We are receiving a panicked calls from pharmacies whose wholesalers will not send them controls. The pharmacies are adamant that they are operating as usual or the problem that triggered the issue is not their fault.

First, some background.

Wholesalers used to ship pharmacies controls with few questions asked. Then the opioid epidemic came and the press and public started putting pressure on politicians and prosecutors. This resulted is mega fines against wholesalers. The big three AmerisourceBergen, Cardinal Health and McKesson — paid $21 billion.

https://www.npr.org/2022/02/25/1082901958/opioid-settlement-johnson-26-billion

As I am writing this article, Morris Dickson is at risk of losing it’s DEA registration for the same reasons.

https://www.npr.org/2023/05/26/1178372700/dea-morris-dickson-drug-distributor-license-opioid-crisis

Suffice to say, the wholesalers are taking a “guilty until proven inncent approach” when cutting off pharmacies. Here is how to prevent issues:

• Wholesalers use a ratio of control v. not-controlled in determining if your store is a problem, so if a patient needs controls, you should require them to get all of their other non-controls from you. This is the optimal
• Make sure you have a relationship with these patients. Make sure you are 100% comfortable giving them controls. Pharmacies only make a few dollars dispensing these scripts. It’s not worth the risk. Just tell the patient “sorry, we are not able to fill this because we have already reached our quota for the month.” When in doubt, kick the patient out.
• Do not dispense any control to any patient that has any red flags. The DEA lists the following indicators of improper prescribing in the “⦁ Pharmacist’s Guide to Prescription Fraud”:
  • The prescriber writes significantly more prescriptions (or larger quantities) compared to other practitioners in the area
  • The patient is returning too frequently for refills.
  • The prescriber writes prescriptions for antagonistic drugs, such as depressants and stimulants, at the same time. Drug abusers often request prescriptions for “uppers and downers.”
  • The patient presents prescriptions written for other people.
  • Multiple patients appear simultaneously, or within a short time, all presenting similar prescriptions from the same physician.
  • People who are not regular patrons or residents of the community present prescriptions from the same physician.
• Make sure your biennial count is completed and documented.
• Make sure your staff – and relief staff — know about all of the above.
• Talk to prescribers and patients about non-controlled therapeutic alternatives.
• Talk to patients about giving them these drugs for a limited time and then weaning them off of it.
• My best advice: Get a reputation in the community as a pharmacy that doesn’t give out controls easily. The abusers of these products talk to each other and you want them telling each other to avoid your store.

If your wholesaler has cut you off, get on the phone with their compliance department and figure out what control caused the problem. Don’t waste time with your rep – they cannot help you. They are just an intermediary that will slow things down. Talk to the decision maker in compliance. If the compliance department says it’s one class or NDC, ask them to just reduce or cut you off of that one class of drugs until things are resolved so you can keep filling the rest.

Ask the wholesaler for a specific ratio and keep to it during an agreed probationary period. Wholesaler want to see you working with them to resolve any concerns they have. Don’t waste your time threatening that you will go to another wholesaler. They don’t care – the amount they make from your store is a pittance compared to what they stand to lose if the DEA cuts them off.

If you were cut off because someone in your store was in the news for anything related to controlled substances, such as a pharmacist or staff member being arrested for stealing controls, you must immediately terminate this staff member, take their keys, cut off their ordering access, and cooperate with authorities. A wholesaler will likely not consider dealing with you until you do this, so do it immediately.

Next, be prepared to explain why your ratio is higher. Do you serve hospice? Is there a surgical center nearby and you are filling for a bunch of patients that have short-term post-surgical pain? Is there a psychiatrist nearby with a large ADHD population?

Next, get on the phone with some secondaries or another new wholesaler and get the account set up ASAP. It can take longer than anyone would like to resolve these issues with a wholesaler, so getting a backup in place is a good idea.

Last, communicate with patients open and honestly. Just say you are having temporary issues getting certain products. Most patients will understand if you are honest.

This may be the most problematic obstacle of all the impediments faced by sellers.

Whereas a great majority of the obstacles are somewhat within sellers’ control, that is not necessarily the case with transferring a facility lease.  Landlords can be unpredictable and typically have a lot of leverage in lease negotiations with prospective buyers.

Become thoroughly familiar with the terms of your lease

Before ever putting your business on the market, you need to be familiar with the legal language in your lease.  Your intermediary might help you preliminarily interpret the lease but should also strongly suggest you ask your attorney to review and interpret the lease provisions.

Most facility leases will address the issue of assignability of the lease.  Many will allow the lease to be assigned, but usually “only with written permission from the landlord.”  You also hope to see the phrase that the landlord’s permission “shall not be unreasonably withheld.”

In addition, there may be provisions explaining what the landlord needs to approve a new tenant.  There also may be notification time frames stated, as well as the landlord’s required response time.  It’s also possible there will be transfer fees associated with obtaining the landlord’s approval.

About lease assignments

Typically, if a lease is assigned to a new tenant, the original tenant remains liable in the event of a default by the assignee.  The implications are if the buyer struggles after acquiring your business and stops making payments on the lease, the landlord can look to collect lease payments from you for the remainder of the lease commitment.  In the final definitive documents of the business sale, you will likely have indemnity clauses in your favor from the buyer.  But, although you have the legal right to do so, there is no assurance funds will exist to reimburse you if the buyer defaults on an assigned lease.

SBA financing requires the lease term (with options) to match the loan term.

There’s another complicating factor.  If the buyers’ financing is based on an SBA loan, the SBA will require the lease term, including tenant options, to match the loan term – usually either 7 or 10 years. That can be favorable for landlords because they can use that fact to achieve longer term lease commitments, but the option has to be the tenant’s, so that creates an offsetting factor.  The real difficulty arises if the landlord has other plans for the leased space and is not willing to negotiate a lease term to match the loan term.  Or, some landlords will use that prerequisite as leverage to try to negotiate unreasonable lease terms. 

