pharmacy owner working in pharmacy using digital tablet

The path to pharmacy ownership: What you need to know to set yourself up for success

The path to pharmacy ownership: What you need to know to set yourself up for success

Synopsis
12 Minute Read

If you’re looking to make the leap from employee to owner of a pharmacy, consider some practical information on what it takes - from a financial capital, strategy, legal, and tax planning approach.

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 One: Starting your business journey

Your professional life is a process rather than an event, one that sees you grow from student to practitioner, and ultimately to retirement. A typical lifecycle in pharmacy ownership goes through four phases:

The foundational stage

 Setting the fundamental preparations required to establish a solid base for your business future, facilitating growth in a stable, viable manner.

The growth stage

Where you address a wide range of needs faced by the business, including financial information systems, technology, human resources, financing, and operations.

The established stage

 Here is where you start focusing on protecting all the value you have created and how you will realize the value you have built when you finally do exit.

The transition stage

 This is the process of divesting of your holdings and then planning for the management and transfer of that wealth within your family requires serious attention.

First steps

You’ve transitioned from student to practicing pharmacist and are looking into what you need to take that step into pharmacy ownership. Key to starting any business is the business strategy and plan. Your strategy is a high-level view of what you need to do to achieve your goal, and includes a business plan, financial modeling, an advisory team, and an exit plan (yes, more on that below).

Business plan

 Creating a business plan makes you look at where you are going and how you will get there – in detail. If you need to go to the bank for financing, you will need a business plan to show them you have thought this through and have a sound business model.

More importantly, a business plan will help prove to yourself the business is viable, and you don’t needlessly waste your time and money pursuing a venture that will not work. A business plan should cover off key aspects, including:

  • Financial
  • Operational
  • Technology
  • Human resources
  • Marketing

Financial modeling

 A key document in the initial stages of the business plan, a financial model is used to determine if the business is viable or not.  It should include:

  • Earnings forecasts - How much revenue will I generate in the first year to three years? When will I show a profit?
  • Cash flow projections - How much will I need to inject and or borrow as the business gets on its feet and when? Have you included best case, worst case, and most likely scenarios?
  • Debt service calculations - Will the business be able to pay the bank on time? What are best case, worst case, and most likely scenarios?
  • Shareholder Compensation - Will the business be able to afford to pay me, as an active business owner, and still provide a return on my investment?

Advisory team

 As a professional, you should focus on what you know and are really good at and rely on others to help you with the things they know and are really good at. A solid team of advisors include an accountant, a lawyer, a lender, financial advisor and an insurance advisor. Ensure they are all working together as a team, supporting you through collaboration.

Exit Strategy

 You likely won’t know for sure what this end game will look like, but you have to start contemplating it early on if you want to achieve it. An exit plan makes you consider questions like how long do I want to do this for? What’s the end game? And how do I get out?

Going through your exit plan objective will also play into how to set up your corporate tax structure early on so you can minimize your taxes and get the most out of opportunities.

Pitfalls to Avoid

Now that you can see the path, here are a couple of roadblocks to avoid at the beginning of your business journey:

Insufficient planning and not early enough: This usually results in increased costs and missed opportunities. For example, don’t sign a five-year lease without a proper business plan that shows value to committing to a long-term location.

Not engaging a full advisory team to cover off all areas: Do what you do best and engage experts to cover off the other areas. Engaging experts to cover off business risks and advice can minimize risks to the business and the shareholders. Experts will help you maximize your opportunities while minimizing your risks.

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

Now that you have a 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.

Understanding the basics

Tax rates and regulations vary from province to province, no matter the structure. Since no two businesses are the same, it is important to evaluate which structure best fits your situation and goals. The following are three basic ways to structure your business.

Sole proprietorship

As a sole proprietor of a business, the income from the business and the taxes on that income are considered yours and charged at personal income tax rates and summarized on your personal income tax return each year. Business losses can be written off against other income. Sole proprietorships are easy to set up and administer. A major consideration of this structure is the potential for exposure not to only professional liability, but commercial and personal injury claims as well.

