Dental Management Service Organizations
It's an emerging story of risks and rewards.

Rewards and risks are abundant in the practice of dentistry.

Dentists are rewarded by an appreciative public for their provision of quality dental care, by their achievement of respect in their communities, and by the assets they accumulate over a lifetime of work.

Risks appear as soon as young dentists graduate from dental school. Should he or she take the financial risk of starting a solo practice, or opt for the relative safety of a partnership? Liability, collections, equipment selection, dealings with staff -- all are included in the assorted other risks that attend a practice almost daily.

Reward and risk also abound in a relatively new practice management paradigm, that of dental management service organizations. Known by several names -- dental management service organizations (DMSO), dental practice management companies (DPM or DPMC), practice management companies (PM) -- the acronyms for these entities are relatively new entries to the industry lexicon.

With their emergence, voices representing significant areas of the profession, industry and government are straining to be heard. And for every shout of "hurrah," there is an admonition to "tread carefully."

Such is the nature of debate of an issue whose facts are being formed and whose ultimate impact is not clear.

What is known is that DMSOs are a growing force within dentistry, and that individual dentists must do their homework in considering the organizations' appropriateness.

Many dentists are finding that becoming part of a DMSO fits with their philosophy of providing care and with their financial aspirations. Others urge caution, citing the uncertainties of the financial market and of who actually is calling the shots when it comes to determining treatment.

Regulators are on the fence. While dealing with the DMSO question is high on the California Board of Dental Examiners' to-do list, the organizations currently aren't specifically addressed by state law or regulation.

Even associations such as CDA and ADA are cautiously probing the relatively new field of play, offering information and stressing the need for education, but also carefully watching the game develop.

"What can be said for sure is that any dentist considering signing up with a DMSO should proceed with caution, just as in any major business transaction," says Raoul Renaud, CDA's chief legal counsel.

The financial collapse of First New England Dental, a publicly-traded DMSO in Boston, early last year and stock market volatility, put the industry and its investors on notice and has somewhat slowed expansion. In California, however, DMSOs are working hard to make more extensive inroads.

Essentially, DMSOs are individual practices that are purchased by a company and managed to varying extent by that company. Dentists who sell their practices to a DMSO often become employees of that company. The parent companies consolidate dental practices in an attempt to gain market share, increase the profitability of practices they acquire, and eventually, go public with their stock.

Although known by their various acronyms, DMSOs share many common features, according to A.J. Smith, DDS, immediate past chair of ADA's Council on Dental Practice.

"In my experience with meeting people involved with various DMSOs, each one claims to be different or better than the rest," Smith says from his Salt Lake City practice.

"There are many, many common threads that are similar or identical in the seven DMSOs we encountered and the many others we learned about," Smith says. "There are commonalities in all of them, and it seems that from my observations most often the things they say that are different are very similar, so my concern is the things that plagued First New England Dental I expect may crop up in other DMSOs."

Smith was involved with focus groups that met around the country last summer to learn about DMSOs through dentists that had been involved, as well as through discussions with DMSO industry leaders. The Council on Dental Practice compiled its findings into a report to the ADA Board of Trustees.

Richard Ryan in Mission Viejo is a principal in a company that assists dentists in the decision making and negotiation process when considering the sale of a practice to a DMSO. He brings up a basic fact about the dental practice industry that has captured Wall Street's attention.
"Remember why Wall Street is interested, and why they have put up a half-a-billion dollars so far," Ryan said. "Dentistry is one of the last cottage industries. As an industry, the average practitioner earns over $100,000 a year with five weeks of vacation with a 96 percent or better collection rate and 40 percent profit margin that makes investors drool on themselves.

"There's so much money out there, and it's Wall Street's job to find these industries or professions to consolidate, because that's what they do."

Experts agree that the stock market's wild ride for the last few months has slowed the formation of DMSOs. An expert with his eye on the national DMSO scene gave his assessment.

"Early in 1997, these companies were going public at the rate of about one a month, but this has somewhat dried up because of the downturn in the stock market, but particularly the initial public offering market, which is now the lowest it has been in about 10 years," says Sanford B. Steever. He edits the Dental Practice Acquisition Report for Irving Levin Associates, Inc., a New Canaan, Conn., research and publishing company which tracks merger and acquisition activity in the national health care market.

"We attribute the previous growth to the availability of capital, particularly in the Independent Practice Organization market in 1996 and '97, to grow dental practice management companies."

Steever says that the companies raise capital on the stock market but that source has dwindled with the market's contortions. Subsequently, companies that would have sought money on the IPO market are now going to venture capitalists, or combining with already publicly traded companies. Ryan also said that now that the stock market is volatile, investors aren't looking at DMSOs as favorably as in the past.