Novation agreements are desirable

As the tenant on a lease, your ideal solution is to negotiate a novation agreement, which means the landlord and prospective buyer enter into a new lease agreement at the same time you are released from obligations under the original lease agreement.  In theory, it’s great.  In reality, it’s extremely difficult to negotiate because in most circumstances the landlord has all the leverage in lease negotiations.  Unless, of course, the business can be relocated, but even that leaves you on the hook for the remaining lease term.

When to talk to the landlord

The other difficult decision is when to approach the landlord.  On one hand, if you discuss a lease assignment early in the sale process, you have to be very concerned about the landlord honoring your request for confidentiality of your intentions to sell.  That is a very legitimate concern that requires significant consideration.  On the other hand, if you approach the landlord two weeks before closing, that’s not enough time to avoid an angry response.

One approach is to informally ask about transferring the lease far in advance of the sale.  For instance, “I’m thinking I might sell my business in the next few years.  What’s the process of transferring my lease?”  Then, once you have a serious buyer with whom you’ve reached a preliminary agreement subject to due diligence, consider contacting the landlord at that time.  The longer the notice you can provide, the happier the landlord will be.  Then again, you still need to be concerned with confidentiality.

Preparation is the key to a successful lease transfer

Because a lot is not within your control, lease transfers can be an extremely difficult obstacle to overcome.  But you need to do what you can to prepare.  Having a good working relationship with your landlord, as opposed to an antagonistic relationship, is a good first start.  Know the terms of your lease and ask your attorney to interpret the language.  It’s important to prepare yourself mentally for a lease assignment that requires you to remain liable for the lease if the buyer defaults.  The possibility of negotiating away that provision is slim.

And, finally, select an intermediary who has significant business sales’ skills, AND also has experience in dealing with lease transfer issues.

Real Estate Transfer Issues

The biggest obstacle created by ownership of commercial real estate in a business sale transaction is establishing the fair market value (FMV) of the property.  Commercial real estate values are much more difficult to determine than residential real estate values.  As opposed to the housing market, where there are comparable and recent sales of homes to help establish value, that is not the case with commercial property.

Eliminate the obstacle created by unknown values of commercial real estate.  Have your property appraised, not by real estate agents, but by professional licensed commercial real estate appraisers.

About commercial property valuation

Commercial properties are usually fairly unique, with differing extents of construction types, build-outs of office space vs. warehouse space, size of land, types of usage, zoning ordinances to be dealt with, and the consideration of location, location, location.  Since there are far fewer commercial transactions than home sales, actual sale comparables are hard to find.  Asking prices are usually astronomical when compared to actual sale prices.  So the few asking prices in the current marketplace are not reliable comparables.

The business value is dependent on the real estate value

There is another complicating factor when a business owner also owns the facility the business occupies: the business value is dependent on the real estate value.  Since business valuations are a function of the business’ cash flow, the cost of occupancy at FMV has to be determined.  In other words, if the owner owns the facility’s real estate and the business is not paying the owner rent, the business shows no occupancy cost in its financial statements.  In this example, in determining the cash flow of the business, the cost of occupancy would have to be considered and imputed (negative adjustment to cash flow).  Before a business is valued, the cost of occupancy should always be adjusted to FMV.  But when it comes to commercial real estate, it is not all that easy to do so.

Benefits of obtaining a real estate appraisal

There is a way to address this particular obstacle.  It is imperative to obtain an appraisal from a professional and licensed commercial real estate appraiser.  There are many benefits to doing so:

• By obtaining the FMV of the property’s sale value and the FMV of leasing the facility, you can adjust the business occupancy cost appropriately and set a reasonable asking price for the business.
• Buyers always have fear of overpaying.  A real estate appraisal eliminates that issue, so you only have to reach agreement on the price of the business.
• Based on the information received, you can determine if you prefer to sell or lease the real estate to the buyer of the business.
• If the real estate is to be sold, a lender will require an appraisal.  When a recent appraisal already exists, and the lender’s appraiser is made aware of the value, the second appraiser’s value is likely to be similar to the first appraisal.  Consider this: which appraiser is likely to provide a higher value, the one you hired or the lender’s appraiser?  Isn’t it a good idea to have your appraisal ready for the lender’s appraisal?

Obtaining a real estate appraisal is an important step in preparing for a business sale

Benefits #1 and #2 above are key.  Given the nature of commercial real estate’s fluidity in perceived valuations, it’s almost impossible to successfully negotiate a business acquisition because the buyer cannot get comfortable with the cost of occupancy he will face.  With that much uncertainty, buyers have a very difficult time moving forward.  The real estate appraisal is one of the most important preparation steps to selling a business because it addresses an obstacle that is sure to arise.

Should you sell or lease your real estate to the buyer?

It’s usually best to allow the buyer to decide.  If you require a sale, you may lose a legitimate buyer and vice versa.  If the buyer leases, you have additional monthly income, or you can turn around and sell the property to a real estate investor.  If you prefer a lease for the monthly income, but the buyer prefers to buy the facility, you can invest the proceeds in another piece of commercial real estate.  Or, you can finance the buyer’s acquisition of the real estate and have a recurring monthly income with a lien on the real estate.

If the business is realistically priced, your intermediary can help the buyer understand it and defend the asking price of the business.  However, even if the intermediary is a licensed real estate agent, as he should be, an appraisal is necessary to establish the real estate price.

Eliminate the obstacle created by unknown values of commercial real estate.  Have your property appraised, not by real estate agents, but by professional licensed commercial real estate appraisers.

