EBITDA and Rhode Island Pharmacy Acquisitions

By Brad MacLiver
Authorship and profile at Google


EBITDA means: earnings before interest, taxes, depreciation and amortization. This is often used to measure the value of some businesses including both pharmacy chains and independently owned drug stores. It can also be used in the comparison of similar companies.
      
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 pharmacies in Rhode Island 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. Net Income             900
#2. + Taxes paid           280
#3. + Interest Expenses    190
#4. + Depreciation         105
#5. + Amortization          45
#6. = EBITDA             1,520

Hindurances when using EBITDA:
#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.

EBITDA was being used as a proxy for cash flow during the 1980's in leveraged buyouts to calculate whether companies could service their debt. By factoring out variables like interest, taxes, depreciation, and amortization, unprofitable business can appear financially healthy. This method of valuation was used frequently during the dotcom era in order to value unprofitable businesses with little assets and few earnings.  The results from that method caused many to go bust -- a blaring example of misapplying EBITDA.

Knowledgeable pharmacy specialists in RI performing pharmacy business valuations will use EBITDA in RI 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 is usually not needed in the valuation formula method for standard retail pharmacy valuations.

The EBITDA number for a specific existing 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 Rhode Island 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 Rhode Island pharmacy. Instead of the EBITDA number, pharmacy buyers should be focusing on sales, gross profit, cash flow, and customer mix.

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The Rhode Island Pharmacy Industry Roll-Up

By Brad MacLiver
Authorship and profile at Google


RI 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 Rhode Island 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 pharmacists in RI - a required key employee.

Industry roll-ups are often initiated by investors seeking investment opportunities. However, in the case of Rhode Island pharmacies, 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 pharmacy chains in Rhode Island.

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

To help fund Rhode Island pharmacy acquisitions during the roll-up, specific funding programs have seen development. These pharmacy chain funding programs are backed by major financial institutions that provide the funding for pharmacy acquisitions. These pharmacy funding programs allow an individual pharmacy business, or an investment group, the capital to acquire and combine Rhode Island pharmacies in geographic areas.

Funders are willing to provide the capital for the RI 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 pharmacy owner through the maze of details will benefit the pharmacy owner in Rhode Island 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 should be calculated by a company that has in-depth knowledge of the Rhode Island 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 pharmacy industry in Rhode Island. 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 RI pharmacy industry roll-up will continue.

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Acceleration Clauses in Commercial Leases and Rhode Island Pharmacy Business Loans

By Brad MacLiver
Authorship and profile at Google


A provision of many RI 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 see the acceleration clause as a vital tool in their business loan and commercial lease programs. Lease and loan documents may not specifically address the foreclosure of a property or the repossession of an asset and this is where the acceleration clause takes effect. Without this clause, the lender would only be capable of foreclosing on one missed payment at a time. With the acceleration clause in place, despite whatever event kicks it into gear, the lender can demand immediate, full payment of all remaining fees and balances.

The pharmacy business loan or lease documents provided to the Rhode Island pharmacy owner will describe the rights, conditions, and obligations relevant to the acceleration clause. When the pharmacy owner (the borrower) doesn’t meet their obligations then the loan or lease goes into default. A payment that is even one day late can cause a default. Due to this, pharmacy business loans in Rhode Island and commercial lease documents should be thoroughly read and understood before signing.

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

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

3. States have different rules requiring notification of an acceleration clause being exercised. Pharmacy owners should understand the laws in the state where they operate. Lack of knowledge is not 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 in Rhode Island should help the process by assisting the landlord re-lease the property. However, please note, should the 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 RI pharmacy.

5. Lenders prefer not to have to go through the foreclosure process, so if your pharmacy 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 Rhode Island 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 RI pharmacy owner through the maze of details will benefit the pharmacy owner in making the best business decision.

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