Dental M&A Markets: Buyers Looking for Acquisitions in 2022
Kevin G. Cumbus
After a wonky, barbelled mergers and acquisitions (M&A) market in 2021, with most transactions coming in the first and last quarters of the year (thanks largely to COVID), 2022 is seeing the most active dental M&A market in history. Four major forces are driving the market: (1) pent-up demand on the buy side, (2) fears around tax increases from the Biden Administration, (3) COVID fatigue related to business ownership, and (4) high demand for specialty practices.
Pent-up demand on the buy side-Private equity (PE)-backed dental service organizations (DSOs) have one mission: grow. They must grow for two reasons: (1) they have capital that has interest expense even when it is not put to work in acquisitions, and (2) the investors (limited partners) are expecting the PE group to provide them a return. PE-backed DSOs typically have a 60-month growth plan, and they exit once they hit their targets. In 2021, the debt capital markets all hit a pause on lending as people tried to figure out COVID's impact on the economy. This pause in lending resulted in a pause in buying (across all sectors), as many deals in dentistry are completed with a blend of equity (cash) from the PE company and debt (up to 4 to 6 times EBITDA) from a lender. Without the debt, deals did not get done. In 2021, many DSOs with which the author's company spoke hit only a fraction of their goal for acquisitions, and that drove an insatiable demand for new practice and group acquisitions in 2022.
Fears around tax increases-When selling a dental practice or group, the author's company has been able to negotiate an average blended federal tax rate of around 24%. This is because the taxes its clients pay are a result of negotiation around the allocation of the purchase price and the tax treatment difference between fixed assets (taxed at the ordinary income tax rate) and intangible assets (taxed at the long-term capital gains rate). When President Biden was pressing last year to increase long-term capital gains taxes to north of 37%, panic resulted. If this passed, the tax benefits of asset allocation on the sale would disappear. For example, on a $3 million sale, the net result of this proposed tax change would be an additional tax bill of $390,000! This fear of increased taxes drove many owners of practices and groups to press for a sale in 2022 that otherwise might have sat on the sidelines for another year or more.
COVID fatigue-Although the business of dentistry faired quite well coming out of COVID (many of the author's company's clients saw massive growth in 2021), the pandemic was hard on business owners. From PPP loans, to more stringent PPE requirements, to furloughs, firings, and hirings, to wage increases and employee shortages, managing a dental practice, much less a group, was no easy task during the height of the COVID shutdown and reopen. As a result, many dental practice owners decided it was time to sell and enjoy their life in other ways. These were not "fire sales"; these were solid businesses with excellent leaders who opted to give up the reins and stresses of business ownership and let someone else worry about payroll.
High demand for specialty practices-Orthodontic and pediatric practices have had DSO acquirors for many years now, but recently oral surgery, endodontic, periodontic, and prosthodontic practices have been in high demand from buyers. Over the past 5 years, starting with the formation of Texas-based U.S. Oral Surgery Management in 2017, a new breed of DSOs has focused exclusively on specialty practices, and the dental profession has seen the creation of many new specialty-focused PE-backed groups. The demand for specialty practices is higher than ever and is reflected in the exit multiples (Figure 1).
All four of these aforementioned factors fueled significant activity in the M&A markets in the dental economy in 2021.
As for 2022, it appears a low supply of new deals in the market is driving up prices. Consider the following: As of this writing there are fewer deals in the market in Q1 than in recent history, and there are more buyers with more capital than ever before. This disequilibrium in supply and demand drives up prices and creates a sellers' market. This sellers' market, however, is expected to disappear by Q4 of 2022 when the supply of businesses for sale returns to equilibrium levels.
To recap, M&A markets are expected to remain white hot until Q4 of 2022. Buyers are still at an acquisition deficit and are willing to pay premium prices for dental businesses to fill the lack of acquisitions that 2020 created. Specialty practices presently hold the reins when it comes to top dollar valuations, and many new platforms are expected to form.
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