Choosing a Path:
As MB2 Dental surpasses its 600th partnered practice, we took time to reflect on how we got here and what separates us from a growing field of DSOs. The road to success in the dental space is long and challenging, and the road to sustained success is even more so. We have always believed that the short-termism that comes with the returns many investors are trying to engineer is destined for failure. During the last 15 years, we have made several key decisions that directed us to where we are today. Think of MB2’s story in two distinct time periods: Pre-Private Equity (2007 – 2017) and Post-Private Equity (2017 – Present). As our sector continues to mature, observing the outcomes of various DSOs’ decisions should be informative to all stakeholders since there are lessons to be learned from both successes and failures.

Our Path Before Private Equity
Doctors often tell us they have spoken with a well-capitalized, early-stage DSO that “is just like MB2 Dental.” Although there may be similarities on paper, many DSOs today operate as relatively newly minted platforms and do not have the tenure, infrastructure, and intangibles that MB2 had established by the time we reached the same capital inflection point. MB2 Dental had an unusually well-laid foundation before taking outside investment from private equity and committing to an accelerated growth strategy. We did not have the pressure of meeting an outside investor’s returns in our early years. Our “slow and steady” approach over a long timeframe created the stability needed to support our rapid growth after our first recapitalization in 2017. Here are some of the important things MB2 Dental accomplished prior to bringing on private equity investment:

• Established a culture. MB2 Dental built its doctor-centric culture over the course of 10 years. Culture does not come together overnight. Before we even knew what “private equity” meant, we had established a strong base of doctor partners who were committed to their individual practices and to their partners.
• Built a leadership team. Outside of Dr. V as the founder and CEO, MB2 Dental’s executive team has come together over the last 13 years and has never turned over. By the time MB2 Dental reached its first recapitalization, most of the leadership team that exists today was already in place. Leading and growing an organization when you have no outside capital breeds a certain level of scrappiness that cannot be taught in business school. This scrappiness is what helps us remain competitive in today’s dynamic environment.
• Institutionalized lessons learned. We have never professed to be perfect. We made many mistakes over our first 10 years, but because of the consistency and longevity of the leadership team, those hard-learned lessons were retained and incorporated into our business processes, which made MB2 Dental a better company.
• Built an infrastructure. By the time MB2 Dental had its first recapitalization, we had a corporate team of 80 people to support our affiliated practices. Infrastructure came before the growth, not after the growth. Having this infrastructure in place to support a high-volume M&A strategy was critical in providing tangible value (beyond the initial transaction) to our doctor partners.
• Established predictable cash flows. Established cash flow with stable organic growth is often taken for granted. This is one of the most critical factors for any company operating within a PE-backed leveraged buyout model. MB2 Dental had this established before taking a dollar of outside growth capital.

When we think about the path to this point, we are grateful that we took the time and had the patience to focus on the above points before pursuing an aggressive growth strategy. It is because of these points that we have been able to grow in a rapid yet sustainable manner. Trying to simultaneously build the leadership, infrastructure, and financial stability necessary to support a growing company and acquire multiple businesses a month is fraught with execution risk, much of which we were able to preemptively mitigate. The probability of being able to grow at warp speed, build infrastructure, hire new talent to support said growth, keep newly associated dentists happy, and achieve returns for outside investors is low. Private equity does not have the luxury of long hold periods, so although there are enticing financial returns associated with private equity, we believe having the patience to lay a strong foundation sets MB2 Dental up for long-term success.

Our Path After Private Equity
Inviting outside investment from private equity was a huge decision for Dr. V and the original MB2 doctor partners. It took the doctors 10 years and their own personal capital to build their practices and MB2, so the concerns of potentially ruining a well-laid foundation and stable (albeit slower) trajectory were not unreasonable. There was one fundamental guideline Dr. V established to guide his decision-making on behalf of the MB2 doctor partners – don’t do anything that will compromise the doctors’ control over their practices or the group. It has been this guiding principle that shaped not just how we have selected our last two private equity partners but also our day-to-day decisions. The list below highlights the key decisions we have made in choosing our path after private equity investment.

• We did not choose the highest bidder. Trying to squeeze every dollar out of a deal with a partner only comes with short-term gratification. We opted for partnership fit overvaluation because we are focused on the long term. We don’t just think about the financial position of MB2 at the time of an immediate recapitalization but also at the next recapitalization and the one after that.
• We are willing to walk away from over-valued investments. The acquisition environment for dental practices has become incredibly competitive over the last few years. Since the beginning of 2022, we have missed out on more than 300 partnership opportunities because the seller wanted a multiple that was +2.0x than we were willing to commit to on the valuation. Preserving the health of our balance sheet and protecting the investment that our 600+ doctor partners have placed in MB2 Dental is more important than rocket-ship growth.
• We have reinvented our support infrastructure. Recognizing missing capabilities, tools, and skill sets is something that takes regular introspection and the absence of ego. Our doctor partners regularly come to us with their needs, and we have responded by building new teams or adding new technology to support our partners.
• We did not overcentralize. One of the earliest ground rules that was established at MB2 Dental was what functions are best left under the practice’s responsibility and what functions are best served by MB2 Dental’s support staff. We have never deviated from this, nor have we succumbed to the temptation to try to solve practice-level problems that can only be solved with practice-level leadership.
• We have improved our data collection and analysis capabilities. The environment we are all operating in has gotten much more complicated. The only way to make better decisions is to have more data. It sounds simple, but aggregating reliable data across hundreds of dental practices is not easy.
• We are thinking about the long-term. The conversations we have as a leadership team and the decisions we make are not based on a final exit point. Every decision we make is based on whether (or not) it will make things better for MB2 Dental’s doctor partners in the next five, 10, or 15 years and beyond. When you condition your thinking to that time frame, it adds immense clarity to addressing short-term issues.