"What's changed is there is not the allure or the promise of an initial public offering out there like there was in the last two years that made some people wealthy," Ryan says. There aren't as many emerging as national players, so we'll have national (DMSOs) branding offices with a common name, marketing during prime time TV, and some will succeed."

Steever says that while not as many deals are being made, the ones that occur are bigger.
"The number of dentists involved is rising, even though the number of deals are dropping, because DMSOs are targeting bigger organizations now," he says.

Data in Steever's Dental Practice Acquisition Report shows that in the 12 months ending June 30, 1998, Florida was the most active state with 27 DMSO deals completed. Second was California with 11, and Texas was third with 10. Those 48 deals were out of a total of 107 deals in 28 states. Steever says the market capitalization of all dental practice management companies in the nation at the end of December 1997 was about $1.06 billion. Three orthodontic companies accounted for more than 50 percent of that amount, so, "that's where the really big money is."

According to Steever, three of the 12 publicly traded DMSOs in the country operate in or are headquartered in California, and two of them specialize in orthodontics; OrthAlliance is based in Torrance, and Omega Orthodontics is in Acton. Gentle Dental, based in El Segundo and specializing in general dentistry, is the leading provider of dental management services in the western U.S. and is one of the largest providers in the country with annual patient revenues exceeding $140 million.

Steever says the very nature of the dental industry makes it especially attractive to DMSOs and their investors.

"In general medicine or HMO, you go in to see a doctor and pay a copayment, and HMO picks up any unforeseen costs above that, so it's hard for them to predict what their costs will be," Steever says. "In dentistry you buy dental insurance and get two cleanings and a few hundred dollars above that. If services go above that, you pay for it. So dental insurers can predict how much they will pay out, so they don't bear as much risk for unexpected costs."

DMSOs have been a major player in the dental industry on the East Coast since their arrival on the scene about two years ago. Now the West Coast is seeing an influx.

"On the East Coast they've sort of saturated the market," says James R. Pride, DDS, owner of the Pride Institute in Greenbrae, near San Francisco. The Pride Institute has about 400 dentists enrolled in graduate-training programs.

When dentists get inquiries from DMSOs, Pride and his staff evaluate agreements, give advice, and track the stock of the companies.

"All the ready takers back East have already taken, and now the DMSOs are into the hard sells," Pride says. "So now they're here where the easier sells are. We're getting activity here in the form of questions from many dentists who are getting the initial letters of inquiry from DMSOs."

Arthur A. Wiederman, a Tustin-based certified public accountant specializing in dentistry, outlined the concept under which the typical DMSO operates.

"Dentists who sell their practices to a DMSO typically will receive a combination of cash and stock for the practice's value," he says. "The company charges the dentist a management fee, ranging from 13 to 20 percent of gross collections, and the company's income is made up of those management fees.

"The theory is the larger the gross of the dentists, the more management fees they pay to the company, which increases the bottom line, and that increases the value of the stock. They send people into member dentists' offices to teach them how to increase their income to increase those management fees."

Wiederman says that if the fee were 15 percent, the dentist would have to increase gross revenues by about 20 percent to 25 percent to cover costs for the increased production and to pay the increased management fee.

"The tradeoff of the short-term reduction in income is cash and stock in the publicly owned company," Wiederman said. "If the group does well, you make money back in multiples by owning the stock. There is a downside as well: the risk of the stock declining."

Robert S. Gartrell, DDS, is managing director of two companies involved in dental practice sales and appraisal in Yuba City, Calif. He says that dentists contemplating affiliation with DMSOs must study the company's stock carefully.

"They have to look at the company's ability to withstand the vagaries of the economy, whether it can make money, and then what are options to liquidate the stock, who can buy it, when it can be sold, and how its value is established," he says. "Many dentists are astute investors but don't look at this as closely as they should."

Experts say reasons vary why a dentist, who may have spent many years building a successful practice, would want to sell to a DMSO and take the risk of the stock declining. One reason is that a selling to a DMSO might provide money needed to fund an impending retirement. Another is that a dentist might be ready to relinquish many practice management responsibilities. There are also cases where a dentist with multiple practices wants to sell one to gain some cash and additional free time.

"Depending on the deal's terms, it could be advantageous to someone who wants to retire in a few years," Gartrell says. "One of the single largest problems all small businesses have is what happens to the business from the succession standpoint. So a dentist must choose between bringing someone in to buy the practice, or sell out to a DMSO and work there until retirement. So it's just one of the choices you can make, provided the deal is reasonable."

Another expert says the issue of great concern to dentists who are nearing retirement age is that they feel they can't sell their practice for as much as they think it's worth.

