How would you feel if you paid double what a pharmacy was really worth? It’s a question that zeroes in on why due diligence matters.
Buying a pharmacy business is a big step, full of uncertainties and unknowns. One of the ways to bring more certainty to a transaction is in undertaking due diligence. It’s something that we talk about all the time and support many, many clients to undertake in support of their purchase decisions. But what exactly is it and why is it so important?
According to the Oxford Dictionary, the definition of diligence is “careful and persistent work or effort”. When you add ‘due’ to coin the phrase ‘due diligence’, it becomes a legal term which involves taking reasonable steps to avoid committing a tort or offence. When applied to buying a business, due diligence involves a comprehensive appraisal of the business to establish its assets, liabilities and evaluate its commercial potential.
Like any investment, it’s important to be sure of what you are paying for AND that you’re paying a fair price. Due diligence is a way to dot your i’s and cross your t’s.
The process of due diligence involves taking a closer look at the numbers, agreements and operations of the pharmacy business. At Holman Hodge, we work with pharmacy owners and prospective owners to guide the process, which often comes down to knowing the right questions to ask, who you seek advice from and weighing up if this is the right step for you.
Asking the right questions
At Holman Hodge, we work with pharmacy owners and prospective buyers to guide them through the due diligence process. Having a specialised understanding of pharmacy business at the granular and industry level, means that we can assist in translating anomalies and in gaining a greater understanding of what is being offered for sale. We know the right questions to ask to flesh out the details, so here are a few pointers:
- Financials
- Ask for at least the last three years of Accountant prepared financials to understand the numbers as well as year to date management reports.
- Review alongside POS (Point Of Sale) reports to cross check and understand the components of the business that are retail versus dispensary.
- Assess the pharmacy’s performance and profitability against industry benchmarks. This includes identifying anomalies in the information (including unexplained significant improvements in recent performance).
- Lease agreements
- Location is a very important factor in a pharmacy’s success and lease costs are amongst the biggest expenses.
- What are the lease terms, when does it expire and what renewal terms are there? Security of the long term tenure is very important.
- Identify risk of additional competitors
- Sources of income
- Ask for a ‘Top doctors’ report to identify where the scripts are coming from. Are there risks associated with the current relationships if there is a new owner?
- What contracts are in place with nearby facilities, such as aged care or nursing home providers? Review the contracts, termination clauses and renewal terms.
- Staffing
- Review the roster and wage costs. Do they align with the pharmacy’s performance?
- What are the employee entitlement balances? Are there any key staff you risk losing from a change of ownership?
- What’s the culture like and the staffing mix?
- Owner involvement
- What is the current owner’s role in the pharmacy and how might this impact ongoing relationships and operations?
- Have the current owners been working fulltime and drawing a salary? This impacts profitability.
- Stock levels
- What is stock valued at and does this reflect current pricing and turnover?
- Are you buying old, slow-moving stock?
The answers to these questions shouldn’t be taken at face value. They are better understood by undertaking a SWOT analysis of the pharmacy business – Strengths, Weaknesses, Opportunities and Threats. This will take into account the pharmacy’s location, competitors, suburb growth, GP relationships, and industry factors such as Medicare, 60 day dispensing, and relevant programs and incentives which the pharmacy may be entitled to.
One such example is from a buyer who approached us to purchase their first pharmacy with a proposed value based on the pharmacy’s eligibility to the Regional Pharmacy Transition Allowance (RPTA) program which certain rural pharmacies have access to. After engaging us, we discovered that the pharmacy wasn’t eligible due to several factors misrepresented by the vendor. This resulted in the business being overvalued by as much as $400,000 and gave the buyer great insight into the true value of the business.
Another buyer approached us after placing an offer based on a valuation of over $4m. When we undertook the usual due diligence, which included comparing the business’ financials with their POS reports, we found that the pharmacy was valued based on the group turnover, not the single pharmacy that was for sale. This meant that the reported sales, and therefore valuation, was overstated by more than a million dollars.
Who should be involved in the pharmacy sale process?
When considering purchasing (or selling) a pharmacy, there are a number of experts you can rely on, and they each play a different role:
- Accountant – to conduct due diligence, ensure financial accuracy and a ‘sense check’ on the numbers (in line with the questions we have raised in the previous section)
- Broker – can assist in finding potential buyers and business valuation
- Lawyer – reviewing and setting in place the paperwork, lease, contracts and agreements
- Valuer – valuation of the business, usually for lending purposes, and valuation of stock
- Banker (or finance broker) – to secure funding (usually based on the due diligence findings).
It’s also important to ensure you have the right balance and the right team supporting you throughout this process. We had a case where the buyer relied solely on legal advice, without involving the other parties until closer to the end of negotiations. When we stepped in to undertake due diligence, we identified that the advisor they had engaged was managing items outside of their area of expertise. This resulted in an over-lapping of duties and additional unnecessary costs for the buyer.
A final tip
Buying a pharmacy is a big move and should be considered as such. Come to us early. We’ll help you to understand the process, what you are buying and ensure that your offer reflects a fair value. From a statutory, compliance and financial point of view, we know what to look for.
We know our numbers, we know pharmacy and what makes sense.
Pharmacies are unique businesses. We’ll work with you to ensure that your investment is sound and you’re set up for success from day one.
About the Authors
Krista Fenix and Serry Leombruno work in our Pharmacy Team to support pharmacies around Australia.
Krista is a Manager at Holman Hodge. She works with over a dozen pharmacies and has built a close affinity with retail and hospitality clients too. Personal experience working in a multigenerational family business and as a qualified Family Business Advisor brings a valued perspective to pharmacy clients, particularly those entering or exiting an ownership group.
Serry Leombruno is an Assistant Manager. He works with a stable of pharmacy clients, supporting tax and compliance, management accounting and advisory around matters such as restructures, cashflow and transactions. Coming from commerce, with a pharmacy and retail background, he has an understanding of system and process, providing insight into business improvement.
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