This article originally appeared on the MNP website. Image credit: The Images of Pharmacy Practice Project | EPICORE Centre & Jim Dobie Photography
by Jim Chagnon, CPA, CA, TEP, Partner, Private Enterprise Professionals
In this three-part series, we’ll explore what it takes to become a pharmacy business owner, how plans and needs change over time, and navigating through each stage with confidence.
Part two: Start-ups and acquisitions
As a pharmacist looking into becoming an owner, there are two main options available to you – opening a completely new shop or acquiring an established pharmacy. This article outlines what you need to consider for either a start up or a purchase.
Greenfield start-up shop
Part One of this series discussed the importance of having a business plan to prove the business is viable. Building on that business plan, you'll want to put extra emphasis on a couple of things which will help to drive success for a start-up:
-
Market
analysis
Given this is not an existing business churning revenue and cash flow, you need data to predict the volumes which are possible and likely in a new location. Specifically:- area demographics
- extent of competition
- features of the location (traffic flow, access, etc.)
- proximity of prescribing physicians
- Break-even analysis
With the market information in hand, you’ll now have to identify the minimum volumes required (front shop and dispensary) to make a go of this venture. The goal here is to do as much work as you possibly can to ensure viability before you launch.
Acquiring a pharmacy
- Market insight
- Purchase evaluation
- Transaction management
Market insight
There’s a lot to consider when looking at acquiring an established pharmacy. One of the first steps is getting a more in-depth view of the market – and what ownership might look like in the context of the current market environment.
Typically, you have limited insight into the pharmacy during early stages and only get more detailed information at a later date. Consider a wide range of factors important in that initial assessment, and a preliminary assessment of risk and success factors, including:
- capabilities and level of involvement of the current pharmacy owner
- revenue sources, their significance to operations, and trends / risks attached
- network of prescribing doctors
- who the competition is and how their business has been trending
- banner agreement – is one in place and what are the terms
- assessing the management team
- is the real estate owned or leased
- state of store and technology and how much capital reinvestment will be needed
Purchase evaluation
Taking into account the above factors, you will want to prepare a preliminary estimate of value, starting with estimated earnings before interest, taxes, depreciation and amortization (EBITDA). This figure, based on the financial statements received for the operation, effectively represents the cash flow which it can generate on an annual basis, before considering how the purchase would be financed and any related income taxes.
Then you will adjust, or normalize, the EBITDA for any items initially identified as either risks or opportunities - effectively the amount of cash flow you can reasonably expect to generate once you are in the ownership seat (vs. what is reflected under current ownership). Examples of some adjustments would be costs specific to the current owner, like a car lease. Or salaries that exceed market standards, or expenses that don’t reflect future changes, such as lease renewals.
An estimate of normalized EBITDA (or cash flow) enables you to make a preliminary estimate of value. In retail pharmacy, most deals are priced by basing the value of the business' goodwill on a multiple of that normalized EBITDA. In other words, its value is calculated as being a number of times its annual, sustainable cash flows. Inventory and certain other assets needed to run the business day-to-day are added to that goodwill figure to arrive at a price.
Two key considerations
1) Estimating the normalized EBITDA is one exercise (and again is only an estimate at this stage)
2) The multiple is not static; there is no one "right" multiple to apply to each new pharmacy opportunity.
Each situation is unique and presents its own set of potential risks and rewards. Those risks and rewards will be perceived differently and will be factored into the pricing analysis differently by each prospective buyer.
Transaction Management checklist
- Letter of Intent (LOI)
- Due diligence
- Agreements
- Closing matters
- Post-closing considerations
You’ve made a preliminary assessment and wish to move ahead. The first step is to make an expression of interest to the seller to see if your mutual expectations match up. Typically, this takes the form of a Letter of Intent.
Letter of Intent (LOI) - A LOI is a relatively brief document outlining the fundamental terms of the offer to express your intentions. They usually are non-binding and subject to negotiation and normally will include, at a minimum, price (often stated as an amount for goodwill plus inventory), amount of cash versus non-cash consideration, how to handle existing employees, and the terms under which current owners will transition their involvement. The LOI is based on a limited amount of information which has been disclosed to you to this point.
