Maria Melone: Dental Advisory on the Buy & Sell Sides

Craig Castelli (00:05):

Welcome to The Close M&A Podcast with Caber Hill Advisors. I’m your host, Craig Castelli. Today our guest is Maria Malone, my partner at Caber Hill and lead managing director over our healthcare business. I tell everybody I meet that there’s nobody who knows more about the dental industry and dental M&A than Maria. She’s done it her entire career and really is an expert in all things dental, but she’s also broadened her view to cover all aspects of healthcare services. So today we’re going to talk a little bit about dental, a little bit about other areas of healthcare. We look forward to hearing what she has to say. Maria, let’s just jump right in here. The dental brokerage field has gotten increasingly crowded in recent years. It seems like anybody with a network thinks that they can advise on an M&A transaction. How many actually know what they’re doing?

Maria Melone (00:54):

Well, first of all, thanks for having me. I’m looking forward to this conversation and I’m just going to give some context as I provide this answer. As you alluded to, I have spent a large part of my career in the dental space and I started working for, at the time, one of the largest DSOs in the country and was on the buy side of dental acquisitions when I was there. We did about a hundred transactions during that time and looked at many more, and I recognized that there was a pretty significant gap between advisors working with sellers at that time and what was starting to become a very sophisticated buyer in the marketplace. And so that’s when I decided to make the switch from buy side to sell side work. I thought that based on my experience, I could bring a much deeper and richer advisory skillset to sellers specifically. One example I guess would be how at that time people looked at valuation. Most advisors back then or brokers were thinking of valuation in really two very sort of simplistic ways. One simply just as a percentage of collections or two what’s called seller’s discretionary income. And in both cases, neither really aligns with how a sophisticated investor looks at a business that they’re potentially going to invest in.

(02:43):

From there, I would say I really saw an uptick, maybe 2014, 2015, of people coming into the space. I think they saw the amount of interest from investors, private equity firms, family offices, saw an opportunity to make easy money and dove in thinking, all I have to do is really match a buyer with a seller, and then my job’s done.

Craig Castelli (03:17):

And the sellers, they experience that same misconception. How often do you talk to a seller and they think, well, I know a buyer, why do I need you?

Maria Melone (03:26):

Yeah, absolutely. I mean, that’s a pushback I think we get often, however, most people will only go through a transaction once in their life going through something once. You’ll likely never do it at your best ability because there’s just too many things, factors that you need to know to get a transaction closed. I mean, you and I have been doing this for years and years and years, and we know how hard it is to actually close a transaction under the most favorable terms for our clients in a way that meets all of their goals and objectives. And I think very few in the market today really hold their client’s interests at the forefront of their process.

(04:28):

Back when things started to pick up and people started to jump into this space, I think it was somewhat easy for them because it was such a frothy market. There was a lot of competition. There really was no shortage of buyers, and in most cases, buyers, I’m sorry, buyers were putting out reasonable offers. I don’t think anybody got a bad deal, but I think a lot of people didn’t get their best deal. And certainly a lot of people ended up partnering with organizations that really didn’t meet any of their goals or objectives, weren’t a good cultural alignment, and generally ended up with the seller having a bad experience post closing.

Craig Castelli (05:21):

Yeah, I think that’s a great point there that you’re making at the end, it was not so much that the headline sticker price suffered as a result of this poor advice. A lot of these “advisors” would just play the numbers game that they’d sign up enough clients, they’d make a bunch of introductions, enough deals will close, they’d make a great living. And if all you look at is the headline enterprise value, they probably got good prices for their clients quite often. But to your point, what was lacking was actual understanding of the buyer-seller fit understanding of the health of the buyer’s organization and real negotiation of the deal structure to make sure that just beyond that headline price, it was the appropriate cash or close, it was the right role of equity structure. It was an appropriate earn on structure of wanting existed. A lot of that just get completely ignored in the frenzy to get deals done and move on to the next one.

Maria Melone (06:23):

Yeah, absolutely. I think that many, just as you sort of already touched on, just focus on what’s the multiple that I close my transaction at and is it a multiple that now I can go brag to my golf buddies about? But there’s so much more that goes into a transaction. And even on the front side of it, if you’re working with any sort of business that is growing and you don’t have a deep understanding of financials, you’re likely going to miss out on getting some credit for growth that hasn’t fully matured in your organization by only presenting historical financial data to the buyer pool.

