This article is a guest post written by David Kaye, Michele Masucci and Michael Schnipper of Nixon Peabody.
The health care industry continues to be a key driver of private equity growth in the United States. In 2018,
Opportunities for growth within the health care industry remain particularly attractive as fears of economic downturn steer investors toward this historically economic resilient industry. Retail health, specifically the consolidation of dental clinics, is one area of rapid private equity investment. Noting the present fragmented landscape of dental health, dental clinics, as well as the greater retail health sector, provide attractive high-margin upside to private equity firms eager to deploy capital. Dental care is increasingly being recognized as vital to a person’s overall health care. Dental Support Organizations (“DSOs”) are an avenue for such investment.
Methods of DSO formation turn upon whether a particular jurisdiction restricts the corporate practice of dentistry. In jurisdictions that restrict the corporate practice of dentistry, DSO formation generally involves the formation of an investor-owned DSO. Under this model, the non-clinical assets (including non-clinical employees) of a target dental practice (generally a professional corporation or other professional entity (“PC”)) are transferred to a DSO. In turn, the investor-owned DSO provides the PC dental practice with non-clinical business and financial management services. Such services are provided in return for an administrative services fee, set at fair market value, and governed pursuant to a long-term administrative services agreement (“ASA”). To ensure a desired level of private equity investment, the target PC must transfer sufficient value to the investor-owned DSO through the ASA.
In jurisdictions that do not restrict the corporate practice of medicine, the DSO may simply acquire the equity of the dental practice (as opposed to purchasing the entity’s non-clinical assets). Although not necessary, an ASA may be put in place to manage the business and financial services of the dental practice, and a fee may be paid to the DSO in return for its services. Alternatively, the acquiring private equity firm and the legacy dentist owner(s) may merely amend the governing documents of the acquired practice to address issues such as governance, profit sharing and restrictions on transfers.
Benefits and Drawbacks of DSO Formation:
DSO formation offers a multitude of possible benefits ranging from the reduction of costs, to improved operational efficiency and limitations of liability. DSOs enable clinicians to negotiate rates as an organized body, providing greater leverage for improved payor rates. Such enhanced negotiation strength, as well as greater overall organization size, support an improved ability to negotiate lower costs for a wide range of goods and services. Through the implementation of standardized clinical and administrative processes, DSO formation enables simpler compliance with regulatory agencies. Further, centralization of administrative tasks reduces costs by eliminating redundancy of process across offices. Paired with improved regulatory compliance, such centralization can enhance overall administrative efficiency in critical areas such as billing and may prove helpful in identifying clinical best practices. Finally, because each dental practice managed by the DSO remains a separate legal entity, the liabilities of each individual practice remain limited to the practice itself. Such limitations of liability may prove particularly useful upon the acquisition of new dental practices, as the DSO is shielded from the potential, unknown liabilities of newly acquired practices. In addition to these operational advantages, a dental practice that achieves a certain level of scale may find it easier to attract private equity investments if it has already restructured into a DSO structure. The existing DSO structure and documents may simplify the private equity investment transaction structure and, in certain scenarios, provide for a tax advantage to the dentist owners.
The primary drawback of DSO formation is increased short-term costs. Formation of DSOs may result in increased costs associated with the corporate reorganization, and the standardization and centralization of clinical and administrative processes. Reorganization and implementation of a complex corporate structure
Conclusion: Given anticipated 2019 health care private equity growth, DSOs are an attractive investment opportunity. Although greater short-term costs and the strain of administrative reorganization may present barriers to entry, successful DSO formation and execution present both clinicians and private equity firms the opportunity to achieve high margin financial returns.
 Deal information sourced from PitchBook Data, Inc., as of 12/31/2018.
 Deal information sourced from PitchBook Data, Inc., as of 12/31/2018; PricewaterhouseCoopers, Private Equity Deals Insights Year-end 2018 2 (2019), https://www.pwc.com/us/en/private-equity/publications-overview/assets/pwc-private-equity-q4-2018-deals-insights.pdf.
 Adam Lewis, Here’s Why 2019 Could be Another Fundraising Boom Year for US PE, PitchBook, Feb. 25, 2019, https://pitchbook.com/news/articles/heres-why-2019-could-be-another-fundraising-boom-year-for-us-pe.
 Bain & Company, Global Private Equity Report 2019 25 (2019), https://www.bain.com/contentassets/f652f8c87c2f4280842140d5fec1db06/bain_report_private_equity_report_2019.pdf.
 Nirad Jain et al., What’s Behind the Surge in Retail Healthcare Deals? 1 (2018), https://www.bain.com/contentassets/3af5172855224fc9818f571c49ef000e/bain_brief_behind_the_surge_in_retail_healthcare.pdf.