A Look Ahead: The Dental M&A Landscape in 2021

Kyle Francis
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Like every business that involves close contact, dental practices were hard hit by the pandemic. Most practices closed for all but emergency services during the spring lockdowns. Almost all have since reopened. And while the ADA says revenue is down in total, many practices have had banner months in the five months since they have been allowed to open up again.

But for some practices, expenses are up because dentists have decided to space patient visits out to reduce contact points. Others have incurred extra cleaning costs and are using more personal protective equipment.

These trends have increased dentists’ interest in selling their practices to investors or joining dental service organizations (DSOs). The consolidation trend was accelerating before the pandemic, but concerns about reduced revenue and increased overhead have more dentists considering their options.

With that in mind, here are some thoughts about the outlook for practices and mergers and acquisitions (M&A) activities in 2021.

The Pandemic as an Industry Resiliency Proof Point

The industry took a hit, and there’s significant anxiety among individual practice owners, which is understandable. But this unprecedented situation also illustrates why private equity groups view dental practices as such an attractive investment opportunity. Investors consider dentistry a “recession-proof” business for good reason. It’s not possible to defer dental services forever.

Specialty practices like endodontists and oral surgery groups proved especially resilient during the pandemic. People still needed root canals and other emergency procedures, and practices adapted to the pandemic quickly, safely providing emergency services to patients. After all, people who work in the dental industry are used to wearing protective gear. There’s less of a learning curve in the sector. Revenue and practice valuations for many specialty practices actually increased this year.

Revenue lagged for general practices, but many are starting to make up for it now by meeting pent-up demand for services. Some patients plan to avoid getting dental care until vaccines are distributed. But investors know dental care can’t be postponed over the long haul, and the longer care is put off, the more expensive treatment is. Delayed cleanings lead to cavities, unfilled cavities lead to extractions, which lead to implants, and so on.

Valuation Methodologies in Flux

While the dental industry is recovering, the business pause poses some process challenges for investors. To deal with a situation without precedent in modern times, investors are looking for new ways to determine practice value.

Normally, investors would analyze the past 12 months of earnings (net income) with interest, taxes, depreciation, and amortization (EBITDA). But due to the pandemic, many practices experienced two months with little or no revenue and then a third with a revenue spike.

So, investors are approaching valuation in different ways to account for the COVID-19 effect on revenue. Some are writing off 2020 entirely and looking at pre-pandemic EBITDA. Others are gathering data for a 15-month period and disregarding three outlier months. Some are looking at revenue before and after lockdown periods to determine what’s normal. There are pros and cons to all of these methods, but the bottom line is that investors are trying to standardize their valuation approach.

Practice values are holding steady. Aside from the blip caused by the initial lockdowns, deals are accelerating in 2020, and that’s likely to continue. Some investors are restructuring deals to decrease the amount paid at closing to offset risks. Others are aiming for longer-term employment contracts with dentists or structuring deals to ensure the selling dentist still has a performance incentive.

Wildcards to Keep in Mind

Practice revenue recovery from the pandemic is somewhat like recovery from a natural disaster. So far, the path has been similar to what dental practices in cities like New Orleans or Miami experience after major hurricanes. The pandemic doesn’t leave the practice building damaged like a natural disaster would. But while dentists don’t have to rebuild their offices, they may have to rebuild teams and/or wait for patients to come back.

One wildcard to look out for is loss of staff due to the pandemic, especially for practices located in rural areas. There was already a shortage of hygienists and, if a practice lost staff with those valuable skills, post-pandemic recovery could become more challenging. It’s possible that this will show up in a practice valuation factor at some point.

Commercial real estate is another wildcard. The pandemic may have far-reaching effects on real estate value because many companies have or are considering allowing their employees to work from home permanently. Dental practices don’t have that option, but dentists who own their practice real estate may find a commercial property glut affecting their building’s value nonetheless.

Post-pandemic politics might also affect the M&A market. Regardless of who’s in charge, the government will eventually have to raise taxes to address the massive relief spending, and it’s easier to raise taxes on entities than it is on individuals. So, it’s likely that capital gains taxes will be raised eventually, which will cut into profits when dentists sell a practice.

There’s a lot of uncertainty right now, not just in the dental industry but across the board. It will be months if not years before the economic effects of the pandemic are fully understood. But DSOs have capital, and private equity groups see the dental industry as an attractive investment opportunity. No one can predict the future, but the 2021 M&A landscape looks positive.

Mr. Francis is the founder and CEO of Professional Transition Strategies. He has worked in the dental and medical field since 2005 consulting for practices, medical device companies, and groups of practitioners. He has used this knowledge to consult more than 50 startup companies and dental practices, as well as help build well over 100 dental and medical practices across the country. He has owned all or part of more than 20 practices and has been an investor in multiple DSO concepts. He created Professional Transition Strategies (formerly Headwaters Practice Consultants) to facilitate the sale of over 350 dental practices as a buyer’s representative, seller’s representative, or transaction broker. He and his family live in Colorado Springs where he enjoys golfing, skiing, and hunting as often as he can.

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