Dental service organizations (DSOs) enable dental practices and their providers to focus on patient care while outsourcing administrative, billing, and other non-clinical functions. As private equity interest in healthcare services continues to rise, DSO M&A transactions continue to be popular. However, given prohibitions on the corporate practice of dentistry and scrutiny from regulatory bodies in many states, transactions involving DSOs present distinct legal and structural challenges. Buyers should strongly consider engaging legal counsel and other advisors who are experienced with the regulatory framework and structuring nuances specific to this sector, including but not limited to the issues addressed below.
Corporate Practice of Dentistry
Most states prohibit the corporate practice of dentistry, preventing lay persons or entities from directly owning or controlling dental practices. Considering these restrictions, dental practices often contract with DSOs to provide non-clinical support to dentist-owned professional entities, in exchange for a management fee. Sometimes entry into this contract is combined with the purchase by the DSO of non-clinical assets from the dental practice. The management fees and the purchase price for non-clinical assets can both be substantial amounts. The structure of the management fees is dependent on applicable state law. For instance, some states prohibit percentage-based management fees or otherwise have fee-splitting laws. Combined with the management agreement, DSOs and dental practices often enter into agreements that restrict the ability of the dentist owner of the practice to sell or transfer equity in the practice.
When evaluating a DSO transaction, buyers must assess whether the desired post-closing structure aligns with applicable state restrictions. This includes reviewing governance documents, management service agreements, and financial arrangements to ensure that control over clinical decision-making remains with licensed dentists. Improper structuring may result in regulatory enforcement, licensure issues, or challenges to the legality of the structure.
Relationships with Practitioners
Dentist retention is critical in a DSO transaction because of each dentist's significant contribution to the practice. Therefore, transaction structures frequently include compensation structures such as production-based compensation and bonuses to maintain continuity of providers at the practice. At the same time, non-compete agreements help protect the buyer's investment and encourage retention. However, these arrangements raise both regulatory and enforceability questions. Compensation arrangements must be carefully structured to comply with standards under healthcare fraud and abuse laws. Moreover, the enforceability of non-compete agreements varies significantly by state, some with differing analyses of reasonability, scope, and frameworks for healthcare professionals. Due diligence should include a review of existing practitioner agreements, and transaction planning often includes revised practitioner agreements to ensure aligned incentives.
Importance of Locations
The physical locations of dental practices are often central to patient retention and operational success. However, leases for clinic space may include change of control provisions that are triggered by an acquisition or equity transaction. These provisions generally require advance notice or landlord consent and may thereby threaten valuable tenant rights, including the lease itself and operational stability. Buyers should therefore identify and analyze these provisions early in the diligence process and may require landlord consent or waiver as a condition to closing.
Prepaid Services
To ensure receipt of payment, dental practices often sell services such as Invisalign or teeth whitening packages on a prepaid basis. This creates deferred revenue obligations that must be addressed in the transaction. From a transactional perspective, this has implications for both valuation and working capital adjustments. Buyers should account for deferred revenue liabilities and consider appropriate escrows, purchase price deductions or other arrangements to reflect obligations that will fall on the buyer post-closing.
Billing and Coding
As with any healthcare transaction, accurate and compliant billing practices are critical. In the dental context, chart documentation and coding must align with Current Dental Terminology (CDT) codes, payer requirements, and applicable federal requirements, including state fraud and abuse laws. Buyers should consider conducting targeted diligence, including chart audits and reviews of billing data, to identify patterns of upcoding, claims without supporting documentation, or billing for work not performed. Such an audit is critical in reducing regulatory compliance or reimbursement risk or identifying inflated financials. If compliance issues are identified, they may trigger repayment obligations, risk of payer audits, or exposure to statutory liability. In some cases, indemnification and remediation plans may be necessary to mitigate these risks.
State Healthcare Transaction Review Laws
An increasing number of states have scrutinized healthcare transactions and enacted transaction review laws that may apply to DSO deals. These laws can vary widely in scope and may require pre-closing notice, approval, or public disclosure, depending on the transaction size, structure, and location. It is critical that buyers assess early whether a proposed transaction triggers any state-level notice review or processes, and if so, build in adequate lead time to comply with filing requirements and potential review delays. These obligations can carry meaningful consequences for deal timing and execution, especially in multi-state transactions. Buyers should also consider the potential impact such laws may have on the exit strategy for the investment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
