Key Considerations to Protect Specialty Dental Practice Interests in Private Equity and DSO Transactions

Specialty dental practices can be attractive targets for private equity investors. Conversely, the sale of a dental practice to a private equity (or private equity-backed) organization can be an effective way to maximize the value of a specialty dental practice. However, there are a number of legal and regulatory issues unique to investing in professional health care entities that need to be carefully considered when engaging in transactions with non-professional entities.

A threshold issue is the extent to which the state in which the practice is located restricts non-professionals from having an ownership or other controlling interest in a professional practice, commonly referred to as the “corporate practice of dentistry” or “CPOD.”

To address CPOD issues, private equity transactions with dental practices often involve Dental Support Organizations, also sometimes referred to as Dental Service Organizations (“DSOs”). A DSO is a non-professional entity that acquires a practice’s non-clinical assets and provides critical administrative and business functions to multiple dental practices. Through the DSO, the practice can become affiliated with a regionally or nationally recognized dental network, which, through economies of scale, can streamline the practice’s administrative, business and marketing functions and improve gross revenue and profitability. Following a transaction with a DSO, the selling dentist typically continues furnishing professional services through a clinical entity for several years, often as part of a wind-down/retirement strategy. DSOs seek to align with general dentists and specialists, including periodontists, endodontists, and oral-maxillofacial surgeons. If you are considering a transaction with a DSO, it is imperative to engage in thorough due diligence, including but not limited to:

Evaluation of the Level of Services and Reputation of the DSO

Large DSOs can leverage their networks to negotiate better rates with payers and lower costs with dental suppliers. Many DSOs offer access to expensive technology for practice management that would otherwise be out of reach for small practices. In addition to administrative and management services, DSOs may also offer compliance and legal support services. Before entering into a transaction with a DSO, licensees are well-advised to evaluate the DSO’s offerings and interview other affiliated providers to determine their level of satisfaction with the post-closing conduct of the DSO.

Compliance with Applicable Law

The allure of a DSO’s offerings—often rooted in the licensee’s desire for freedom from the administrative hassles of running a practice—must be viewed in the context of a dentist’s ongoing obligations as a licensee, as well as applicable state and federal law. There have been numerous major enforcement actions against DSOs and their affiliated practices under the federal False Claims Act, in which settlements exceeded five and twenty million dollars for improperly submitted claims. Often, a provider or other employee with inside knowledge of the operations of the DSO will initiate the civil suit as a qui tam relator, or whistleblower, in order to obtain a portion of the government’s recovery against the defendant DSO and affiliated practices.

These settlements demonstrate the importance of assuring that a potential DSO arrangement will fully protect the provider’s independent clinical judgment with respect to the practice of dentistry. This is not only critical for compliance with fraud, waste and abuse laws, but also with respect to certain states’ prohibitions on the corporate practice of dentistry. If an arrangement violates a corporate practice of dentistry prohibition, the underlying management agreement may be adjudicated an unenforceable, illegal contract, and the practice will be susceptible to recoupment actions by payers for claims submitted under the illegal arrangement. Often, state dental boards reserve the right to issue fines or, even worse, suspend or revoke a dental license for violation of state dental practice laws.

The Financial Terms

DSOs require their acquisition targets to produce detailed records substantiating the value of the dental practice, including verifiable and accurate balance sheets and profit and loss statements, accounts receivable, patient volume, and projected revenue and profits, along with any industry-specific considerations, such as third-party payer contracts and referral sources. This type of information is critical for establishing the valuation of the dental practice during the negotiation of the purchase price and other related terms. The purchase price is often a combination of cash at closing and an earn-out tied to the provider’s post-closing performance.

The Importance of Assembling an Experienced Team

There are many nuanced, industry-specific issues that arise within dental transactions, so it is important for parties to engage experienced legal and financial advisors from the inception of the deal to the closing. In addition to the purchase and sale documents, the parties must consider patient records, patient credits, collection of accounts receivable, transition of the practice and employees, work-in-progress, corrective treatment, restrictive covenants, and updating state registrations among other issues.

Frier Levitt attorneys represent clients in a variety of dental transactions and have in-depth knowledge and understanding of DSO transactions. If you are considering alignment with a DSO or other dental transaction, contact Frier Levitt to speak to an attorney.