If you want to know how to deal with real estate you own in a pharmacy sale, give ColonyRX a call today.

Understand who your buyer is – and is not – and tailor your message to them.

Sellers Must Understand Buyers’ Motivations When Selling a Business

In making the decision to pursue an acquisition of an existing business, buyers have multiple motivations, among them: controlling their own destiny; more freedom and flexibility in their daily lives; recognition and status; and obviously income and security. If they succeed in making the right acquisition, each of those are achievable goals.  However, by the time a buyer is looking seriously at your business, the motivations behind the decision to pursue an existing business are already present.  As they get serious about buying a particular business, the primary motivation becomes risk aversion.

Knowing there are significant risks in any business acquisition, buyers are fearful.  Especially in face-to-face meetings, buyers endeavor to identify risks that might magnify their fears.

Buyers want to minimize risk

Understanding a buyer’s’ motivation to avoid risk is particularly important when, after an LOI is signed, a buyer requests to meet with the seller on the company’s premises.  Having reviewed detailed information provided by the intermediary, the buyer has preliminarily determined there is a reasonable chance the business fulfills his goals.  In a first meeting with the seller, the buyer hopes to confirm his initial good feelings about the business, but is primarily concerned with identifying downside risks that would preclude him from acquiring the business.

Most buyer risks are really obstacles which have already been identified in this series of newsletters.  If you have adequately planned for the sale of your business by addressing identified obstacles and disclosing known but unresolved issues in the marketing package, the meeting with the buyer is likely to go well.

Avoid “war” stories

In any face-to-face meeting with buyers, it is important to be forthright and honest, without volunteering irrelevant negative information beyond what’s been specifically asked.  Be very positive about the business and avoid unnecessary war stories you might have encountered.  Buyers are picturing themselves in your shoes and it’s better for them to hear the pleasant aspects of your role while minimizing the unpleasant aspects.

Disclose all known issues

Do not try to hide known obstacles.  When obstacles arise in buyer meetings that have not been previously disclosed, it can be very detrimental to successfully concluding the transaction.  For disclosed obstacles, be prepared to discuss them in the most positive light with positioning that enables the buyer to see future opportunity for increased profitability if the obstacle can be overcome.  Again, always maintain your integrity and answer all questions honestly. However, don’t over-volunteer information and don’t disclose general industry things, like PBM issues or generally known issues with your city. If it’s in the newspaper or talked about at pharmacy conferences, you don’t need to disclose it.

Know your reason for selling

Every buyer will ask why you are selling.  It’s important to have a smooth answer to that very important question.  The buyer needs to know that you look forward to transitioning your life.  If the buyer feels you are just looking to run away from the business with no other legitimate motivations for selling, it raises all kinds of risk questions in the buyer’s mind.

Be prepared to sign a non-compete agreement

The buyer also wants assurances that you will sign a reasonable non-compete agreement and has the right to expect you will.  If you waver on that question, the buyer will fear he will be competing against you (unsuccessfully) in a short period of time.  It’s another reason why your answer to your reason for selling the business needs to be solid.

Be prepared to provide a training transition period for the buyer

Most buyers will want assurance that you will be available to help train them during a transition period after closing.  Depending on the nature of the business and the buyer, the period of time can vary significantly.  But, again, it is important to answer affirmatively without hesitation.

Be prepared to respond to seller financing questions

Most buyers will ask whether you will consider seller financing.  It is best to answer in the affirmative that you will discuss it with your advisor and have the advisor get back to you. really want your participation in the financing.  By inquiring, what they are really asking is, “Do you have confidence I will succeed?”  If you answer the financing question negatively, it will raise a big red flag about your confidence in the future success of the business.

Be prepared to answer questions about your employees

Buyers will ask questions and be very concerned about employee capabilities and retention.  They will want to know that the business can run without you, and occasionally without their own presence while they are on vacation. Hopefully, you’ve addressed that already, but you need to be prepared to answer buyers’ questions regarding that very common risk element.

Be prepared to discuss customer concentration issues

Buyers will be concerned about customer concentration as well as customer retention.  They will be concerned that customer relationships are too dependent on the personal relationship with you.  To diminish doubt, assuming that is not the case, you need to answer affirmatively and with confidence that they should have no need for concern.

Risk aversion is a major factor in buyers’ decision-making.  Sellers need to appreciate how important that motivator is and prepare for buyer meetings accordingly.

At Colony RX, we will prepare you for meetings with buyers and be there to back you up.

Negotiations in the sale of a business are seldom easy.  You need to be prepared for an emotional roller coaster ride.

In small business sales, in most instances, negotiations are between a first-time buyer and a first-time seller.  The negotiations typically involve the biggest and most important transaction of both parties’ careers.  And both parties are usually Type A personalities, further complicating the ability to reach an agreement.

Sellers and buyers tend to have Type A personalities

Here’s how Wikipedia describes Type A personalities: “The theory describes a Type A individual as ambitious, aggressive, business-like, controlling, highly competitive, impatient, preoccupied with his or her status, time-conscious, and tightly-wound.  People with Type A personalities are often high-achieving “workaholics” who multi-task, push themselves with deadlines, and hate both delays and ambivalence.”  Does that describe you pretty well?  That same description will also likely apply to the buyer of your business.  Both parties are used to “having it their way.”  In light of that, it is not surprising that business sale negotiations are so difficult to conclude successfully.

Preparation is the key to successful negotiations

As emphasized in other issues of this newsletter series, preparation is the key.  Hopefully, the first two paragraphs of this newsletter help you understand the need to be flexible.  Imagine trying to negotiate with yourself!