In a crowded DSO space in which there are too many investors seeking short-term financial returns, we find it helpful to remind ourselves of these points. We opted to take our path, knowing that it would not be the easiest or the fastest one but the one that would ensure our doctor partners and we would be here doing what we love for the long term.

A Different Path
There are other paths that can be taken. The DSO market is now oversaturated with countless groups. These groups come from different starting points, different sources of capital backing, and have different priorities, but they are all trying to achieve the same outcome – rapid growth and positive financial returns for their investors. The capital that has been invested into most DSOs is not patient capital. Most groups do not have the luxury of allowing a company to develop and grow over an extended period because they need to return capital to their shareholders in a finite time period. This dynamic necessitates a different set of priorities than the ones MB2 Dental set during on our journey. This path has led to disastrous outcomes in some cases and is destined to lead to other adverse outcomes in the future. The priorities on this path include:

• Relying on arbitrage only to create equity value. Most investors flocked to the dental space with the belief that there is massive arbitrage opportunity in the entry and exit valuations of aggregating dental practices. The market may have been in that spot for a short time window, but it is not there now and not returning to that. Investors’ expectations of the DSO market have matured past simple arbitrage. Since building an infrastructure to support sustainable long-term growth a lot of time, arbitrage is the “easy button” on value creation.
• Overvaluing practices. Many groups are overconfident in their ability to command a high multiple when they exit their investment, which fuels their willingness to pay above-market valuations for the practices that they add. While this may have mathematically made sense over the last few years, it certainly does not make sense in our current interest rate environment and with the investors’ recalibrated expectations of an investible DSO. Many groups will see their equity value wiped out as their debt service balloons in a rising rate market or when they find investors are not as receptive to providing exit liquidity at a premium valuation.
• Overstating a practice’s earnings to close a deal. Whether it is a lack of understanding of practice-level economics, or over-confidence in a practice’s earnings growth potential, or the need to just bridge an expectation gap with a selling dentist, many groups valued their acquired practices on overstated earnings. This creates an almost insurmountable hole for the DSO and the practice to dig themselves out of. If the earnings on paper were not real, then the likelihood of improving profitability post-sale is virtually zero. Less-than-expected cash flow is a dagger to a DSO when their cost of carry doubles due to rising interest rates.
• Overselling dentists on both operational and financial outcomes. With the amount of misinformation and unrealistic expectations that have whipped up the market over the last 3-5 years, DSOs have had to pitch a greater value proposition to selling dentists in an increasingly competitive market. We have seen countless dentists oversold on the support capabilities or expected investment returns of a DSO. Delivering expectations to an audience that does not really understand the market is very tricky, and once the underdelivering catches up with the over-selling, there will be groups that will have to contend with doctor alignment and engagement issues.
• Prioritizing acquisitory growth over building infrastructure. The investors backing DSOs are looking to deploy capital in the most efficient way to maximize returns. The way they accomplish this is by acquiring cash flow (buy dental practices). Investing in infrastructure takes a lot of time and capital, and you generally do not see a return on that infrastructure for a long time. Any investor with a 5-year investment horizon will be biased to direct its capital towards new practice acquisitions over increasing corporate overhead. The result of this will be a multitude of DSOs with an over-expanded base of practices and underdeveloped leadership and infrastructure to support their businesses.

The early signs of many DSOs running out of capital, not securing new investors to recapitalize their business, and worse, finding themselves in default on their debt are starting to show. The difference between a PE-backed company’s equity being worth something or nothing may be just a couple of misguided priorities. Unfortunately, we expect that an overcrowded DSO space is going to experience fallout as a result of short-term vision, and many doctors will fall short of their hard-earned financial outcomes, or worse.

Conclusion
We have surveyed the broader healthcare market, and the feedback on not just the dental space but all physician practice management sectors is that the Roaring Twenties are over. An M&A-fueled environment has already produced some catastrophic failures in which companies saw the value of their equity go to zero. As a result, this has paved the way for a new set of investor expectations. The investment committees that are responsible for deploying private equity funds’ capital are smart investors. They are good at pattern recognition and learn their lessons quickly. These investors have already recast their expectations as to what will define a successful DSO in the future. We all must anticipate what will be needed to sustain success for the rest of this decade and not relive the boom period that followed COVID. Blaming weaker capital markets as the root cause of a DSO’s future demise is an easy scapegoat, but all companies must navigate the same market dynamics. If you are a doctor who is selecting a DSO, be sure you look to the path that the group is setting for itself. That will be the greatest predictor of future success.