Private Equity in the Dental Industry

Private equity has become a popular term in recent years within the dental industry, given the proliferation of dental support organizations (DSOs) that are backed by private equity. Despite the growing popularity of private equity, we have observed that the concept is often not well understood by surgeons and dentists. There could be a number of reasons for this, which may include a lack of prior experience with private equity or perhaps no formal education on the subject. Let’s consider what private equity is and why we believe dental practitioners should pay increasing attention to the role that private equity plays within their industry.

What is private equity?

Often referred to as “PE,” private equity is a type of alternative investment vehicle that’s created when a private equity firm raises capital from various types of investors, such as high-net-worth individuals and accredited investors, family offices, foundations and public pension funds.¹ The capital raised from these investors, commonly referred to as “limited partners,” is pooled to create a private equity fund that subsequently invests in various companies, known as “portfolio companies,” that the fund manager believes is aligned with the fund’s investment thesis.² The private equity firm, which serves as the general partner of the private equity fund, often plays an active role in either the management or direction of the portfolio companies, with the goal of increasing their value before eventually exiting and returning a profit to the general and limited partners. Unlike other alternative investments, such as hedge funds, the lifespan of a private equity fund can be as long as five to 10 years or more.

Additional characteristics of private equity often include:

• Illiquidity – investors are typically required to hold their private equity investment for an extended period³ with few (if any) opportunities to exit before the fund winds down.
• Smoother investment profile – private investments can avoid the “noise” of daily trading where non-economic factors like investor sentiment may unduly impact pricing 
  
• Enhanced returns/yields – uncorrelated returns may enhance total portfolio outcomes by lowering volatility and increasing risk-adjusted returns
• Flexibility and access – investors gain the ability to invest in differentiated securities, companies and asset classes potentially unavailable in the public markets
• Different regulations – unlike public markets, private equity funds are often unregistered with less regulatory oversight. They’re only available to accredited investors and qualified institutions with sophisticated knowledge of the investment risks inherent in private equities, and the financial ability to withstand potential significant losses

The appetite for private equity investments in dental practice portfolio companies, specifically, appears poised to continue to grow for a variety of reasons:

• The industry is viewed as a stable and non-cyclical investment
• Demand for dental services is inelastic, which means it does not wildly fluctuate with the overall economy
• The industry is still rather fragmented
• An increasing number of surgeons/doctors are turning to DSOs to help manage the nonclinical aspects of running a practice⁴   

What is a private equity recapitalization?

When a doctor or surgeon opts to affiliate their practice with a DSO, the financial consideration received may vary but often includes elements such as upfront cash compensation and rollover equity in the DSO. This initial tranche of rollover equity is often referred to as the “first bite.” For DSOs with private equity backing, there is often a focus on an additional secondary sale or recapitalization event in the future. This event, often referred to as the “second bite,” allows the surgeon/doctor partners to participate in a second liquidity event with their rollover equity. Recapitalization events seek to create liquidity for the incumbent private equity firm and its limited partners, and may simultaneously present an opportunity for the surgeon/doctor partners to liquidate their position entirely, partially liquidate their position and roll forward remaining equity, or roll forward all of the equity.    

There’s a host of quantitative and qualitative issues to consider when surgeon/doctor partners are faced with a secondary sale or recapitalization event. Common issues to be considered include (among others):

• Renewal of non-compete agreement
• Change of terms within the employment agreement
• Taxation impacts
• The trade-off between the certainty of upfront cash and participation in the potential appreciation of equity
• Personal financial goals and needs

Key takeaways for surgeon/doctor partners

We believe private equity’s role and presence in the dental industry is likely to grow given the numerous attractive facets of the industry. Surgeon/doctor partners affiliated with private equity-backed DSOs should have a fundamental baseline understanding of private equity before trying to make prudent decisions when an event like recapitalization occurs. Also, it’s critical to understand how your private equity interests contribute to your personal financial goals—doing so empowers you to make more informed decisions and improves your chances of creating financial independence for yourself and your family. 

At Corient, our team enjoys helping our clients live well, practice well, transition well and retire well. Our team centers our advice around you and focuses on simplifying your wealth and finances at every step so you can more fully enjoy the life that your wealth helps support.

¹ https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/private-equity
² https://www.investopedia.com/terms/p/privateequity.asp
³ https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/private-equity
⁴ https://www.mcguirewoods.com/client-resources/Alerts/2023/5/consolidation-dsos-secondary-private-equity-sales#:~:text=Dental%20practices%20enjoy%20high%20levels,advantage%20of%20economies%20of%20scale

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