Craig Castelli (07:17):

And you mentioned multiples. Multiples are such an elusive term, and I want you to give the anecdote that I hear you give so frequently about a single deal where depending on how you calculate it, the multiple could be wildly different numbers.

Maria Melone (07:34):

Yeah, yeah. So I mean, this is a real live example of a client I worked with. I can honestly tell you they transacted at 28 times, 15 times or eight and a half times. And this is something that I do tend to talk about in speaking engagements and certainly with our clients because the multiple is just one side of the equation that gets to what is the value of the business. And so the other side of the equation is EBITDA. Again, this is something that sophisticated investors use as the basis for determining what they think the value of a business is. And back to my original commentary, that is something that most traditional dental brokers didn’t really understand. And on top of that, calculating an appropriate EBITDA really does take some degree of financial training or understanding, not to mention what it would take to do the appropriate amount of modeling to help a client or ensure that a client can get credit for that growth that hasn’t fully presented itself in historical financial information.

Craig Castelli (08:58):

Right, exactly. And if your background prior to getting involved in this business was anything other than finance, accounting or something in corporate development, it’s got to be really challenging to ever rise to the level that’s adequate to advise larger growing groups. It’s one thing to work on the local level and sell a practice from one owner-operator to another. The banks are going to drive the value 99% of the time of those deals anyway. But anything more sophisticated really requires an entirely different skillset.

Maria Melone (09:37):

And just to fully answer your original question, back to that multiple example, the differences in how getting to those multiples was as reported earnings, adjusted earnings and future earnings based on historical trends of the business and a proven ability to deliver on growth.

Craig Castelli (10:03):

So shifting gears a little bit, it seems like a lot of these same folks are now trying to dip their toes into the med spa waters. Why is that the next sector that everybody’s walking to?

Maria Melone (10:17):

I think it’s not just med spa. I think healthcare in particular is an area that will, I think for many years, continue to have investors’ interest in some areas, in some specific disciplines, there is some assurance or some comfort that revenue is recession resistant. In other disciplines, it’s more about the payer mix. Some businesses and med spa in particular, your payer mix is generally fee for service. There is really no insurance that’s part of that payer mix.

Craig Castelli (11:03):

Makes it an easier business to understand for the unsophisticated advisor, if they don’t have to understand how CMS works, their job’s probably a lot easier.

Maria Melone (11:13):

Oh, absolutely. And I think for the unsophisticated broker, they also aren’t necessarily factoring in other market conditions that may be present outside of healthcare or other conditions, say at a macroeconomic level that do sort of drip in and impact the work that we do. And in particular, all this tariff nonsense that we’re dealing with that really doesn’t impact healthcare businesses per se, but our colleague Jordan, who deals with a lot of manufacturers really has to consider that to a greater degree when working with a client.

Craig Castelli (11:59):

Yeah, absolutely. It really is amazing, the psychological impact all of that had, fortunately, knock on wood, seems to have faded into the background because we are seeing a lot of these healthcare business owners reinvigorated about taking their businesses to market. So enough about other groups. Let’s talk more about you and the team here and your approach. I specifically want to hone in on the fact that we’ve seen a lot of notable challenges plaguing some of the private equity backed DSOs and MSOs in recent years. How do you advise your clients on this point and help them really navigate what’s become a more challenging buyer environment?

Maria Melone (12:44):

Yeah, so first of all, I would say just to give people some understanding of why, maybe this is an important thing to think about. We had many years very low interest rates, which really fueled significant growth. And I think many DSOs really grew way too quickly. They weren’t, they definitely weren’t focused on integration or operations, and they really had no acquisition strategy. They didn’t really vet potential acquisition candidates that they were looking at. They really just focused on the total number of deals that they were able to bring under their umbrella. And when we had interest rates spike, we also were seeing labor costs rise. We’ve got pressure on the top line revenue with insurances continuing to lower what they’re willing to reimburse, really puts a lot of pressure on what you’re actually the profit of the business, which is going towards debt service. And a lot of groups were caught off guard by that, which is why we saw a real pullback in the last couple of years in terms of activity, particularly in healthcare and definitely within dental.

Craig Castelli (14:23):

I think also, I just want to add one thing to that. We saw most of the increases in valuation apply to the smaller groups. So the spread from what you’d pay for an add-on to what the platform was worth overall continue to shrink as there was more and more competition for the add-ons. And so in order to be successful, there had to be more than just multiple arbitrage to your strategy. And unfortunately for some, I just don’t think there was.

