Think Twice Before Entertaining an Unsolicited Offer for Your Business
Kevin G. Cumbus
Most dental practices in America with over $1 million of collections or more than one location have likely been contacted by and received an unsolicited offer from a buyer. Buyers in the dental market like to connect with dentists and groups directly to inform them of their EBITDA (earnings before interest, taxes, depreciation, and amortization) and value. This allows the buyer to control the narrative, the financials, and the process. It puts them in the driver's seat in the relationship as they work to win the practice over and shield it from other opportunities in the market. The less that you, the practice owner, know, the better for the buyer.
Dental service organizations (DSOs) and private equity groups (PEGs) keep track of how many deals they close each year that are the result of their outbound marketing efforts, and they are proud of these numbers. These are deals they won in a noncompetitive process. They simply had to pay just enough to convince the seller to commit-an amount that usually was well below market value. While there is nothing wrong with this, per se, the seller should beware.
By taking an unsolicited offer from a buyer without allowing for a competitive process, practice owners may be doing a disservice to both themselves and their estate. By taking that offer, as enticing as it may seem, the seller almost certainly will be leaving money on the table and, moreover, may miss an opportunity to make a deal with a partner that would be a much better fit for the long run. This is not an indictment of any one DSO or PEG; but practitioners should know that value is being destroyed on the "sell" side and vast amounts of wealth are being created on the "buy" side through deals made in this manner.
Bringing a Knife to a Gunfight
My favorite scene in one of my all-time favorite movies, Raiders of the Lost Ark, is when the cool, swashbuckling adventurer Indiana Jones takes down a sword-spinning bad guy with a nonchalant single gunshot. While it has always brought me amusement, the message has always stayed with me: never bring a knife to a gun fight.
Working through an unsolicited offer from a private equity (PE)-backed DSO is the equivalent of doing just that. Initially, the conversations may feel welcoming. However, the seller should know that behind the friendly, accommodating business development person with whom you are meeting (perhaps over plates of sizzling steaks and bottles of red wine) and who may be promising you rich returns on your equity, is a team of analysts, high-priced attorneys, brilliant CPAs, and PE experts working to buy your business. These business pros are all wading through your practice's numbers, helping the CEO pull together an offer that they hope you will accept. While they may leave some wiggle room in the offer for you to feel good about negotiating the deal and may appear to be crafting the deal to "meet your needs," be assured that they have no intention of paying more than they have to or taking on too much risk. As the seller, you are a team of one (maybe two if you have a good CPA or office manager), while they are a team of many. While you are hustling to stay on top of your clinical practice, they are meeting regularly to run models and cash flows on your business and are fully focused on completing your deal for the least amount of money and risk to them. In deals where the seller is unrepresented, he or she is at a clear disadvantage.
Information asymmetry exists in any transaction where there is a buyer and a seller. It is present when two parties have unique knowledge about an asset being sold. For example, a used car salesman might know that a car on his lot was in a massive accident, has a bent frame, and leaks a pint of oil per day, but the buyer only sees a shiny new paint job and new tires. Buyers make decisions based only on what is apparent to them. When DSOs are considering making an offer on a business, they ask questions, and lots of them. This is done to try to shrink the information gap that they face (Figure 1). They start by asking for financial and operational information, which may seem innocuous enough to the business owner. This opens the door, and the buyers ask for more information, and then begin seeking clarification on certain items that they have discovered. In this process, buyers are continually shrinking their information gap to gain more clarity into your business, all the while hoping you will not work to shrink the information gap you have regarding them.
Some examples of this knowledge gap that uninformed sellers face are: the quality of the buyer's balance sheet, the quality of the equity being offered, deal knowledge (what options are there?), the culture of the buyer, and the buyer group's reputation in the broader market. The seller must also consider whether the group can be trusted with his or her life's work, and whether the group will really follow through on what they say they are going to do.
By the time the offer comes in, the information gap is likely to be very small on the buy-side while an information chasm will probably still exist on your side of the table. At this point buyers have information that you do not, which they use to their benefit and not to your gain. Buyers know what they will ultimately likely sell the business for and what they can afford to pay while still earning a high economic return for their shareholders and partner doctors (through the arbitrage on the multiples), all while allowing you to feel like you received everything you wanted in the deal.
The buyers are financially incented to pay you as little as possible and still get a deal done. Again, this is not a knock on the buyers. However, potential sellers should not misinterpret buyers' questions about their business as simple curiosity. Rather, it is a way to get you to reveal information about your business so that they can understand it as best as possible.
Sell Through a Marketed Process
A private equity group that owns a DSO would surely not sell to the first group that provided them an unsolicited offer. This is because they know that the only way to maximize the value of their investment is to go through a marketed process. Even PEGs want a mergers and acquisition (M&A) advisor/investment banker to help them prepare their business for sale, craft a story for buyers, and drive a competitive process. They know an M&A advisor will add value by ensuring that they get exposure to the right buyers at the right price. Sellers only get one chance to monetize their efforts and cash in their chips at the highest possible value. Competition and deal tension drives up value. An advisor does the due diligence that the buyers are going to do and prepares the owners for the questions that they are going to face. By the time the business goes to market, everyone on the sell-side is aligned and ready for battle.
PEGs understand that they need to prepare to sell to maximize their value. When they submit an unsolicited offer to buy a dental practice, they know the practice is unprepared, and they will look to take advantage of that. Before entertaining an unsolicited offer, a practice owner should know the rules of the game, team up with an M&A advisor, and plan to win.
About the Author
Kevin G. Cumbus
President, TUSK Partners, Charlotte, North Carolina (tusk-partners.com), a dental M&A advisory firm for large practices and DSOs