Thorough preparation before selling your business can help minimize the likelihood of contentious negotiations.  Especially by pricing the business reasonably and disclosing known negative issues up front, you can eliminate the source of major problems.  Overpriced businesses and known but undisclosed “skeletons in the closet” are major hurdles that usually result in failed negotiations.  The good news is that those issues are within the seller’s control and can be addressed early on in the process.

Typical areas of unresolved issues that require negotiations

Assuming you’ve done so, there will still be numerous areas of unresolved conflicting interests that will require negotiations.  In addition to price, following are examples of other unresolved issues open to negotiation: undesirable due diligence requests (asking to speak with employees), the structure of the sale (asset sale vs. stock sale), non-compete agreement terms, consulting/training agreement terms, purchase price allocations, seller financing requests from the buyer, terms of seller financing and security, accounting measurement issues, earn-out terms (contingent portion of a purchase price); language of representations and warranties made by the seller in the definitive documents, etc.

How to resolve issues

The key to successful negotiations is to maintain flexibility.  Recognize your Type A personality and subdue your urges.  Be patient, do not be overly aggressive or controlling and most importantly – listen.  Try to determine why particular aspects of the terms being negotiated are important to the buyer.  Ask him to explain his reasoning.  Listen.

Then create a list of unresolved issues and determine which of the items remaining to be resolved are most important to you.  Explain to the buyer why certain terms are so critical for you.  Determine which of his important issues you can compromise on, subject to his willingness to compromise on your important issues.  Let the buyer know you are interested in a win-win situation where both parties feel good about the negotiated settlement.  It may take several rounds of open communication to resolve all issues, so maintain your patience.

Depending on the nature of issues and where you are in the sale process, your intermediary can handle most of the communications in negotiations.  In most instances, it’s better to present solutions in writing – through formal offers and counteroffers.  At times, you might consider face-to-face negotiations, but always include the broker as a buffer in case things get explosive.  If you can’t work things out face to face, a good intermediary might still succeed in helping the parties to find mutually acceptable terms.

Use your attorney as an advisor, not a negotiator

Although you’ve probably involved your attorney prior to the writing of the definitive documents, it is imperative to control your attorney at the final stage.  Use your attorney as an advisor, not a negotiator.  Many attorneys tend to try to dominate in negotiations, and when negotiations occur between the lawyers for the buyer and seller, both cannot dictate the terms.  As in the negotiations between buyers and sellers, solutions need to be “win-win”.

Every business sale transaction has risks on both sides.  Tell your attorney up front that you want to understand the risks, but you also want to make a deal.  Let him know you intend to be the decision-maker on any contentious issues.  As opposed to communicating directly with the buyer’s attorney, ask your lawyer to communicate through your intermediary.

Concluding thoughts regarding negotiations

A few concluding thoughts:  Often your first offer is your best offer.  Take the time to give that first offer serious consideration and counter the offer with terms acceptable to you.  And finally, almost every deal will seem hopeless several times during negotiations regarding the offer, due diligence and the definitive documents.  Don’t give up.  With patience and a good intermediary, most issues can be resolved to reach a successful sale.

On lists of deal-killers, this obstacle is often near the very top.  Nothing is more important than keeping your focus on maintaining the operations and profitability of your business while you are involved in the sale process.

Owners losing focus happens often for two reasons: (1) after going through the emotional decision of making the decision to sell, some owners mentally check out and spend significant time focusing on their after-sale life; (2) some owners become too focused on the sale process at the expense of maintaining their business.

This is a huge obstacle and here’s why.  Your business’ value is primarily based on it’s profit.  Buyers, their advisors and their lenders assign more importance to the most recent fiscal year’s profit than previous fiscal year’s profit.  If your recent earnings are less than previous earnings, the recent earnings will depress the value of your business.

An example of declining SDE with a $135,000 negative effect

Let’s look at an example using three years of the same EBIDA numbers, but in a different order.  Let’s assume increasing annual EBIDA as follows: Year 1 EBIDA = $250,000, Year 2 EBIDA = $300,000 and Year 3 EBIDA = $315,000.  The three-year average of EBIDA is $295,000, and at a multiple of 3.0, the business is valued at $885,000 (3.0 x $295,000).

Now let’s assume the same numbers in decreasing order:  Year 1 EBIDA = $315,000, Year 2 EBIDA = $300,000 and Year 3 EBIDA = $250,000.  Because the most recent year is substantially less than the previous two years, the buyer, his advisors and lenders are only going to value the business based on the most recent years EBIDA ($250,000), not the three-year average EBIDA ($295,000).  Valuing the business at a multiple of 3.0 on the $250,000 of EBIDA yields a valuation of $750,000.  That’s $135,000 less because the current year’s EBIDA was less than the previous two years’ EBIDA. It is a very important concept to understand.

The same concept applies to your interim earnings in the year of your attempt to sell the business.  Buyers, their advisors and lenders will always request to see a comparison of your current year-to-date earnings vs. previous year-to-date earnings for the same period of time. 

Continuing the example, but with a 33% reduction in value

Again, let’s look at an example.  Let’s make the same previous assumptions where the business was valued at $750,000 based on the most recent year’s EBIDA of $250,000.  Let’s assume you file tax returns on a calendar year ending December 31 and you receive an offer for $750,000 on June 15 with closing scheduled for August 15.  The buyer, his advisors and lenders are going to request to see your financial statements for the six months ending June 30 of the current year (Year 4) and will want to compare those results with the first six months of Year 3.  If we assume your business is not seasonal and earnings occur pretty much on a straight-line basis, as of June 30 of Year 3, the earnings would be $125,000 (1/2 of the $250,000 EBIDA of Year 3).  If you provide six-month financial statements for Year 4 that show less year-to-date EBIDA than Year 3, there’s going to be a big problem, resulting in either termination of the transaction or a downward adjustment to the purchase price.

