factor is how much a business's value depends on the specific owner. A practice where the owner is genuinely the face of the business, it's known as Dr. Smith's office, typically wouldn't command more than roughly three times EBITDA in a standard business valuation, since the owner leaving represents real risk to future performance. Compare that to, say, a supermarket where the owner is essentially invisible to customers, nobody knows or cares who owns it, that kind of business can reasonably command a five or six times multiple, since the owner's departure doesn't meaningfully affect operations.
Right now, we're seeing DSOs pay multiples of five, sometimes seven times EBITDA for practices that are, by nature, deeply owner-dependent businesses. That's a real overpayment relative to how these things are typically valued elsewhere in the business world.
To be clear, if you sold to a DSO at a strong multiple and walked away well compensated, there's nothing wrong with that decision, and I'm not suggesting otherwise. If someone offered to buy my car today at full original price despite three and a half years of depreciation, I'd take that deal immediately too, as long as I understood exactly what I was agreeing to.
But here's where it gets more complicated for the DSO itself. Say a DSO acquires 20 practices, each valued at 5 million dollars, each generating 1 million dollars in annual EBITDA, for a combined 100 million dollar portfolio generating 20 million dollars in aggregate EBITDA. Because that combined portfolio is now a considerably larger business, it can often command an even higher multiple when sold as a whole, potentially 10 to 14 times EBITDA depending on the buyer. Sell 60 percent of a 240 million dollar valued business (20 million EBITDA times a 12x multiple, for example) to an investor, say a hedge fund, and that 60 percent stake alone is worth 180 million dollars, even though the original owners only paid 100 million total for everything in the portfolio. The original owners profit substantially, take their money, and often eventually exit entirely.
Private equity and hedge funds typically hold assets for three to five years before selling again, so eventually that DSO gets sold onward again, sometimes ultimately to a large institutional buyer like a pension fund. But by that point, if the original selling doctors have started departing per their contractual timelines, and revenues have softened as a result, the underlying assets are often worth meaningfully less than what was originally paid for them. The investors left holding that later-stage ownership are the ones exposed to that gap, not the original sellers, who've already been paid and moved on.
This is the part that reminds me of 2008 and 2009. Real estate was significantly overvalued heading into that period, and when prices eventually corrected back toward actual underlying value, it triggered a much broader market disruption. I see real structural parallels here. If someone buys a house for 300,000 dollars during a hot market, sells it for 800,000 dollars, and the market later corrects to 325,000 dollars, the seller who already cashed out is fine, it's whoever bought at the peak who's exposed. And notably, that kind of experience tends to make an entire market more cautious about similar bubbles going forward, which is part of why we haven't seen real estate speculation return to quite the same intensity as the mid-2000s. I'd expect something similar here: if a handful of DSOs run into serious, visible trouble over the next five or six years, it will likely cool future investment appetite in this exact growth model.
Reason four connects back to something in reason two: those original owner-operators are typically only obligated to stay two to five years. What happens after that commitment ends, particularly for practices already dealing with managed care pressure and inflation, especially if that owner was the practice's primary producer? Productivity can decline meaningfully, which eventually affects the DSO's broader financial picture. Some owners do choose to stay on happily, keeping their old office, their patients, their autonomy day-to-day, without the ownership headaches. But in our experience, many sellers don't plan to stay past their contractual obligation, since selling was their exit strategy from the start.
Here's a relevant recent example. A former MGE Power Program client from the early 2000s who owned three practices sold them to a DSO. They're now in the process of buying those same practices back, at roughly 29 cents on the dollar. That tells you something about the practices' condition after the original owner exited, and it likely created real headaches further up the DSO's ownership chain. But for this particular client, it worked out extremely well, essentially selling at a significant premium and later reacquiring at a steep discount, functionally walking away with a large profit while ending up back where they started. I'm not suggesting anyone plan around that outcome specifically, but it's a real illustration of how this can play out, and it's not impossible you could find yourself in a similar position years down the road if you do sell.
So as practices acquired under this model run into difficulty, someone eventually has to absorb them, another DSO, or potentially the original owner buying back in, as happened in that example.
One additional factor worth a brief mention, not quite a fifth core reason, but relevant context: a possible ban on non-compete clauses. The FTC issued a ruling that doesn't eliminate non-competes outright but makes them considerably harder to enforce. That ruling hasn't taken effect yet, the public comment period was extended through April, and if it proceeds, it would likely take effect around October. If you sold a practice and retain equity or a stake in it, your non-compete typically carries real enforceability today, worth discussing with your own attorney rather than relying on anything here as legal advice. But loosening non-compete enforcement could make it considerably easier for DSO-employed associates to leave for other opportunities, at exactly the moment when, as I covered last week, there's an unusually large wave of practice opportunities opening up for private practitioners over the next five to eight years. That could make DSO-affiliated offices harder to staff consistently going forward. Worth noting too, roughly 35 percent of dental school seniors surveyed in 2022 said they intended to work for a DSO after graduation, so there's a real pipeline of talent that may end up weighing these same considerations down the road.
So that's what we see building. What are we actually telling MGE clients? A lot of it echoes what I covered last week, which is genuinely worth listening to directly for the full data on current dentist demographics and market opportunity. But at a high level: if you're in private practice and worried the future belongs entirely to DSOs, you're in a good position, private practice has a strong runway ahead. If a DSO offer makes sense for your specific situation and you're comfortable with the terms, including the commitment to stay on, that's a legitimate, reasonable choice, do what's right for you and your family.
For private practitioners planning to stay independent, a few concrete priorities: get out of PPO participation if you haven't already, since ongoing inflation and reimbursement compression will keep pressuring in-network economics. If that feels difficult or impossible, we offer a free Fees and Plans Analysis reviewing your specific PPO participation and a practical path to reducing it, link on the episode page. Invest genuinely in your sales and communication skills, the same seminars and training mentioned earlier apply here directly. And seriously consider acquiring additional practices, a substantial number of practices coming to market over the next five to eight years simply won't be DSO targets, and represent real opportunity specifically for private practitioners, something I went into more detail on last week.
If you're currently a DSO-employed associate wondering what your own path looks like, there's genuinely never been a better window to open your own practice, roughly a five-year window by our estimate, worth starting to look now. Obviously honor your existing contractual obligations in the meantime, but if practice ownership has been a long-term goal, this is a strong moment to start actively pursuing it. The same applies if you're currently a dental student, even early in your program, there's still real time to position yourself for this opportunity by the time you graduate.
Private practice doesn't have to mean a single office either. Some of our clients run what amounts to their own small DSO structure, six, seven, eight offices with junior partners genuinely invested in each one. That model still preserves what I think matters most about private practice, real patient relationships and treatment decisions driven by clinical judgment rather than insurance company constraints, which is fundamentally what I believe this profession should be built around.
This ran a bit longer than usual, and covered more financial terminology than most episodes, so I appreciate you sticking with it. That's genuinely what we see coming. If you have questions about any of this, feel free to email me directly at jeffb@mgeonline.com, I'll include that on the episode page. If you want to learn more about MGE generally, find us online at mgeonline.com or call 800-640-1140. Have a great week, and we'll see you at the next episode.