Legal Checklist for your Purchase of a Pharmacy
By: Peter A Saad and Gordon Chan
Are you planning your purchase of a pharmacy? Similar to any other business acquisition, there are a number of legal factors you should consider in your pending transaction.
In a sizeable acquisition, such as that for a pharmacy, this is not a time to rush. Be sure to allot the time required to analyze the following legal matters and confirm that each critical element is in order. For every numbered task below, it is possible that you will spend several hours, therefore budget your time accordingly. Be prepared and conscientious. The more time you spend on the evaluation of your targeted pharmacy of interest, the more educated and informed your final decision will be.
- Perform your due diligence.
Due diligence provides you with an in-depth wholistic review of the pharmacy. Typically, you will request that the seller provide you with thorough documentation so you may understand the pharmacy’s history, philosophy and daily operations. As you review, always keep this in mind: taking the seller’s word for it will never suffice. On the contrary, be prudent and conduct your own due diligence in all relevant areas. Some points of consideration include:
- Composition of prescription volume (retail prescriptions vs. compounding prescriptions, historical numbers and trends, LTC contracts, brand names versus generic, brand card usage, etc.)
- Management (staff risks)
- Patient diversification (is there a concentration risk associated with a specific medication or patient?)
- Prescribing doctor network and concentration
- Competition (potential and existing)
- Any implications with billing rates within the provincial plans depending on radius of competition?
- Current banner programs and incentives (what can I do as a new owner? Are there funds that need to be repaid based on unused term of banner agreement?)
- Operational efficiencies (technology, staffing, hours of operation)
- Real estate (lease or ownership)
- Capital reinvestment (present state of the store and need for reinvestment)
- Review the financial disclosure.
When the financial disclosures are presented to you, do not merely accept. Review the numbers judiciously with your own team of professional advisors. Be guided by two principles: (i) buyer beware or Caveat Emptor; and (ii) trust but verify. Perform your own work and understand that you may potentially need to recreate the financial statements from both the underlying bank records and the pharmacy system records.
- Determine the value of the pharmacy.
Similar to the acquisition of a residential or commercial property, a pharmacy is worth what a buyer is willing to pay or what a lender is willing to finance. Evaluate the cash flow and determine whether or not it is sufficient to repay your loan (if any). When it comes time to count the existing inventory, be sure to review each item’s age and condition. Consider the answers to these questions:
- Are any items obsolete or nearing expiry?
- Are there applicable discounts?
- Was the inventory purchased from a licensed supplier?
- Be prepared for negotiation.
It is highly unlikely that you will be the first buyer and seller to be far apart on price. Explain to the seller how you arrived at your valuation and ask the same of them. It is possible that an element or two may have been missed on either side. As you uncover additional information during due diligence, the purchase price conversation may change. Honest negotiation and open communication can help both parties come to a numerical agreement that is fair and reasonable.
- Identify whether this is a share sale or an asset sale.
Determine the type of acquisition: share sale or asset sale. There is no “one size fits all” transaction. Both acquisition types have advantages and disadvantages as debts and liabilities, along with legal implications will differ according to buyer, seller and the pharmacy. As a result, there is often tension between the best interests of the buyer and the best interests of the seller. Be sure that you have a clear understanding of the risk profile.
- Execute a Letter of Intent or Term Sheet.
A simple way to commence the acquisition process is to propose a non-binding offer to the seller, which can be drafted with the assistance of your legal advisor to formally express your interest in the acquisition of the pharmacy. This non-binding offer often takes the form of a Letter of Intent or Term Sheet which outlines the proposed terms and conditions of your acquisition. The non-binding nature of the document dictates that the offer is not final, and yet also signals a strong intention to bind the parties to a definitive agreement. By demonstrating a willingness to transact, the seller may be inclined to divulge more information about the pharmacy, which helps you decide whether or not to proceed with the purchase. Once a Letter of Intent or Term Sheet has been signed by all parties, it serves as a guide to draft your final purchase agreement.
- Evaluate the pharmacy’s reputation, and confirm legal and regulatory compliance.