You also will include whether the offer is for the operating assets of the pharmacy or for the shares of the corporation operating that pharmacy. There is a lot involved in this decision, but generally speaking:
- If you are the purchaser, an asset purchase is often more desirable for tax purposes
- If you are the vendor, a share sale is typically more desirable for tax purposes
Just be aware there are two options, and your advisors will help you structure it the most appropriate way.
Due diligence
Now is when you get to see more details and assess whether your earlier assumptions about the pharmacy are valid. Due diligence allows the buyer and their representatives to look behind closed doors and see if things are really what they appear to be. Due diligence also varies in scope, depending on if you are buying the pharmacy assets or its corporate shares.
Operational due diligence would include reviewing:
- Rx composition – volumes, historical trends, compounding, LTC contracts, methadone, generic vs brand, etc.
- Efficiencies – staffing, hours, technology
- Banner programs and incentives
- Management – key staff risk
- Customers
- Competition - existing and potential
- Rx, POs, and other systems – licenses
Financial due diligence will focus on confirming whether the information reported in the financial statements is reliable. The tax due diligence will target Canada Revenue Agency audits, reassessments and potential exposure to those events in future.
Legal due diligence will cover contingent liabilities (such as creditor claims and legal actions), and contractual obligations (such as leases and banner agreements), among other things. A human resources assessment will concentrate on employment contracts, terms, vacation entitlements, years of service, etc.
Having a team of experienced advisors, including a lawyer and an accountant, to work with and offer guidance is critical for the due diligence needed before making a commitment as significant as ownership.
Agreements
Upon satisfactory completion of the due diligence procedures, final purchase and sale agreements can be drafted to add more detail to the original LOI. Some examples of those details are:
- anticipated date for closing the deal
- preparation of closing financials and tax returns
- adjustments to purchase price based on final numbers
- indemnities, representations, and guarantees of the parties
- undertakings re non-competition and non-solicitation of employees and customers
- transfer of existing lease or agreement to purchase the property, etc.
Closing matters
Then, at the closing date for the purchase and sale, legal documents are signed, funds are exchanged, consents and notifications are completed. Also at this time, inventories are counted, and employee letters / contracts are updated / amended / signed.
Post-closing considerations
The deal is closed. Now what?
Integration planning should start before close to ensure a smooth transition as there are many considerations for operating the new business under new ownership. If it is the first and only pharmacy, it will take on a different approach than if subsequent acquisitions are being integrated into the existing organization.
Your advisors can help you work through a host of items that will need to be considered in advance of closing to help ensure smooth sailing on Day One following the closing. For example, they can help with structuring a communication plan to inform customers, team members, and suppliers of the ownership change and what your vision of the future is.
As well, you might require a management team transition plan. You definitely will need systems access and operation changes, revised supply chain processes, new banking signatures, cash flow management and insurance coverages.
Pitfalls to avoid
You’ve followed up on the opportunity to acquire a pharmacy or start one up from scratch and think you have got all the information you need to make a sound decision. Being overconfident or blinded by that shiny prize often is a major pitfall, as is not having planned enough or in a timely way.
Be careful not to become emotionally attached to a particular opportunity – maintain a rational, business perspective in your assessment before committing.
Valuation issues can present lengthy detours, if you don’t have the expertise and data supporting your bid valuation compared to the current owner’s valuation. And poor transaction management and integration problems can make what seemed a deal of a lifetime a bit of a nightmare. Make sure you have an experienced team of advisors who are thorough and objective to help you be successful in your ownership quest.
To
incorporate
or
not
to
incorporate?
In
Part
Three
of The
path
to
pharmacy
ownership series
we
examine
both
options
as
part
of
corporate
structure
planning.
Contact
For more information, contact Jim Chagnon, CPA, CA, TEP, at 289.293.2311 or jim.chagnon@mnp.ca