How to price DPM services in a noncorporate state

2013 05 07 15 48 08 155 Climo Thomas 200

In a previous article on, I parsed corporate from noncorporate states indicating with the latter the need for introducing a dental practice management company (DPM) to attract the much larger amount of capital available from the private equity market.

In that article, I identified the problem of pricing management services while avoiding the pitfalls of state and federal legislation prohibiting fee splitting, revenue sharing, and kickback arrangements.-->

I also spoke of the need for an owner-dentist considering the DPM business model to retain a healthcare law firm to build the management contract, arrange the arms-length legal separation of the management company from the dental practices, and stay within the rules and boundaries of both state and federal legislation in the pricing of management services of a DPM.

Now, the rest of the story.

Without legislation

Thomas Climo, PhD, is a dental practice management consultant and a past professor of economics in England.Thomas Climo, PhD, is a dental practice management consultant and a past professor of economics in England.
Thomas Climo, PhD, is a dental practice management consultant and a past professor of economics in England.

In most industries, management companies price management services off a percentage of gross revenues. For example, a golf course management company takes anywhere from 2% to 5% of gross revenues for its management services; these revenues include income from green fees, cart fees, club rentals, food and beverage in the clubhouse, merchandizing, driving range fees, teaching and instructional fees, and the organizational markup of hosting group events.

The 2% to 5% management service price pays for the salaried and wages staff of the management company and its administrative costs, and it includes a profit margin -- after costs -- in the range of 10% to 15%.

However, were we to do this rather straightforward pricing for a medical or dental management company, the management company would be culpable and liable for having violated at least three federal laws and a number of state-driven statutes prohibiting any correlation between the income made from the practice of medicine or dentistry and the income paid to the management company for managing the office staff serving the clinical staff.

Since good management in every case has to do with good performance of the entity being managed, federal and state legislation for the dental industry has created a myth separating good management from good performance. In fact, this industry has taken the myth one step further, making it against the law to tie good management to dental practice performance.

The Stark law

By legislation, a DPM cannot derive its method of remuneration from either the gross revenues or net income of the dental practices it provides management services to, nor can there be any formulaic manner in which management services are merely a derivative of the financial statements of the dental practices. In other words, the management service must be priced separately and independently in a kind of cost-plus setup rather than as a proportion of revenues of the practices being managed.

We have already shown that almost every nonmedical or nondental management company in the world prices its services on the basis of a percentage of gross revenues. We illustrated this through the connection of a golf course management company with the various fees charged as revenues of the golf course.

However, something strange happens when the management company is handling billing and collections from the health entitlement programs available in the U.S. and paid for by the U.S. government: Although green fees are not paid for by the government, medical and dental services are.

Former U.S. Rep. Pete Stark (D-CA) introduced legislation in 1992 -- the Stark law -- that would prohibit a for-profit management company to allow its health practitioners to participate in the profits of the management company when government programs such as Medicaid and Medicare are involved. The reasoning was that in this setting it was likely the management company would set up a fee schedule that would overcharge for management services, especially in circumstances in which there was direct financial benefit to the physician or dentist providing the medical or dental service.

In addition, Stark was concerned that a company providing management services to medical and dental operations might be enticed to intervene with the provision of medical and dental services to enhance profit rather than improve healthcare outcomes.

Under the Stark law (and its ancillary antikickback statute), a "financial relationship" means an ownership or investment interest or a compensation arrangement, direct or indirect. An ownership and investment interest can arise through debt, equity, or other means and includes an interest in an entity that holds an interest in a Department of Health Services (DHS) or DHS-defined entity. An ownership or investment interest includes but is not limited to stock, certain stock options, partnership shares, limited liability company membership interests, and loans, bonds, and other financial instruments that are secured by all or part of the entity's property and revenues.

A compensation arrangement arises from any remuneration, direct or indirect, between the referring physician and a DHS entity. A physician has a direct compensation arrangement with a DHS entity if there are no intervening entities between the physician and the DHS entity, or there is a single intervening entity, the intervening entity is a physician organization, and the physician is an employee, independent contractor, or owner of the physician organization. A "physician organization" is defined as a physician, a physician practice, or a group practice that complies with the Stark law's definition of a group practice. Replacing "physician" and "physician organization" with "dentist" and "dentist organization" has the same impact where Medicaid and Medicare are involved.

Although Stark's legislation was addressing the reasoning of the federal government, state laws also exist for every noncorporate state matching and mandating this same separation of management services and its remuneration from the remuneration in the form of patient fees in a dental practice. This survey contains the statutes in each noncorporate state that prohibit the same kind of collaboration as prohibited by the Stark law.

With legislation

It is important to note that any practicing dentist accepting Medicaid and Medicare who creates a DPM for an eventual exit sale to private equity must retain a healthcare attorney that is a specialist in Stark and antikickback legislation. So must private-pay practices operating in noncorporate states.

For practical purposes, a table that could have simply taken gross revenues of the dental practice and multiplied this by an agreed-upon management service percentage would have to move from the application of a percentage charge of revenues to one in keeping with Stark, state law, and antikickback. Here is a theoretical example:

Main Street Dental Practice Management Co.
Income statement for a one-year period from performing management services
Revenues of the practices   $4,000,000
Charges for management services: Cost Cost-plus @ 10%
     Sales/marketing $180,000 $200,000
     Accounting $72,000 $80,000
     Billings and collections $144,000 $160,000
     Staffing or human resources $108,000 $120,000
Other management services $36,000 $40,000
Revenue of the DPM   600,000
Less: Operating cost @ 5% of DPM revenue   $30,000
EBITDA or net income of DPM   $570,000  
Click here to view this table in a separate browser window or on a mobile device.

In the illustration, "cost" of providing management services is identified for each line item, allowing "plus" associated with the line items to consolidate and pass on to the management company in what is tantamount to a 15% net income margin -- in this case $600,000 -- from the practices.

To codify the cost-plus arrangement, there would have to be a bookkeeping ledger separate and independent from the ledgers of the practices, subject to audit, verifying the actual cost of management services together with an acceptable margin agreed upon by the management company and the licensed dentist or professional corporation in the management contract.

Pricing ingenuity

Ingenuity in pricing is essential in the DPM arena. Although we all know that percentage of revenue is the best way for a management company to price its services, a trapezoid of cost accounting, together with a projected profit margin, is needed in order to avoid violating Stark, state law, and antikickback.

My recommendation is to get an economist, a certified public accountant, and an attorney on board before commencing a DPM arrangement. The added cost will be more than compensated for by the higher value and exit price for your DPM by introducing private equity into the buy-sell negotiation.

Every dentist whose aim is to achieve a higher exit sale for his or her practices (numbering at least four or more) must come to grips with whether the practice is in a corporate or a non corporate state and whether government entitlement programs are involved in the billing and collections of the procedures performed by the practices to be managed.

Be careful not to traverse federal or state laws, but do not be dissuaded from making the financial transition from solo practice to DPM owing to the hardship in the form of barriers to entry introduced by government regulations.

Thomas Climo, PhD, is a professor emeritus of accounting and finance at a major university in the U.K. He has published extensively about the importance of modern managerial and financial decision-making for dentistry. He is a consultant to corporate and solo practitioner dental practice management companies in the states of Arizona, California, Connecticut, Nevada, New Hampshire, New York, and Massachusetts. He can be reached by email at [email protected] or by telephone at 702-578-2757.

The comments and observations expressed herein do not necessarily reflect the opinions of, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.

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