In addition to an assessment of the financial health of the pharmacy, it is vital that you also consider the operating history, location and patient list. Determine whether or not the community respects the pharmacy and values it for quality service and products. This is a worthwhile consideration particularly if you intend to make changes to the pharmacy’s operations after acquisition. Such changes may affect patient and customer familiarity factors (i.e. service standards or value propositions), which in turn, can influence your return on capital.
Third-party consents may be required for the acquisition to ensure compliance, which can take time to obtain. A pharmacy is a regulated business, and therefore it is essential that you confirm the pharmacy’s existing adherence to all relevant rules, regulations and requirements, and ensure its compliance with all governed billing practices.
- Know the seller’s arrangements with current staff.
Ensure you understand internal working relationships and workplace dynamics of the pharmacy. Are there vital members of the pharmacy staff who may be integral to the ongoing operations? Has any employee received or requested special accommodations, which will need to be addressed on a go-forward basis? Consider the employee liability and risk profile that you, the buyer, are willing to accept.
- Review the seller’s real estate.
Are the premises from where the pharmacy business is operated leased or owned? If owned, be sure that your lawyer conducts on-title and off-title searches to assess the legal risks associated with the property (if it is included in the transaction). If leased, carefully review the lease agreement in place. Is the lease assignable? If assignment is permitted, what are the landlord’s conditions and can you satisfy them? Other key lease factors to identify include:
- Term of the lease (including any renewals)
- Rent and fair market value (including any “hidden fees”)
- “Danger clauses” such as: the landlord’s right to relocate, demolish or terminate the lease, or restrictive assignment provisions that may impact your ability to sell the business in the future
- Sophistication of the landlord/property management
- Timeline and depth of negotiations for entering into a new lease
- Draft a non-competition agreement.
When a pharmacy owner sells their business, part of the sale is the “goodwill” of the business, which includes the services, reputation, and other factors that may draw patients and customers there. Entering into an enforceable non-competition and non-solicitation agreement with the seller ensures that the seller will not open a new competing pharmacy within the immediate vicinity or become involved in another competing operation that may draw patients and customers away from you immediately after you take possession. A non-competition and non-solicitation agreement can be heavily negotiated to ensure that the interests of the seller and buyer are evenly balanced.
- Know your rights and obligations outlined in the purchase and sale agreement.
A definitive purchase agreement typically includes various representations and warranties which are intended to be factual statements to induce each party to enter into the agreement. The agreement often outlines the rights and obligations of the seller, and the purchaser (you). There may also be post-closing matters that require your ongoing involvement. Your legal advisor is there to ensure you understand all of them and to allocate the risk based on the premium or discount price you are paying to purchase the assets/shares. Ultimately price drives the risk allocation borne in the purchase agreement. If you’re paying a premium price, demand premium protections. If you are receiving a discount or fair deal, consider taking on additional risk in the agreement as the seller likely wants more finality.
- Understand change of ownership requirements and any third party payor risks.
To avoid transactional delays, knowing the regulations in your jurisdiction to ensure compliance with the governing pharmacy college can be helpful. For example, some boards of pharmacy require post-closing notification, whereas others require the submission of a new pharmacy application prior to the official closing date. Pay careful attention to understand the College’s treatment of share vs. asset transactions, since this can prove to be very helpful, particularly because each transaction type may require different documents and considerations. Furthermore, third party payors are becoming more significant in the change of ownership process. Be sure to review recent audits, investigate any clawbacks that may become an issue in future re-accreditation, and understand if the pharmacy is subject to any advanced accreditation considerations currently. A change of ownership does not give you a blank slate. Depending on the payor, you will likely be subject to the same advanced scrutiny as the seller. Make sure you understand this risk.
The necessary preparation to complete a pharmacy transaction successfully can be demanding. It can also be disheartening to all parties if transactional delays are due to simple administrative hurdles that could have been corrected at the outset. Executing the simplest matters correctly and efficiently affords you more time to focus your attention on the complex matters. By working with an experienced lawyer in the industry, you enjoy the peace of mind that comes with knowing all pertinent details have been attended to so you can effectively evaluate your acquisition.
If you are considering a pharmacy acquisition or you are already in the midst of a deal that requires legal counsel, contact us for M&A expertise and consultation. Our team adds value at every stage of the process from valuation and due diligence, to financing, lease negotiations, post-closing transition, and ultimately, a successful transaction.