"Usually when a dentist calls me, he will say, 'You know, I haven't funded my pension, and here's a chance to get $200,000 to fund it,' " Pride says. "That's the No. 1 selling tool. The dentist says that he's missed out of all the good stock deals, and they've convinced him he will become a multimillionaire."

Smith says stock options and the promise that the stock's value will increase is a big lure to those nearing retirement.

"To me, it could be like selling your practice and going to Las Vegas to make it big," he says. "It's a real gamble. I'm not sure I would want to risk my practice and my retirement on the theory that the stock market will make me a millionaire."

Wiederman counseled a dentist who didn't want to deal with managing his practice and was considering a deal with a DMSO.

"I looked at him and ran the numbers, and I told him that in this case he had to understand that if he did this deal he'd always have to manage the practice," Wiederman says. "I told him that the DMSO will not put in someone to manage his employees and vendors. They will only make management consulting professionals available to come in once or twice a month to give advice. I told him that I can refer him to those people, and for him this doesn't make sense."

Ryan provided an example of a transaction not tied to retirement or to practice management reasons.

"I had a client who was a practitioner in Northern California with two locations, and both practices were growing," Ryan says. "He lived in the Santa Cruz area, just had a third child, and found himself pressured trying to practice and manage two locations and still find time to spend with his family. So he decided to keep the practice where he lived, and to sell one. The DPM gave him a cash deal, and he walked away with close to half-a-million dollars."

Wiederman emphasizes that all deals are different.

"But the bottom line with each individual is to look at the objectives of why they want to do this and what they're trying to accomplish," he says.

A dentist who took the plunge into the world of DMSOs is Richard A. Harder Jr., DDS, who operates a dental group in Irvine for Gentle Dental. He sold his practice in April last year.

"The main reason I made a change was that my practice is very large," said the 1979 graduate of the University of Southern California School of Dentistry. "It's hard to sell a practice worth over a million dollars. So after having practiced for about 20 years, I began to realize I would have to decide how to get equity out of my practice, and still continue to be involved. I knew that with Gentle Dental I could restructure my practice for a premium and have a long-term association with them."

Harder had worked with a dental group management company for about 10 years.
"Then when they merged with Gentle Dental and the company went public, I decided that this might be a good way to go forward with the plans for my practice," he says.

Harder says he wanted to disengage from some practice management responsibilities, yet wanted to maintain some control in his clinical practice.

"I see all the payables and approve them, and the company provides a lot of accounting and administrative support. But I can still monitor costs," he says.

DMSOs count on the business acumen of business management professionals to run the company, but state laws, including those in California, restrict ownership of dental practices to dentists. Some DMSOs meet the requirement, while others manuever around it.

"Very frequently the DMSO contracts with a dental professional corporation," Smith says. "The dental corporation then buys the practices, so the dentist technically owns the practice to comply with state laws."

Harder's arrangement is a different case entirely.

"I have my professional corporation contracted long term with Gentle Dental, and I own the practice in terms of the professional staff and the records," he says. "I still manage the dental group personally."

Robert H. Christoffersen, DDS, president of the California Board of Dental Examiners, says DMSOs aren't addressed in current law and that it is a high board priority to study the issue closely. An ad hoc committee will be formed to help determine how DMSOs will be regulated.

"In their various forms, DMSOs have rapidly bought up practices, and we're finally getting a handle on what form or forms they are taking, and now we're going to address it," he says.

Christoffersen says the BDE does not categorize DMSOs as good or bad.

"We want to do what's best for the patient, and in the long run, what's best for patients is best for dentists," he says. "The bottom line is that DMSOs don't fit into current law, so we have to either redefine them through the Dental Practice Act, or redefine them through statute."

Renaud, the CDA's attorney, says that there is such a broad spectrum of types of DMSO's that it is impossible to state that all DMSO's are legal or illegal, or that they are all good or all bad. He urges caution and thoroughness when contemplating entering into a deal.

"Tell the company that you will insist on receiving copies of all documents and having them reviewed by your lawyer before you will sign," Renaud says. "If the company refuses, saying the documents are 'proprietary' or 'confidential,' be very suspicious."

Smith says that if he were considering a DMSO, the first thing he would consider is the people promoting it.

"I would learn everything I could about them and their past business," Smith says. "They are using entrepreneurs who are looking to make a big profit from your practice."

Next, Smith says that from a practice standpoint, he would determine if the arrangement would be good for him and if he would like being an employee.

"If you can get past the practice issue and still feel good, then you have to consult a financial advisor. Get competent financial advice," he says.

Finally, Smith says that if the deal is still attractive, the legal considerations must be dealt with by experts.