Let’s continue the example.  If you have a six-month Year 4 EBIDA of $90,000 vs. the $125,000 EBIDA of Year 3, it appears your projected EBIDA for Year 4 would only be $180,000 (2 X $90,000) vs. the $250,000 EBIDA of Year 3.  Now a buyer can legitimately argue, at a multiple of 3.0, the business is only worth $540,000 (3 x $180,000).  In addition, at a level of $180,000 of EBIDA, the threshold for achieving a 3.0 multiple may no longer be valid.  At a multiple of 2.8 times the Year 4 projected EBIDA of $180,000, now the business values at $504,000.  That would be $246,000 less than the $750,000 offer you accepted, a 33% reduction in value!

Maintaining focus is extremely important

Until due diligence is completed, including the buyer’s review of your interim operating results, the buyer can usually escape the transaction or attempt to renegotiate the offer.  Can you see how difficult it would be to successfully resolve the situation created in the example above?  After seeing the interim results, the lender will not finance the transaction at an acquisition price of $750,000.  The buyer and his advisors will want to renegotiate to a level of about $500,000 to $550,000.  The seller will not want to accept 25 – 33% less than the original offer.  Unless the seller gives in, this deal is likely to fall apart and the seller will likely have to take the business off the market if he is unwilling to settle for less than his original asking price.

The example above is a painful scenario, but it happens – way too often.  As a result of the seller not maintaining the profitability of the business during the sale period, he’s wasted his time, the buyer’s time, the broker’s time, the advisors’ and lender’s time.  In addition, by this time, significant dollars have likely been spent by both parties on professional advisory fees.  It’s a shame.

Two things to learn

1) Keep your focus on the profitability of the business, especially during the sale process; and 2) If the new fiscal year has already started before you decide to sell, and you know the results are down, take that fact into account when setting the asking price.

Lesson two above parallels the advice to disclose issues upfront. If you know your interim operating results are going to be down versus the previous fiscal year, disclose it and position it the best you can.  But don’t ignore it.  It’s not possible to conceal it.  Your interim results will be examined and will be a deal-killer if you are not prepared to consider them in your negotiations.

It’s best to eliminate skimming cash and the running of excessive personal expenses through the company, or the skimming of cash, several years before selling your business.

Properly documented personal expenses run through the business, which have nothing to with operating the business, can be added back into EBIDA, so long as you have documentation to prove it. And make no mistake, the onus is on the seller to prove the expense had nothing to do with the operation of the business.

In reviewing a marketing package for the sale of a business, one of the first things a buyer is going to see is the normalization of cash flow that show those “junked up” or messy personal expense add-backs.  First impressions are lasting impressions and messy normalizations definitely create a negative impression from the beginning. Therefore, it’s important to be 100% fair and conservative when doing these add backs.

Types of personal expense add-backs when selling a business

Personal expense add-backs might include a number of non-business expenses related to vehicles for you and your family; household; travel, vacation and entertainment; insurance; professional fees; cell phones, membership dues; country clubs; and season tickets. It may also include payroll checks to family members not working in the business, etc.

A buyer will want a seller to prove those non-business add-backs.  Particularly if they are material to the calculation of EBIDA, a buyer is not going to just take the seller’s word for it.  The need to prove/verify those add-backs can lead to some uncomfortable moments for both parties during the acquisition process.

A few notes about add backs:

• Usually, we can get most documented add backs included to the seller’s credit.
• Buyers tend to be a distrustful of addbacks.  If a buyer sees personal expenses that are so exorbitant that it may border on tax evasion, they begin to lose faith in the integrity of the seller.  They may think, “If you’re not being honest with the IRS, how can I expect you to be honest with me?”
• One addback category we have major problems getting buyers to agree to are “projected add backs” related to staffing. Here, the seller says something like, “I have three techs, but I only need one. You can clean that up after you buy the store.” The buyer’s correct answer to this is, “if it’s so easy to reduce staffing, please do so before the sale and show me that the business is stable for 3 months before I buy it. I cannot come into your business and fire people day one.” Seller’s will usually lose this argument.
• Many business sale transactions are financed by lenders backed by the SBA.  While you may be able to convince a buyer that personal expense add-backs are justified, lenders may not be so accommodating. In small business lending evaluations, it is not unusual for the personal add-backs to be such a significant portion of SDE that the lender is unable to approve the financing of the acquisition.

Clean records help facilitate a smooth business sale

Many owners have been running small personal expenses through the business for so long, they’ve forgotten about them.  Family cell phone bills, family insurance bills, family automobile repairs, etc., can be so routine, you almost forget they are non-business.  Those expenses can add up quickly and significantly reduce SDE.

In preparing for a sale of your business, the best thing to do is to completely eliminate those non-business expenses so you can maximize cash flow (SDE), thus maximizing the value of your business.  It’s also best to eliminate non-essential business expenses.  A couple of years of “clean” records will make the selling process smoother and yield a higher sale price.

Stop skimming cash when selling a business

Pharmacies typically have very little cash compared to insurance payments. However, some pharmacies large front stores, cash RX business and other large non-RX business can see a lot of unreported cash. The problem with skimming lots of cash from these stores is that it distorts gross margin and makes the store harder to sell. Our advice: don’t do it. 

Excessive tax avoidance negatively impacts your ability to sell C-Corporation stock

To avoid double taxation of a C-Corporation, a possible alternative is for the C-Corporation owner (stockholder) to sell his shares of stock in the corporation (as opposed to the corporation selling its assets) to achieve favorable capital gains tax rates.

Prospective sellers should be aware that buyers are unlikely to acquire the stock of a C-Corporation that has a potential tax liability for excessive personal expenses run through the business or for skimmed cash.  This is just another reason not to do these things.

Do you need to minimize the personal expenses you run through your business? If you want to know, give ColonyRX a call.

