Vermont EBITDA and Pharmacy Acquisitions

By Brad MacLiver
Authorship and profile at Google


EBITDA: earnings before interest, taxes, depreciation and amortization..... is often used to measure the value of some businesses including independently owned pharmacies. It can also be used in the comparison of similar companies whether independents or pharmacy chains.
       
Generally, EBITDA makes it easier to evaluate various companies and to compare them against industry averages by removing the non-core and irregular operating costs, such as interest, which can vary depending on the management’s choice of financing, taxes which can fluctuate depending on acquisitions or losses from prior years, and arbitrary factors of depreciation and amortization.

The EBITDA formula can be used as a guideline when valuing larger companies, or when comparing the profitability of large similar companies in the same industry.

For the effective use of EBITDA, these larger companies should possess significant assets, have heavy amortization schedules, or bear substantial amounts of debt. Considering independent Vermont pharmacies don’t meet that criteria, this formula is not a useful measure as the sole means for valuing pharmacies for acquisition purposes.

To Calculate EBITDA:
1) Calculate net income by obtaining total income and subtract total expenses.
2) Determine the total amount of taxes paid to federal, state, and local governments.
3) Compute interest fees paid to companies or individuals for the use of credit, or capital.
4) Establish the cost of depreciation (the expense recorded to allocate a tangible asset's cost over its useful life).
5) Determine the cost of amortization (the expense for consumption of the value of intangible assets, such as goodwill, patents, and copyrights, over a specific period of time, or the asset's expected life.
6) Add #1 through #5.

EBITDA calculation example:
1) Start with net Income   1,300
2) Add taxes paid            375
3) Add interest Expenses     225
4) Add depreciation          115
5) Add amortization           60
6) Result is EBITDA        2,075

EBITDA Drawbacks:
1) Can be misleading number when it is confused with cash flow.
2) Can make even completely unprofitable firms appear to be financially healthy.
3) Numbers are easy to manipulate.
4) Can overlook cash requirements for growth in accounts receivable.
5) Can miss cash requirements for growth in inventories.
6) Not factual when valuing small companies.
7) Not effective for companies with few assets, small amounts of debt, or low depreciation or amortization schedules.

In previous years, EBITDA was being used as a way to estimate cash flow in leveraged buyouts to calculate whether companies could service their debt. Factoring out interest, taxes, depreciation, and amortization can allow an unprofitable business to appear financially healthy. This method of valuation was used extensively during the dotcom era to value unprofitable businesses, with few assets, little earnings, and the results from that method caused many to go bust. This was a blaring example of misapplying EBITDA.

Knowledgeable Vermont pharmacy specialists performing pharmacy business valuations will use EBITDA in pharmacy valuations, but only as part of a larger formula when computing values for specialty pharmacies especially those who have a niche in HIV, disease management, long term care, etc. However, EBITDA should not be used as part of the usual formula for standard retail pharmacy acquisitions in Vermont.

The EBITDA number for a specific existing Vermont pharmacy is important, for the most part, when the existing ownership is establishing their store value for the purpose of a line of credit, borrowing, creating a Trust, stock values, etc., but EBITDA does not have the same importance when selling a pharmacy. This is due to the fact the buyer will not have the same expenses as the seller.

Buyers may not have the same tax base, interest expense, or the same depreciation schedule, thus it is important that the buyer calculate an estimated EBITDA that is specific to their operating model, business systems, buying power, cost of operations, etc., not the sellers. It should also be noted that EBITDA assumes that the buyer will acquire all of the assets, working capital, accounts receivable, and liabilities. Those assumptions do not hold true regarding an acquisition of a VT pharmacy. Instead of the EBITDA number, Vermont pharmacy buyers should be focusing on sales, gross profit, cash flow, and customer mix.

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Pharmacy Industry Roll-Up in Vermont

By Brad MacLiver
Authorship and profile at Google


VT Industry Roll-Ups are where an industry’s many players are consolidated into smaller groups for economic benefits. Recessions, new government regulations, or other aspects of the industry that may be stifling profits end up providing incentives to consolidate

A principal reason for an industry roll-up is to achieve economies of scale in purchasing, marketing, information systems, logistics, distribution, and top management. Consolidated businesses also have less risk from the impact of an unsatisfied customer and have the reward of being able to recruit, or keep, key employees.

An example of an industry roll-up can be seen with the Vermont pharmacy industry. It is a well established industry and is still experiencing sales growth. However, pharmacies and drug stores have seen a steady decline in their profit margins due mainly to government regulations, even as sales increase. There has also been a shortage of Vermont pharmacists - a required key employee.

Industry roll-ups are often initiated by investors seeking investment opportunities. However, in the case of pharmacies in Vermont, the roll-up is a necessity due to declining net profits ratios. Companies that are acquired in a roll-up are usually small independently-owned businesses whose owners believe in the economic benefits of combining forces with a larger organization, or simply need an exit strategy. In the pharmacy industry roll-up, independents have been a majority of the acquisitions, but there has also been a consolidation of a number of the larger VT pharmacy chains.