Maria Melone (14:54):

Yeah, no, that’s a great point. I think in terms of how we work through this with our clients, it really goes back to the fact that we have a really deep understanding of the marketplace. I’ve been in the space for over 25 years. You’ve been in the space for 10 plus years. We just have a lot of knowledge about almost every DSO in the space, not to mention the private equity or family offices that are backing these organizations. And so one of the things that we really focus on is first of all understanding why is our client even looking to transact? What do they hope to achieve through a transaction and how do they want their life to look post-closing a big part of making sure that the right decision is going to be made when they ultimately are considering various offers.

(16:01):

So that’s the first step. From there, it’s really having, again, all of that knowledge to advise our clients when they do get those offers, what’s really, we peel back the layers of the onion. What’s really behind the organizations that are putting these offers in front of you? What is the performance and behavior not only of the DSO itself, but potentially the private equity firm or family office that’s backing? That is something we spend a lot of time with helping our clients understand because I think we deeply feel that that’s certainly one aspect of a predictor of success post-closing of the relationship between our client and who they ultimately decide to partner with.

Craig Castelli (16:54):

And I think there are a couple of bright spots there. I mean, these are not insurmountable challenges. I think for a lot of groups, these are setbacks and they may delay recapitalization events, but not much more. I think there’s also some longer term perspective that’s necessary if you’re in the shoes of a seller, intrinsically, dental and medical practices are not worth eight times, 10 times, 12 times, 15 times EBITDA. They’re just not. So it requires this deal structure. It requires elements like rollover equity just simply to be able to reach those valuations. There’s only so much that is going to be transferred in the form of equity from a fund and debt from a lender, and the rest has to come somewhere else. So I think in the frenzy, a lot of people lose sight of that. But the reality is if you don’t like some of these terms, if you don’t like some of the risk associated with the deal structure, go sell to another doctor. They can get a bank loan for four times, five times, maybe even a little bit more than that, it’ll be all cash. You’ll probably walk away pretty quickly and you don’t have any of that. You want to chase the sexy multiple, then it follows the same risk-reward profiles just by any other investment.

Maria Melone (18:13):

Yeah, I think that that’s a great point. And I would say just to add on, there has been a big shift in deal structure in the last, say three to five years. Part of it, the result of, as you’ve pointed out, some of these groups having financial pressures and needing to be very careful about how they use cash and debt and bring on debt in particular. The other piece of it though has more to do with guarding, protecting the risk of the revenue relative to the provider, specifically the seller. And so we have seen a big shift away from cash at close for many, many years. It was at least 80% cash at close for a seller. And I think finally, groups and investors have recognized that providers are really key, and if you want the business to continue to perform and grow, they need to be invested in the organization moving forward.

(19:23):

And with that comes again, really understanding what does that equity role mean? What are the terms and conditions of that equity role? I mean, you and I, I’m sure can list probably a thousand different ways that organizations structure their equity. But one quick example is relative to your ability to liquidate. In some cases you may be required at the next capital event to continue to hold maybe as much as 50% of your equity role. What does that mean? It means that you can’t access that equity, that value those funds likely for another, say four to seven years.

Craig Castelli (20:12):

Right? And the doctors really are the only asset of any of these businesses, and so there needs to be some mechanism to ensure loyalty, and there’s a little bit of a carrot and a stick right there. I think another interesting point I just thought of on your comment about the cash at close is that as interest rates rose as the economy got a little bit more choppy, lenders especially started to put limits on how much cash any portfolio company could pay at closing in a deal just as a multiple of the equity itself. And so as a buyer, you’re faced with a choice. I can keep the same structure, but I got to reduce the multiple, therefore reducing the valuation, or I can keep the same multiple because all people seem to care about in multiples and the cash is a percentage of the overall deal is going to be less. Now the reality is same amount of cash in actual dollars under scenario A or scenario B, but things had to be engineered a little bit just because we’re all playing a game here and you had to cater to the psyche of that business owner. So thinking a little bit forward now, tell us what’s on the horizon. What’s your outlook for the next several years?

