By Brad MacLiver
Authorship and profile at Google
When a ND pharmacy is considering selling a cash flow instrument such as the pharmacy’s receivables, or a pharmacy business note, the price the North Dakota pharmacy owner receives will reflect how much time is involved before the Buyer/Investor/Funder of the cash flow instrument will recoup his principal investment and the desired rate of return the Investor needs to make it desirable to take the risk of buying the pharmacies cash flow instrument.
To entice an Investor to shift the risk of holding the cash flow instrument from the pharmacy owner in North Dakota to the Investor, there is typically a financial incentive for the Investor. The incentive is the rate of return, which is required to compensate for the Investors perceived risk. The risk is based on the credit of the cash flow instrument’s Payor, previous payment history, seasoning, interest rate, and other variables. Discount rates may change depending on the circumstances of the cash flow instrument, the economy, etc.
If the North Dakota pharmacy owner or an investor could take the cash flow instrument to the bank and cash it in at face value, the asset would hold more value. However, since this can’t happen the risk of holding the cash flow instrument makes it worth less than face value.
Time Value of Money:
The concept of cash being more valuable to have a dollar today instead of tomorrow is based on the Time Value of Money (TVM). Most business people are aware of the TVM and how it is fundamental to both personal and corporate decision making, but to make sure we are on the same page, we will cover the basics of TVM.
TVM assumes that money earns interest over time. Therefore, as the cliché says time is money, and because of this we can compare money at different points in time that have different values and call them equal.
An example: If $2.00 today earns 8% interest, it will be worth $2.16 at the same time next year. Therefore, $2.00 today = $2.16 next year = $4.31 ten years from now.
Using the same reasoning, the reverse case is also true. An investor will refuse to pay $1.00 today for a dollar that won’t be collected until next year, or even 10 years from now. Today’s dollar will be discounted to reflect any risks, inflation, economic conditions, etc.
Along with interest rates and principal amounts, a cash flow instruments such as Pharmacy Business Notes in ND, are originated with a certain time period. The TVM can be looked at, as if it were on a sliding scale. The earlier in time the Note is paid off, the smaller the amount becomes. When the Note is paid early, you don’t get to collect the compounded interest amount, which would have accumulated if you had waited the full time period. The Note has already been written and the terms set. Unlike a loan where the rate of return needed to cover the risk is added to the loan amount. An investor cannot go back to the buyer of your business and change the terms of the note. Therefore, the investor looks at the portion of the note, which is going to be purchased and subtracts the rate of return needed to justify the risk. This is called Discounting. The amount of the discount is contingent on the risk.
Example:
If you sell something for a $3.50 with 11% interest, equal payments received over a 7 year period, you would expect to receive $7.27. However, should the note be paid in full in 3 years you will only have collected $4.79. You are not collecting the other $2.48 because you are no longer risking anything (you are not earning it). If you want an investor to advance you the $7.27, you will no longer have any risk because you have transferred it to the Investor. To compensate the Investor for accepting the risk of holding the note, the Investor will discount the note, and pay you an amount equivalent to the time and risk involved.
The price you receive when selling your note will be the discounted rate according to the basic TVM principals minus the amount that allows an investor to justify the risk.
If a note is a length of 3, or more years, it may be beneficial for you to sell only a portion of the note. Because the payments from a month in the 5th year will hold less value than payments collected this year, it is beneficial to you to only sell the number of months that you need to obtain the cash that meets your current financial needs. You can always sell more payments at a later date if you need additional funds. Determine what cash you really need and we will calculate the number of months we will purchase to meet your needs.
Although it involves a much shorter period of time, understanding discount rates is the same when selling a pharmacy’s accounts receivables in ND.
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By Brad MacLiver
Authorship and profile at Google
ND Industry Roll-Ups are where an industry’s many players are consolidated into smaller groups for economic benefits. There are aspects of the industry, such as recessions and new government regulations, that may be stifling profits. This ends up providing incentives to consolidate.
One of the main reasons 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 pharmacy industry in North Dakota. 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 pharmacists in ND - a required key employee.
Industry roll-ups are often initiated by investors seeking investment opportunities. However, in the case of pharmacies in North Dakota, 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 North Dakota pharmacy chains.
During the pharmacy industry roll-up pharmacies in ND 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 ND pharmacy acquisitions during the roll-up, specific funding programs have been developed. These pharmacy chain funding programs are backed by major financial institutions that provide the funding for pharmacy acquisitions. These North Dakota pharmacy funding programs allow an individual pharmacy business, or an investment group, the capital to acquire and combine pharmacies in geographic areas.
Funders are willing to provide the capital for the pharmacy roll-up because they recognize that combining the individual pharmacy businesses provides a greater total business value than if each individual pharmacy value were added together. This synergistic value reduces the risk of funding the individual acquisition.
When considering the buying, selling, or financing a 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 pharmacy industry expert to guide a North Dakota pharmacy owner through the maze of details will benefit the ND 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 pharmacy industry in North Dakota 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 North Dakota 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 in ND have been watching what has been occurring in the 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 pharmacy industry will continue to slide to lower levels, and thus the North Dakota pharmacy industry roll-up will continue.