During the pharmacy industry roll-up pharmacies with better financial wherewithal are acquiring their local competition and combining two or more stores into a single location. This results in more customer traffic through a single location and reduces the expenses that come with multiple locations. This can dramatically drive up total sales while driving down the administrative and overhead costs per customer.

To help fund Vermont pharmacy acquisitions during the roll-up, specific funding programs have been developed. These pharmacy chain funding programs are backed by significant financial institutions who can provide the funding for pharmacy acquisitions. These pharmacy funding programs allow an investment group or an individual pharmacy business in Vermont with the capital to acquire and combine pharmacies in geographic areas.

Funders are willing to provide the necessary capital for the pharmacy roll-up because they recognize that combining individual pharmacy businesses provides a greater total business value than if each individual pharmacy value were added together. This synergistic quality reduces the risk of funding the individual acquisition.

When considering the selling, buying, or financing a VT pharmacy, whether an independent drug store, or multiple pharmacy locations,  due diligence and understanding of all aspects of the transaction should be considered. Using the services of a Vermont pharmacy industry expert to guide a pharmacy owner through the maze of details will benefit the pharmacy owner in making the best business decision.

All transactions involved in the pharmacy roll-up need to have the business valued at the current market value. Business valuations for the Vermont pharmacy industry should be calculated by a company that has in-depth knowledge of the pharmacy. Simple accounting formulas used by many to estimate a value do not provide an accurate picture because the simple formulas do not take into account the aspects that are causing the pharmacy industry roll-up.

The aspects of the market which are stimulating the roll-up are also having downward pressure on the pharmacy business valuations. Pharmacy owners have been watching what has been occurring in the Vermont pharmacy industry. While profit margins slip, new regulations are being imposed, and as reimbursements are pared down there is wide expectation that the business values in the VT pharmacy industry will continue to slide to lower levels, and thus the pharmacy industry roll-up will continue.

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Acceleration Clauses in Commercial Leases and Pharmacy Business Loans in Vermont

By Brad MacLiver
Authorship and profile at Google


A provision of many VT pharmacy business loans and commercial leases is an acceleration clause. The acceleration clause in the loan/lease agreements allows the lender to accelerate their collection of payments contingent on an event occurring. These events may include lack of payment by the borrower, failure to keep the property adequately insured, failing to pay tax assessments, not maintaining the property, selling the property/asset, etc.

Lenders view the acceleration clause as an important tool in their business loan and commercial lease programs. Loan and lease documents might not specifically address the foreclosure of a property, or repossession of an asset, but this is where the acceleration clause comes into effect. Without the clause the lender would only be able to foreclose on one missed payment at a time. With the acceleration clause, despite whatever event kicks the clause into gear, the lender can demand immediate and full payment of all remaining balances and fees.

The pharmacy business loan or lease documents that are provided to the Vermont pharmacy owner will describe any rights, any conditions, and any obligations relevant to the acceleration clause. When the pharmacy owner, in this case the borrower, is unable to meet their obligations, the loan or lease then goes into default. A payment that is even a single day late is able to cause a default, so VT pharmacy business loans and commercial lease documents should be thoroughly read and completely understood before signing.

Tips:
1. If a Vermont pharmacy’s slowing cash flow is going to cause a business loan default, but the VT pharmacy owner has additional unencumbered assets they may be able to negotiate with the lender by offering additional collateral.

2. If a pharmacy in Vermont can catch up on their payments they can reinstate the business loan before the acceleration starts.

3. States have different rules specifying the requirements of notification when an acceleration clause being exercised. Pharmacy owners should comprehend the laws in their state because lack of knowledge is never an excuse.
                                 
4. When an acceleration clause is exercised on a commercial lease, there is the possibility the landlord cannot collect rent from both the defaulting tenant and a new tenant at the same time. To save themselves some money, pharmacy owners should help the process by assisting the landlord re-lease the property. However, please note, should the Vermont pharmacy be in the process of being sold and the files and inventory moved to a competitor’s location, the pharmacy buyer will require restrictions in the Purchase and Sale Agreement  that the new tenant cannot be another pharmacy.

5. Lenders prefer not to have to go through the foreclosure process, so if your pharmacy in Vermont is headed in that direction start talking with the lender about finding a solution. Communication with the lender is a good thing.

6. Some pharmacy business loans and commercial leases require a “personal” guarantee from the business owner. This means that the business owner’s personal assets and credit will become involved in the event of a default. The “corporate” status of the business will not keep the lender from seizing the personal assets.

When considering financing a Vermont pharmacy for acquisition, or expansion, due diligence and understanding of all aspects of the transaction should be considered. Using the services of a pharmacy industry expert to guide a pharmacy owner through the maze of details will benefit the pharmacy owner in making the best business decision.

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