In my first call with pharmacy owners, I ask if they own or lease their building. If they say they own it, I ask how much its worth. If that number is too high (and it doesn’t have other tenants) compared to the profit the pharmacy makes, the owner’s options are limited.

A similar thing happens when stores have a high value of inventory. This is something we see often with specialty pharmacies where they make very little profit on each RX but require large amounts of capital to cashflow the business.

As a reminder, because buyers require a return on their investment, businesses are ordinarily valued as a multiple of their earnings.  In other words, the profit generated by the business needs to be enough to accomplish three things: (1) service the debt on the acquisition; (2) enable the new owner to pay himself a reasonable salary; and (3) have some profit left over for working capital and reinvestment needs.

If a business has hard assets valued in excess of the Enterprise Value (fair market value of the business as a going concern) as computed from applying the appropriate multiple to its EBIDA, it may not be salable as a going concern.  A liquidation sale of individual assets at fair market value may provide more funds for a seller than its Enterprise Value (based on SDE).

An example of a Pharmacy that cannot be sold due to the high value of its assets

Purchase Price	$1,730,000
Down Payment (15%)	$259,500
Acquisition Loan	$1,470,500
Annual Debt Service on
$1,470,500 Loan (15 years/9%)	$177,257
SDE	$160,000
Cash Flow After Debt Service	($17,257)

This means the new owner will take a loss $17,257.40 a year on the deal. The deal is dead because it’s too “asset rich”. The Seller’s best option is to liquidate the individual assets to multiple buyers. If you have no idea how to do this, give ColonyRX a call and we will guide you through it.

It’s important to know the Enterprise Value of your business

Especially when considering your exit, it pays to know the Enterprise Value as well as the fair market value of your assets if you simply liquidate.  In most cases, Enterprise Value will exceed Asset Liquidation Value, but there are numerous and varied exceptions, especially if your business is in a capital-intensive industry or you have extremely valuable real estate or exceptionally high inventory.

As your exit time frame approaches, to maximize the funds you receive at closing it may be best to minimize large capital investments that require financing.  Typically, the Seller transfers all assets to the buyer unencumbered, which means the Seller must pay off all loans from the proceeds of the sale. However, we have structured deals when the buyer assumes the loan.

Do you know if your company’s Enterprise Value exceeds its Asset Liquidation Value? If not, give ColonyRX a call.

When a business owner dies (or becomes incapacitated) earlier than expected without a contingency plan to deal with the situation, it can be fatal to the business. Plan today to avoid catastrophe. 

When a business owner dies (or becomes incapacitated) earlier than expected without a contingency plan to deal with the situation, often the company cannot survive the owner’s death or absence.  Studies show that the business represents 50-90% of a typical business owner’s net worth.  So the business owner’s family is not only overwhelmed by the personal loss of someone they love, they may also be devastated financially.  A 50% to 90% loss in net worth is not the type of legacy you want to leave your family.  For their years of emotional support during your entrepreneurial business ownership struggles and efforts, they deserve more.

Do not procrastinate

Most of us have a tendency to avoid facing our own mortality.  It’s not enjoyable to consider your own death.  So, we put off designing a will and estate planning because it requires us to think about dying.  But as Ben Franklin wrote, it is a certainty, it is going to happen.  And we do need to face it.  Especially as a business owner, where a large portion of your net worth is tied to the business, you are not being fair to your family or others in the business if you procrastinate.

Of all the articles in our newsletter series, heed the advice of this one and get started on a contingency plan TODAY!  Overcome the Power of Inertia, do not procrastinate and do something NOW.  (While you’re at it, start working as well on your “alive” exit plan, it’s more enjoyable.)

Examples of problems encountered if no contingency plan exists

Your premature departure, if you are the sole or primary owner, can result in several problems for the business.  There may be a leadership vacuum.  Who is going to run the business if you are not there?  What’s going to happen to the business?  Will it be sold, liquidated or continue under new management?  Employees may worry the company will not survive and begin to look for other jobs.  Especially if you have personally guaranteed loans, lenders may call in outstanding debts.  Customers may become concerned and switch to your competitors.  Concerned vendors may detrimentally change the company’s payment terms, perhaps requiring cash on delivery. Without a contingency plan, the company is unlikely to survive these types of scenarios.

Develop a one page written contingency plan.

You need to work with your family and your employees to come up with a simple contingency plan. You also want to have a PIC designate.

Here is a sample for a PIC/Owner to share with their staff.

I don’t’ intend to die anytime soon, but if I do, here is some useful information:

• You will need a PIC. I have spoken with Pharmacist A who agreed to step in on an emergency basis until a long-term solution can be found.
• For payroll, Person X is backup on the payroll account. They will make sure everyone is paid. Their number is ____.
• For all other bills, Person X is a signatory on the bank account. Their number is ____.
• The lease and other important documents are located in the file cabinet here.
• Person X knows my passwords for my e-mail account. They can be reached at ____.

That’s it. Keep it really simple. If you want to have a longer plan including your attorney, your CPA, your lenders, a life insurance specialist, and possibly a professional exit planner and a pharmacy intermediary) to develop a written contingency plan, you can do that, too. But to get started, just keep it really simple as noted above. This longer plan should address what your intentions are for the company if you die unexpectedly.  What will ultimately happen with the business? 

Contingency plans do not need to be confidential

Whereas confidentiality is very important when you are trying to sell a business, the opposite is true with a contingency plan.  You want all the parties mentioned above to participate and be knowledgeable of the details of your contingency plan.  If something unexpected happens, all parties will then have expectations of what should occur, aiding a successful transition.

What will be your legacy?

