Manage Integrate Private Equity-backed Dental Service | FTI (2024)

DSO rollups have been a popular investment strategy in the healthcare sector among private equity sponsors in recent years. However, some DSOs have struggled to achieve targeted synergies and integrate effectively despite the promise of scaling an attractive business model. In order to maximize value from their portfolio of dental practices, DSOs must address a variety of challenges common within the dentistry subsector. Stakeholders should be aware of the risks and opportunities of DSOs within their portfolio prior to investing in these platforms, and need to develop corresponding mitigation plans.

Trends in the DSO Industry Highlight an Appetite for Investment in a Fragmented Market

Over the past decade, the dentistry market has experienced significant growth in private equity-driven M&A activity, most notably in “growth” and “add-on” transactions.¹

Chart 1: Dental PE Deal Count by Type ²

*As of 03/31/24

Specific attributes of this industry, including a higher proportion of private pay users, lower regulation, and more predictable cash flows, has led to the rise of Dental Service Organizations (DSOs) within a large, growing, and relatively fragmented industry.

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While the dental specialty has historically represented a more defensive subsector within the healthcare market, recent cases of stress/distress in DSO platforms have been driven by challenges in recruiting and retaining clinical staff, inability to effectively integrate acquisitions across the clinical network and back office, inability to optimize the Revenue Cycle Management function, and the impact of inflation on the cost of capital, supplies, supporting services, and labor.

Despite the high volume of DSO rollups, the industry remains largely fragmented, with over three quarters of practices consisting of a single office.³

Chart 2: DSO Affiliation and Practice Sizes ⁴

This fragmentation is an opportunity to leverage economies of scale for DSOs, but also presents unique challenges for firms looking to optimize value across practices. To maximize returns for equity sponsors, DSO platforms should not only seek growth through acquisitions, but also organic “same store” growth by increasing specialty procedures and other service offerings.

Given that a significant portion of the dental market consists of single-location practices, DSOs often find themselves needing to acquire a large volume of smaller, individual practices to achieve scale. Consolidation of these practices can present a unique set of challenges for DSOs, mostly due to antiquated billing systems, disjointed revenue cycle procedures, higher proportions of bad debt, and process challenges during cash-to-accrual conversions.

Distinctive Revenue Cycle Management Challenges Impact DSO Realization of Value for Individually Acquired Practices

The impact of a billing system’s accuracy and efficiency cannot be overstated. Many individual dental practices utilize outdated systems that rely on manual processes with limited reporting capabilities.⁵ One difficulty with these systems is the reliability of properly valuing revenue streams and accounts receivable, resulting in lower cash generation than anticipated during the diligence process. DSOs should consider updating and standardizing billing systems as part of their integration strategy, and must evaluate the time and capital required to execute such conversions. Upgrading or consolidating billing platforms is often a time-consuming and costly undertaking that may overburden RCM and clinical staff, often resulting in collection slowdowns during and following software conversions, mainly due to the time required to train RCM team on to new system, software, and processes.

Another challenge for DSOs is the lack of standardization of revenue cycle policies and procedures. Individual practices may not have standardized approvals for when and how write-offs occur. Approaches to managing payment denials can also be dissimilar across practices within a DSO, impeding leadership’s ability to evaluate cash collection initiatives across the organization. When and how patient insurance information is verified, and patient collection efforts occur can also vary from practice to practice despite being part of the same DSO. This fragmentation can erode time-to-collect metrics, reducing cash on hand.

While a payer mix favoring private pay often appeals to healthcare investors, this can also create challenges for DSOs. Many dental insurance plans limit coverage to preventative services, which can result in higher patient responsibility for charges arising from non-preventative care. As a result, dentistry has higher financial barriers to care compared to other specialties.⁶ Without defined point-of-collection processes standardized across the organization, DSOs risk writing off significant A/R balances that are patients’ responsibility. While these claims may appear to have higher reimbursem*nt rates under private pay, the shift of responsibility to patients could result in lower collections for DSOs if not handled effectively.⁷

Many practices that have operated independently for years likely employ cash-based accounting methodologies to limit administrative burden for financial reporting.⁸ DSOs acquiring these practices will need to consider periods of conversion as these practices shift from cash-based to accrual-based accounting. Without dedicated resources to manage integration efforts, conversion periods can prove to be costly and drawn out.

Managing Integration Efforts Across DSO Platforms Is Crucial for Value Optimization

To address these issues, DSOs must define and execute robust integration strategies that prioritize standardization of key processes and procedures, and ensure the right management team is in place. Understanding and resolving these challenges in a timely manner will be essential for organizations engaging in diligence efforts as well as those looking to optimize value from existing practices within their portfolio. To accelerate value creation, DSOs and equity sponsors should consider how to optimally integrate disparate practices and position them for growth. FTI Consulting has extensive experience across the Physician Practice Management spectrum, and with DSOs specifically, to identify and execute on opportunities to maximize value through proper integration planning, operational execution, and cash management.

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