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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Rhode Island Pharmacy Acquisitions and Bridge Loans

By Brad MacLiver
Authorship and profile at Google


With the changes in the Rhode Island (RI) pharmacy industry independent drug store owners, small and regional Rhode Island pharmacy chains, and pharmacy equity investment groups are acquiring pharmacies to obtain a larger competitive footprint in a geographic area. During the acquisition phase of the business expansion there may be opportunities that require action, which is faster than the traditional funding process.
                       
Bridge Loans are a short-term financing option. They are used while waiting for permanent financing or the next stage of financing to be obtained. These loans provide a business owner with funding to "bridge" the gap between a company’s current needs and their long term financing requirements.  Generally, permanent financing is used to "take out," or pay back the bridge loan taken out.

One characteristic of a bridge loan is that they are able to close quickly.  This in turn allows a company to capitalize on a timely business opportunity or acquisition. The quick access to money can enable a business the chance to avoid some penalties, temporary problems, or even bankruptcy. If there are some longer term issues that need to be dealt with, this form of transitional financing provides the company time until longer term financing can be secured.

Another characteristic of bridge loans is that the process will typically require less documentation than more conventional financing. Bridge loan lenders don’t usually have the same government regulations to adhere to, so they tend to have more flexibility in their lending criteria and the documentation they require. However, less documentation does not mean they won’t perform due diligence to have a comfort level with the transaction before they fund.

Examples of using Bridge Loans in Pharmacy Transactions in RI:
1. An independent Rhode Island pharmacy owner learns of health issues and decides to quickly sell the family owned pharmacy to an employee or local competitor. Traditional financing for the pharmacy buyer may require a time line that is not acceptable when considering the circumstances. A bridge loan can be used to quickly accomplish the transaction.

2. A small pharmacy chain needs $1 million to expand their business. They have 3 new equity investors who will be investing in the firm over the next 6 months, but at different intervals. However, the business has opportunities which require action sooner than 6 months. The quick closing bridge loan allows the pharmacy chain in Rhode Island access to the needed funds so they can complete their expansion and increase profits. Money from the 3 new equity investors will pay off the bridge loan.

3. A Rhode Island pharmacy owner in a leased location has an opportunity to quickly acquire a commercial property that would be a great RI pharmacy location, but the property is in disrepair. A bridge loan provides the needed funds to acquire and rehab of the property and once that is complete conventional long term financing can be obtained.

4. A pharmacy group developing new pharmacy locations can receive bridge loan funding to get through the permitting process of a project when conventional financing isn’t available at this early stage due to there is still too much risk. A bridge loan allows the project to move into the construction phase and then qualify for other forms of financing.

5. When a Rhode Island pharmacy is owned by two or more partners and one of the partners is ready to exit the business, a bridge loan can help ensure the cash flow and uninterrupted operation of the business during the partner buyout.

6. Real estate, or equipment bought at auction may have a narrow window for closing the deal and timing of traditional financing would keep the buyer from proceeding with the opportunity. Benefits of a bridge loan will permit the pharmacy owner to quickly respond to the opportunity.

When there are business opportunities, buying pharmacies in RI, selling pharmacies, quick deadlines, an old loan maturing before a new loan can be put in place, funding needs during the permit, planning, or evaluating stages, etc., bridge loans can be an essential financial tool.

Tips regarding Rhode Island pharmacy bridge loans:                        

1. Bridge loans are quick to obtain, but quick to expire.

2. A bridge loan is similar to a hard money loan and the terms are often used interchangeably in conversations. Both are short-term, higher interest rate, non-standard loans, but in some circles hard money refers to the lending source and a bridge loan refers to the duration of the loan.

3. Because bridge loans usually come with higher interest rates than traditional financing a larger down payment, meaning a lower Loan to Value (LTV) and a lower level of risk and provides an opportunity for lower interest rates.

4. With the shorter time period of bridge loans borrowers will need to be aware that fees for valuations, legal, dues diligence, etc., will be amortized over a shorter period than traditional financing transactions.

Keep in mind that the types of deals that require a bridge loan may be considered either speculative in nature or to have higher risk factors. Banks will often not offer bridge loans due to this. Banks must adhere to government regulations and are required to justify their lending practices, so riskier bridge loans do not typically fall within the lending parameters of many banks. All this means that a majority of the bridge loans will come from private investment firms.  It is best to consult with a company that has access to many funding sources who can provide bridge loans.

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