Without a contingency plan in place, if you die or become incapacitated next week, would your business survive?  Would your family be devastated financially because most of your net worth is tied up in the business?  Is that going to be your legacy?

Don’t let the absolute worst scenario develop for your family.  Start working on a contingency plan TODAY and make it your top priority.  What could be more important?

Give ColonyRX a call today to help plan for a contingency exit.

“A bank is a place that will lend you money if you
can prove that you don’t need it.”   Bob Hope

Pharmacy Acquisitions That Cannot Be Financed

Some prospective sellers think a prospective buyer is just going to write them a check for the full price of the business.  That is the rare exception. Almost all prospective buyers will pursue financing for their business acquisition.  But there are pitfalls that prevent financing and they tend to parallel the potential obstacles to a sale.

Pitfalls to lender-financed acquisitions

Prior to September of 2008, business acquisition financing was much more readily available than it is today.  Before the credit crunch in the fall of 2008, qualified buyers could obtain a Small Business Administration (SBA) loan for the purchase of a business that was reasonably priced in relation to its Sellers Discretionary Earnings (EBIDA) with a 15% to 20% down payment.  The most common pitfalls at that time were:

• Inadequate EBIDA
• Business not priced right in relation to its EBIDA
• Buyer with insufficient cash for the down payment and working capital needs of the business
• Buyer with inadequate experience in the industry
• Business with too high of a customer concentration
•  Current year’s interim financial statements indicate decreasing operating results versus historical financial statements
• Buyer unable to secure a lease term to match the loan term

Underwriting criteria is much more restrictive since September, 2008

Prior to the credit crisis in September 2008, it was usually possible for prospective buyers to obtain SBA loans without the seller participating in the financing of an acquisition.  After that crisis, the SBA underwriting criteria is now much more restrictive.  In addition, the SBA is currently requiring a prospective buyer to have a higher level of direct industry experience, down payment requirements have increased and it’s more difficult to finance the goodwill portion (business enterprise value in excess of hard asset value) of a business acquisition.  In addition the debt service coverage ratios have increased.  (Debt service coverage is the excess of EBIDA less the new owner’s salary, less the annual loan payment on the acquisition loan.)

However, changes in 2023 have provided some great changes.

You can read about these here: https://colonyrx.com/2023/05/17/elementor-5626/

Most lenders prefer transactions larger than $250,000

Historically, it’s been difficult to obtain financing for business acquisitions under about $125,000 for two reasons: (1) SDE is insufficient to enable a prospective buyer to pay himself enough to meet his other financial obligations.  As a result, there’s not enough left over for debt service coverage. (2) Lenders prefer larger deals to smaller deals.

In today’s lending environment, most SBA lenders are unwilling to consider transactions less than about $250,000 (which requires about $100,000 of SDE).  Again, there are two reasons:  (1) with ever-increasing requirements, it is difficult to achieve adequate debt service coverage ratios at SDE less than $100,000. (2) With tightening credit standards, lenders are being much more selective of transactions they will consider, with minimums often set at $250,000 for business acquisition financing.

Financing pitfalls tend to parallel obstacles to the sale of a business

With a better understanding of lenders’ requirements, you can see why Inadequate Seller’s Discretionary Earnings (SDE) is one of the primary obstacles to a sale.  Of the seven financing pitfalls listed above, all but number 4 are also obstacles to a successful sale of a business.

Seller financing can be minimized

To put it simply, owners are much more likely to be asked to provide some seller financing, especially if the deal is large.  That’s the bad news.  The good news: in many instances, seller “carry back” can be limited to about 10-20% of the purchase price.

However, if other financing pitfalls/business sale obstacles are encountered, the percentage of seller financing required to complete a transaction will increase.  That’s why it is so important to identify obstacles to a successful business sale.  Once identified, you can address the issues and likely reduce the amount of seller financing that will be required when it’s time to sell your business.

The following is a list of questions for you to ponder that might help clarify your thoughts as to whether you should consider selling your business

Is your interest in the business waning for any of the following reasons?

• Personal burnout?  Boredom?  Fatigue? On a daily basis, do you enjoy the functions you perform?
• Are you still using the talents that helped you succeed in business?  Or… Have you replaced your strengths with support staff, and now have to function in your areas of greater weakness?
• Do you have to do the things you like least?

Are you keeping pace with the competition?  Are you losing ground?

• When was the last time you “scouted” the competition?
• Do you have the energy and enthusiasm to remain competitive?
• Are you investing in new technologies and equipment to enable growth?
• Have you developed an aversion to risk?
• Are you open to new ideas?

Have you identified successors for the business when you leave it for one reason or another?

• If you have second-generation family members, do they have the entrepreneurial spirit and interest necessary for success?
• If they don’t have the required competencies, are you setting them up for failure?
• Would leaving an inheritance rather than a business be a better decision?

Is the company your primary personal asset?

• How risky is the business climate?
• What if something happens to you?  Will your primary asset retain its value in your absence?
• Does it make sense to diversify your assets?

Is the company struggling financially?

• Are you being adequately compensated for your time and efforts?
• Do you have the energy and enthusiasm to recommit and restructure to improve the prospects of the firm, or are you hoping for a comeback without changes?
• Are you willing to risk the investment of the additional funds necessary to achieve a turnaround?

Is the company doing exceptionally well?

• Did you know that the best time to sell is after achieving outstanding results?
• If you have come off a great year, in this economic environment, can you be sure it will be repeated?

Most importantly, from a personal enjoyment standpoint, is time passing you by?

• Is it time to spend more time on personal pleasures – family time, entertainment, vacations, hobbies, travel, etc.?
• Would reducing your daily level of stress be appealing?
• With more time for relaxation and exercise, would your health improve?