Partnership

A partnership acts similar to a proprietorship, but with more than one individual involved. A proportionate share of the business income is allocated to each partner to be included in their incomes for personal tax purposes. Also, business losses can be written off against other income of the partners on their personal returns. As with a sole proprietorship, all partners are jointly liable for all debts.

Corporation

A corporation is a legal entity entirely separate from you, the business owner. Profits, taxes, and tax returns are all calculated separately from you, the individual, at lower corporate tax rates. A corporation is subject to federal, provincial and territorial regulations, has more complex administration, and is more costly to set up and maintain.

Things to consider

If you are starting out small, as a single investor with no partners, you might consider a sole proprietorship. As your business evolves, and your planning objectives change, you might want to revise your business structure to provide greater benefits. There are more complex structures and options available as the business matures.

Risk management, income tax and regulatory issues jump out when weighing the pros and cons of incorporating.

Risk management

A corporation offers a number of ways to mitigate risk through your business, the foremost being reduced personal liability: your personal assets are protected from creditors and other claimants should the business be unable to meet its obligations. Note there continue to be professional liability exposures.

If you acquire real estate through a corporation, for example the building the pharmacy is operating in, you remove yourself as the individual from tenant / personal injury liability. Consideration will need to be given to whether one or multiple corporations are used if acquiring multiple locations. Under a single corporation, risks are shared among the locations, whereas separate corporations can isolate those risks. The use of multiple lenders may also require separate corporations in order to address security requirements of those lenders against appropriate business assets.

Income tax

 Being incorporated provides substantial tax advantages, including:

  • Tax deferrals: Corporate tax rates can be up to 40 percent less than personal tax rates on the first $500,000 of taxable income annually, which can represent up to $200,000 a year in tax deferrals. As owner, you can use those tax savings to retire debt faster, acquire more stores, make improvements, or invest surplus funds and build wealth faster.
  • Compensation planning and income splitting: With appropriate regard for both regulatory and taxation rules, it is possible to introduce family members with lower income who are active in the business, such as a spouse or adult children, as shareholders of a corporation in order to benefit from tax savings.
  • Family trusts (often with a holding company): Family trusts are effective in succession planning, protecting assets, and multiplying the benefits of lifetime capital gains exemptions.
  • Capital gains exemption: Eligible taxpayers may claim a lifetime capital gains exemption of $892,218 in 2021 (tax savings of up to $239,000 per taxpayer). As noted above, an incorporated business can be structured to multiply the capital gains deduction via direct shareholdings or trust interests with their spouse or adult children. The business must be a qualified small business corporation to be eligible for this deduction.
  • Dividends and / or salary: You have a lot of flexibility as an active employee and corporate shareholder in claiming income, through dividends and / or salary, enabling personal income smoothing, and ease in budgeting and cash flow management.
  • Financing: The use of a corporate structure provides more after-tax funds to repay debt and facilitates interest deductibility.
  • Growth: Should the corporation acquire multiple pharmacies in future, you will be able to offset losses against profits where a single corporation is used.

Regulatory

There is no doubt the pharmacy regulatory requirements of corporations are complex, are different across provincial jurisdictions, and can be costly to set up for continued compliance, including share ownership requirements. It is critical to structure your corporation properly to balance the cost / benefit ratio and obtain maximum benefit for the circumstances. Work with an experienced team (lawyer, accountant) that is knowledgeable in building corporate structures to ensure it works for you and the regulators.

Most Common Pitfalls

One of the biggest errors people make when starting out as business owners is not putting enough time into planning the right structure. Know what you want to achieve, who you want to achieve it with, and consult with advisors on the how.

Don’t be fooled into handling an incorporation on your own. Whatever size business, you’ll need to draw on the experience and expertise of advisors to make sure incorporating is the best fit for you now, is flexible for the future and you are compliant with all regulations now and in future.

The road to pharmacy ownership can be challenging, but with proper planning and the right team working alongside you, the journey can be a successful one.

Contact us

For more information, contact Jim Chagnon, CPA, CA, TEP, Partner.

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