Maria Melone (21:32):

I would say pretty positive. I think healthcare in general, as I mentioned earlier in our conversation, is an area that investors are going to continue to have an interest in for a number of reasons. One is, again, relative to the revenue stream and many of the disciplines being recession resistant. And so there’s some degree of comfort that there will be a fairly stable revenue stream. I think that other areas of potential investment are becoming maybe more riskier or a little less preferable. And I also think that healthcare generally is growing as an industry, and there are so many exciting. I could think of a number of, in dental in particular, AI coming in, new products and materials. There’s so many advancements. You think about med spa, there’s so many products that are now allowing people to get an effect that doesn’t require surgery. So there’s so much coming in front of us that I think this makes it really exciting. The other piece of it is we’ve got a growing population. People are going to be needing services, and these investors have money that they need to deploy.

Craig Castelli (23:09):

Right? Yeah. Let’s not forget about that incentive as well. Raising larger and larger funds and the pressure to deploy capital continues to fuel things, continues to create some level of a safe floor to everything, lower middle market M&A, but definitely a lot to be excited about. What are you working on right now that you’re most excited about?

Maria Melone (23:35):

I’m really excited. This year we made the decision to get together once a month. We have a team that is spread throughout the country, and I’m really enjoying that. I think it’s really good for the team and our work together. I’m also very excited that fairly soon here we’re going to be bringing on another female member of the team. So I really look forward to having her and being able to work with her and maybe help her just given my experience and how I got to where I am today in the finance realm, which is still heavily male dominated. I really am very interested to take my skillset beyond dental. I think it’s a very natural evolution and almost a hundred percent of what I know will easily translate to other healthcare disciplines, and as always, improving my pickleball game.

Craig Castelli (24:38):

Save the best for last, right?

Maria Melone (24:40):

Yes.

Craig Castelli (24:40):

All right. Last question here. Give us a piece of advice for a business owner, something that they might not have heard somewhere else.

Maria Melone (24:48):

So what has recently happened with a client of mine, and I think it’s very important, even as I think back over history, is getting tied to a particular number, especially very early on in a process or even before you start a process. I have this client who brought on a new wealth manager and within a very short time was told, this is what you need if you want to sell your business. And from my perspective, it’s certainly a challenge for me, and I think that it distracts the seller from other aspects of a transaction that especially given where he is in his career and what he wants to accomplish, he’s going to lose sight of the true opportunity in front of him by just focusing on this one number,

Craig Castelli (25:52):

Especially if that number doesn’t fully contextualize all aspects of the deal or isn’t produced by somebody who really understands what’s going on. I mean, I’m a big believer in the role of the wealth advisor in the overall M&A process to help business owners understand what they can do with the proceeds of a sale, what they need out of a sale in order to fulfill all of their other life’s objectives. But that comes with the caveat that the analysis has to fully contextualize everything that goes into a deal and all of the different ways that a business owner earns an income out of the sale of their company.

Maria Melone (26:36):

Yeah, it’s really very inappropriate, for example, to advise on this is your goal of how much money you need or want to support your lifestyle when you ultimately retire. This is how much you’re going to pay in taxes, and so do the reverse calculation of what you need today. Again, we’ve touched on this. There’s so many other elements to closing a transaction, many of which have very significant economic consequences. And many of those are on the upside.

Craig Castelli (27:14):

Right? And frankly, oftentimes, seller get fixated on a number for considerably less justifiable reasons. It could be as simple as the guy they played golf with last week said he got a certain multiple, and now you have a business owner who hasn’t properly calculated their own EBITDA and assumes that the same multiple should apply without any visibility into the terms of the deal, or whether that really was in fact the actual multiple and get too hung up on things which ultimately can cause them to miss out on what would otherwise be a great opportunity. Right?

Maria Melone (27:49):

Yep. Exactly. Yeah.

Craig Castelli (27:51):

Well, Maria, this has been a lot of fun. Thanks for joining. If anybody watching here wants to get ahold of you, what’s the best way for them to reach you?

Maria Melone (27:58):

It’s pretty easy, Maria@caberhill.com. You can also connect through our website, caberhill.com, and always happy to connect with people, answer questions, and just make sure those that are considering a transaction really have a full picture of the market conditions and potentially things that will impact their eventual exit.

Craig Castelli (28:28):

You’re a doctor who owns a business. There’s truly nobody better to advise you than Maria. So thank you for joining once again, and thanks everybody for watching us on the close.

Maria Melone (28:38):

Thanks so much.