Spend some introspective time considering the answers to these questions and it may help you decide if you should consider selling your business in the short-term.  Regardless of your short-term decision, make the commitment to plan for the longer-term sale of your business so you can maximize its value when the timing is right.

Another Favorite Famous Quote
“You are now at a crossroads. This is your opportunity to
make the most important decision you will ever make.
Forget your past. Who are you now? Who have you
decided you really are now? Don’t think about who
you have been. Who are you now? Who have
you decided to become? Make this decision
consciously. Make it carefully. Make
it powerfully.”  Anthony Robbins

In a team environment, it’s important for colleagues to develop healthy relationships that allow them to trust each other. When one of the members starts expressing toxic behaviour, it can be challenging for the team to operate smoothly and maintain high efficiency and productivity levels. Learning how to deal with negative behaviour in the workplace is essential when you’re a manager and can increase your job satisfaction if you’re a regular employee working in a team. In this article, we explain what toxic employees are and share techniques you can use for managing toxic employees respectfully.

What are toxic employees?
Before you explore various techniques for managing toxic employees, it’s beneficial to learn what a toxic employee is and explore their key characteristics. A toxic employee is an individual whose actions and words negatively impact the work of others. In some instances, they may even cause internal issues for the entire team. Toxic team members tend to complain a lot, gossip and blame others for their own mistakes. It’s also common for them to repeatedly report their team members, which they may do simply out of spite.

As a result of their actions, toxic employees can make others stressed and cause the entire team to work in an atmosphere of frustration. Although working with a toxic team member can be challenging, it’s important their colleagues and managers realise that their negative behaviour can be the result of emotional issues or personal life difficulties that the toxic person is handling. If you’re a manager, knowing how to deal with negative team members can help you improve your leadership skills and maintain a positive work environment.

How to steps on managing toxic employees
Learning to deal with negativity in the workplace is one of the key challenges for you as a manager or team leader. Here are some techniques you can use for managing toxic employees:

1. Don’t take their behaviour personally
   When you encounter a toxic team member, remember that their actions probably have nothing to do with you. Presumably, they’re the result of the negative emotions they keep in themselves as a result of the personal problems they’re experiencing. Making sure you don’t take their behaviour or words personally allows you to look at them more objectively and treat them with more compassion. In some instances, showing you care about their well-being and don’t consider what they do offensive can make a negative colleague trust you and openly discuss their negativity.
   
2. Try identifying the cause of the problem
   In some instances, you may observe that some people joining a team already express signs of toxicity. Other times, it’s possible they become toxic as a result of some events or decisions. If you’re experiencing the latter, it may be helpful to carefully analyse their behaviour and determine when their actions have started negatively impacting others.
   For example, you may notice that someone starts gossiping and undermining others after their colleague got a promotion. This might indicate jealousy as the cause of the problem. To handle it, you can openly discuss with the toxic person that they too can advance their career by developing the right skills and learning to inspire others rather than demotivating them.
   
3. Document toxic behaviour
   Before you approach a toxic team member to discuss their behaviour, it’s necessary to gather evidence that shows their offensive or negative behaviour. For example, you can gather emails in which they undermine or offend their colleagues. It’s also useful to collect formal complaints that other team members submitted to inform the company about the problem. Make sure to save any documents or files you obtain, as it may be necessary to show them to higher management if you decide it’s impossible to resolve the issue and choose to escalate it instead.
   
4. Give them honest and direct feedback
   As a team leader or manager, one of your tools for disciplining team members includes one-on-one reviews. After identifying whose toxic behaviour negatively impacts the team’s performance and trying to discover the root of the problem, it’s often helpful to schedule a meeting with that person and give them honest feedback. In some situations, a toxic employee may not be aware of the impact their words and behaviour have on others. Explaining it to them and requesting they start thinking of others when expressing their negative emotions is essential.
   
5. Explain the consequences of their actions
   Usually, it’s not appropriate to terminate someone right after noticing they’re toxic at work. Instead, employers introduce guidelines that you, as a manager, can use to discipline subordinates. An essential element of this process is clearly explaining the consequences of someone’s negative behaviour to them. Depending on your work schedule and environment, you may choose to do this in person or via email. Sending a written warning can be especially useful if you’ve already spoken to the toxic team member but they’ve still not improved their behaviour.
   
6. Start assigning them tasks they can complete independently
   Sometimes difficult employees contribute positively to the team’s overall performance, despite their toxic behaviour. For example, this can happen when the person who gossips or undermines others is an expert with years of experience in the field. To make sure they stay with the company and to help others free themselves from their negative impact, determine if it’s possible for the person to work fully independently or remotely.
   
7. Try deciding on a compromise
   Even if you try different approaches, in some situations it’s necessary to accept that some people may never change. If it’s impossible to reassign them to a different team or terminate their employment, you might try finding a compromise. When deciding what’s best for the entire team, consider everyone’s opinion and ideas. For example, you may ask the toxic person to always contact you first when they have a complaint instead of being offensive towards colleagues. That way, you can identify the issue quickly and try reassigning their tasks so they don’t interrupt the team’s performance.
   
8. Terminate them.
   If you read this blog, you own a pharmacy. The buck stops with you. If the strategies are not working and a toxic team member is making people miserable, cut your losses and fire them. It’s not worth the stress and loss of team cohesion.

What to avoid when dealing with a toxic team member

Interacting with a toxic team member requires you to stay respectful and objective, even if their actions impact you personally. Remember, as a manager, you represent your employer and it’s appropriate that you foster a culture of understanding and compassion. Here’s what to avoid when dealing with a toxic subordinate:

Never bring it up in front of the entire team
As a leader, it’s your responsibility to provide solutions to problems without disrupting your team’s work. When you encounter a toxic individual at work, it’s advisable to either talk to them about their behaviour or wait to see if their actions bother the rest of the team. