Understanding the Risks: Due Diligence Essentials When Selling to DSO or Private Equity Buyers

If you’re contemplating selling your practice to a DSO or private equity (PE) group, you may have heard about their extensive request for due diligence work. What should you, as a seller, be thinking about for your due diligence?

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Sales Price Reality

It is important to remember that the sales prices in these offers have two pieces – cash and equity in the acquiring DSO or PE – and the two parts must be considered separately.

The cash portion is a known value that is easy to understand in the transaction, but the value of the equity is much more subjective and more difficult for potential sellers to analyze.

This equity value is often established by the buyer, and it may not be based on a fair market value assessment. The buyer may even show significant increases in the initial equity value based on their internally projected future performance, including planned, but not identified, acquisitions of additional practices.

You need to consider both components separately and be comfortable with the risks associated with the equity portion.

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Access to the Equity Portion

Once the seller is comfortable with the value and risks associated with the equity portion of the sale, they then need to investigate any redemption restrictions on their shares.

Most often the equity in the buyer must be held for a period of time and, in many cases, cannot be liquidated until the buyer is sold or recapitalized. These limitations add risk to the sale for the seller and need to be considered as a part of the deal.

Projected Performance

As previously stated, the value of the equity may be based on the buyer’s projections of their future performance or the planned acquisition of additional practices. The buyer may even show, as an added benefit, the future payment of dividends to the seller based on their equity ownership.

Sales Price Updates

As the seller works through negotiations with the buyer, the sales price may increase from the initial offer. Watch carefully!

• Does the increase come in more cash a the time of sale?
• Is the increase in the form of more equity and/or a higher valuation of equity?

Pay attention to how the sales price is increasing and the risks that come with the increase.

(Download Video Transcript)

Due Diligence

If you are a potential seller, make sure you are doing your due diligence on the potential buyer. Some data requests and key points of interest for you include, but are not limited to, the following:

• Historical financial statements for the buyer
• Projections of future performance used in their proposal
• How the buyer is valuing the equity in the transaction - request support for their calculation
• Talk, independently, to other dentists who have sold to the same buyer
• Make sure you understand any restrictions on liquidating the equity interests
• If you will work for the buyer after the sale, compare your current compensation to what you'll receive as an employee - factor the compensation decrease into your analysis of the deal
• You can sell your practice for all cash (probably not to a DSO or PE) and have the option of investing the proceeds in equity - the stock market

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A huge sales price might not be as attractive as you initially think if it comes in the form of high buyer equity. There are risks in the valuation and liquidity of the equity that can have a significant impact on the price you ultimately receive for your practice.

The experts at SVA are here to help you.