"If you make it through all these hurdles, then you can make the decision," Smith says.

The president-elect of the Pacific Coast Society of Orthodontists offers similar advice.

"The final crux for our recommendation to our members was that we didn't say you should or shouldn't join, but you should be very careful before signing an agreement," says John E. Grubb, DDS, of Chula Vista, Calif. "Have it looked at by professional attorneys and accountants."

Renaud says that in addition to contract review by a dentist's attorney, the ADA's Contract Analysis Service -- offered through CDA's Council on Dental Care -- is helpful.

"If you do decide to go with a DMSO, be very conscious of what your contract says," Renaud says. "It will govern any disputes or controversies that may arise in the future."

Harder investigated thoroughly before making his decision to affiliate and contract with Gentle Dental early last year.

"Over the years, I had talked with some dentists who were involved, principally in professional corporations that allowed them to maintain some control of their practices, and they had spoken well of Gentle Dental," he says. "I had talked with experts, met with their chief financial officer and others in the company before making a decision. I also got advice from my accountant and attorney who scrutinized the contract, and I was very personally involved."

Pride says that upon a thorough reading of the contract, dentists will find that many refer to managed care and that many DMSOs believe the future is in capitation, PPOs, or similar programs.

"They will usually have a clause about the payer mix, including general language like the average patient will be enrolled in PPO or capitation programs, and they say they expect only 30 percent of the practice to be fee-for-service."

According to Gartrell, the current climate of the dental market in California makes this a fact of life.

"With various state projects such as Healthy Families, there are managed care companies out there gaining contracts," he says. "And frankly, that's a part of the marketplace you just have to get used to. Many dentists don't want to participate in a managed care program, but under a DMSO they may have to. This can put a dentist into an ethical situation, too. Can they provide quality care at the compensation level provided?"

Harder says he now cares for more fee-for-service patients than when he was in private practice.

"I got involved with managed care years ago, and now we're moving more back into fee-for-service," he says. "I'm seeing less growth in managed care and more new and established patients in traditional indemnity plans as opposed to capitation."

Harder also insists that very little has changed operationally.

"I'm working with the same staff, and there was no major impact on our operations or on our patients," he says. "The company provides the management of the nonprofessional assets, including staffing, while I manage the professional staff. So, we work synergistically together. And I have a five-year contract as a managing dentist, so it's a very fair arrangement."

A dentist who sells a practice to a DMSO will provide from 13-20 percent of the practice's gross to pay for management fees. For those fees, the dentist typically will receive the following services: 1. DMSO will actively market the practice to increase business. 2. In some cases, DMSO will take over bookkeeping, accounting, and billing. If not, DMSO closely audits in-office functions. 3. DMSO provides management consulting services. 4. DMSO, in most cases, centralizes supply and inventory to reduce costs.

According to Gartrell, any contract a dentist is considering should provide practice control or ownership for the dentist should the DMSO go out of business.

"That could be dicey in the legal sense," Gartrell says. "There should be at a minimum some clause that allows dentist to hold onto the operation should the DMSO go under."

Harder's contract contains such a clause.

"I looked for the possibility to reverse the transition where, if for some reason the industry went sour, I could still have my practice," he said. "So it's important that everyone should look at all of these factors if they are considering such arrangements."

According to Harder, there is a fundamental difference between private practice and operating an office under the DMSO concept.

"The major thing you have to realize as a sole practitioner owner is that your staff looks to you solely for direction. By contracting with a DMSO, you have to be a team player working in a group because you have some shared responsibility," he says. "After my merger-acquisition, there has been more team spirit, and less of an autocratic workplace, and that's provided some fresh air for me."

Ryan says that while many people in the industry perceive DMSOs as negative, that doesn't tell the whole story.

"I think that with any new business or change there are things we can point at that are negative," he says. "First New England Dental has been the most prominent, but there is very little focus on more than two dozen others out there buying practices and at some level succeeding."

Ryan added that regardless of whether a dentist has interest in selling, practice valuations have never been better in the last 25 years.

"Also, I have had a large number of clients over the years who have built up very financially successful practices that are cash cows," he says. "But most of the dentists have not identified an associate or combination of associates that can buy him out, so the dentists have no good exit strategies. A DMSO can provide the answer."

Are DMSOs here to stay? Smith thinks they are, especially in the field of orthodontics. "There are a couple that are very successful," he said. "One of their CEOs says they want to be the Pearl Vision of dentistry. However I think some of the others may not be here to stay. They are not as well capitalized and not as well thought out."

Ryan says that he and the others can't decide if consolidation of an industry is a good or bad thing.

"That's what the market will decide," he says. "There is not in most things all good or all bad. It's up to those to either seek out those opportunities or not."