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By Brad MacLiver
Authorship and profile at Google
When a ND pharmacy or drug store is being sold, seldom does the buyer pay “out of pocket” cash for the acquisition. Even when cash is available, pharmacy acquisition strategies usually involve financing the transaction.
Typical acquisitions take 6-9 months to complete, so the North Dakota pharmacy seller will need the buyer to provide some proof up front about their ability to close the transaction. Acquisitions will involve many hours of due diligence and negotiation, so the process should involve qualified parties.
Along with the buyer and seller the acquisition will involve attorneys, accountants, lenders, valuation companies, industry specialists, along with others. No one wants to pursue 6-9 months of work involving a variety of highly paid professionals without having some confidence of the pharmacy buyer’s ability to close the deal.
The process will begin with determining the value of the business. There are many companies that offer valuation services. However, pharmacies in North Dakota are not ice cream stores. There are many aspects of valuing a pharmacy that are unique to the industry, so generic valuations or simple accounting formulas should not be used. An industry specialist should be used for valuing the pharmacies instead of a valuation company that has a broader spectrum.
In order to complete a valuation the selling company needs to provide up-to-date data. Lenders will not accept old data, or a sellers “gut feeling.” Lenders need to make a decision to finance based on sound and verifiable information.
Structuring the transaction is extremely important. The seller of course wants as much money as possible and wants cash. The buyer needs to spread out the debt service and wants to have as little cash as possible invested in the acquisition.
Pharmacies and drug stores are in an industry where it is more difficult to obtain business loan due to the majority of the value in a North Dakota pharmacy is the customer files and not hard assets. Therefore, for the acquisition to be financed a lender will need a strong understanding of the industry and what, beyond the collateralized assets, the company offers to reduce the perceived risk.
ND Pharmacies have typically been known for generating profits and to be stable businesses. However, they are usually in leased locations, and their furniture, fixtures, and computers will only provide $15-20,000 of collateral for a buyer possibly requesting a million dollar loan. A lot of money is tied up in inventory, but the small pills are considered by a lender to easy to move out the door in the event of default. Due to these circumstances many lenders will not loan money to these traditional money making businesses. For a transaction to be a successful one, it takes a lender who understands how the pharmacy industry works.
Tips regarding North Dakota pharmacy acquisitions and finance:
1. An attorneys or CPAs who has been representing the pharmacy seller in ND for many years may see the transaction as putting themselves in a position of losing a client when the business is sold over. Be certain that they are working diligently on the transaction instead of slowing or hindering the process.
2. Because the pharmacy acquisitions process takes 6-9 months worth of work to finish, each party involved should stick to their time tables. Important items will much too often end up sitting on the desk of someone that is outside of the control of the buyer or seller.
3. All financial information has to be current and the data supplied to both the buyer and the lender will need to be updated on a continuous basis over the lengthy acquisition process. The situation can change dramatically during a period of nine months, so the North Dakota pharmacy seller needs to continually prove the company's financial condition.
When working on “pharmacy acquisition finance,” make sure the lender and the valuation company are experts in that industry for the highest chance of success. Make sure you are working with company that has the ND pharmacy expertise, experience, and is a direct correspondent with lenders who understand how pharmacy works.
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By Brad MacLiver
Authorship and profile at Google
The U.S. Department of Health and Human Services provides a program for discounted prescription drugs to qualified Federally Qualified Health Centers (FQHC), Disproportionate Share Hospitals (DSH), and other qualified entities. When these facilities don’t have their own pharmacies they are allowed to contract with a local ND pharmacy. The drug pricing program is often referred to as 340B, named after the section of the law that established the program.
Section 340B legislation was enacted to provide uninsured and indigent populations with access to very discounted medications. Because the program exists to assist certain populations, there are various restrictions and regulations dictating how the program operates and who the medications can be dispensed to.
North Dakota Pharmacies can be contracted by a FQHC or similar 340B qualified entities to both manage and dispense the medications. Patients belonging to these entities provide increased traffic to the pharmacies, allowing them the opportunity for additional front end sales along with the Rx sales.
Pharmacy owners who participate in a 340B pharmacy program are obligated to manage their business consistent with customary business practices. In the event of an audit the pharmacy in Wyoming should have dispensing and inventory records, billing statements, etc. Business records should show that drugs purchased by customers, under the 340B Drug Pricing Program, were not diverted to people who are not part of the program.
Along with the additional record keeping a ND pharmacy owner will need employees who understand the various state and federal rules and regulations, which govern the 340B program. The pharmacy will also need to have a location for the 340B inventory, which is separate from their normal inventory, or have a software management system to track the separate inventories.
A system of separating the inventory is required due to the drug inventory used for the 340B pharmacy program is owned by entity that contracted the North Dakota pharmacy. Since the 340B inventory is not “owned” by the pharmacy this inventory will be treated differently for tax purposes. The pharmacy generates income from dispensing fees they are paid instead of a mark-up or profit margin on the inventory.
Since customers participating in a 340B program can only purchase the designated medications from a pharmacy contracted with a 340B entity, this allows a pharmacy to have a market niche. A contracted pharmacy servicing 340B customers benefit from additional customer traffic visiting the store.
With the current economic situation and high unemployment, many people have lost their insurance benefits. This will likely expand the need for 340B pharmacy programs and provide additional 340B customers to a participating pharmacy.
However, when a pharmacy owner is weighing the potential benefits of a 340B program, they should also consider other aspects of their business and the current market conditions of the pharmacy industry. What are the North Dakota pharmacy’s goals over the next couple years? A younger pharmacy owner with long term objectives can benefit for many years from the added customers. However, a pharmacy owner considering selling the business in the next couple years should be aware that acquisition values are based on the customer files, and many buyers are not currently willing to include 340B customer files in their offers. This results in a lower pharmacy business valuation and market price for the pharmacy despite the volume of business. Also, due to the current economic conditions there are some 340B customers who despite the deeply discounted prices, have chosen not to purchase medications. Pharmacy owners in North Dakota need to consider the added costs and time of 340B inventory and customer tracking and reporting, may not be offset by the fees received.
If a pharmacy owner is considering the benefits of participating in a 340B program, or is considering selling the pharmacy in the couple years, it is advisable to discuss the options with the ND pharmacy industry expert.
By Brad MacLiver
Authorship and profile at Google
Almost everything you own and use for personal, or business, purposes is a capital asset. When ND pharmacy owners sell a capital asset, the difference between the amounts you sell it for and the amount you paid for it (the basis), is a capital gain, or a capital loss.
Capital gains may also refer to "investment income" that arises in relation to real assets, such as property, financial assets, and intangible assets such as goodwill. In the U.S., all capital gains must be reported and the appropriate tax paid.
When selling a North Dakota pharmacy or a drug store, there are specific tax strategies that can be used to help offset the tax liabilities. Unless a professional is handling a large number of pharmacy acquisitions in North Dakota, they usually do not know these federal regulations that allow for reducing the tax liability for the pharmacy owner.
During this period of history where it is more difficult to finance a business, pharmacy sellers may already be required to lower their asking price, so a pharmacy buyer can qualify for the financing required. On top of the lower offers they will be required to pay higher percentages in taxes.
This is a dilemma for the North Dakota pharmacy seller who wants as much money out of the deal as possible. For most pharmacy owners in North Dakota, their business is the largest asset they will ever own and selling the business at a certain dollar amount has been part of their retirement and estate planning. Knowing they will need to cut out a larger chunk of the proceeds to give to the government will cause some pharmacy owners to reconsider their retirement plans. The good news is there are financial tools and strategies that allow the pharmacy owner to proceed with their plans.
Family Foundations are tax exempt/nonprofit organizations, which provide tax advantages and control over philanthropic activities. Family foundations are typically private foundations that are funded by a small number of sources, and do not conduct widespread fund-raising activities. They may receive gifts from friends and limited sources. Family members serve as trustees, directors, and officers. As private foundations they can make grants, or donations to other organizations. Having a Family Foundation provides a number of benefits including, income tax deductions, exemptions from estate and gift taxes, along with the reduction or elimination of other taxes.
One other strategy that can be used to assist the capital gains tax burden is the Charitable Remainder Trust (CRT). These trusts are legally described as Split Interest Trusts because of their blend of both philanthropic motivations and personal financial aspects. CRT’s are capable of reducing tax liabilities, increase the financial wealth of a business owner, and provide a platform for charitable giving at the same time.
CRT’s are established when someone donates assets to this special type of Trust. These assets can be real estate, stocks, cash, and the like. The CRT will be established for a set period of time or until the death of the donor (the pharmacy owners). The pharmacy owner or a family member can receive income from the Trust’s assets, but upon the donor’s death, those assets will go to a designated charity. Part of the income received from the Trust can be used to purchase life insurance on the donor. The proceeds from the life insurance will go to designated heir(s) who receives it without incurring any estate tax liability.
Some tax strategies including the use of CRTs are not widely known. It would be advisable for North Dakota pharmacy business owners to be aware of the different tools that are available in structuring a business transaction. They should also be aware that only a professional with vast experience in CRTs should be used to setup a Charitable Remainder Trust. Not following the strict IRS guidelines could be cause for increased taxes, penalties, and in some cases criminal charges.
Over the years there have been unscrupulous individuals who have tried using CRTs and similar financial tools in illegal scams. With the increase in capital gains taxes there are expectations more scams will be floating around out there. Be knowledgeable about the possibilities, but be confident you are working with experts in your industry.
You should consult a firm with extensive experience in pharmacy and drug store acquisitions in ND. Firms that have the knowledge and expertise to structure the transaction appropriately, for tax considerations, can save a North Dakota pharmacy owner large sums of money when a pharmacy is sold.
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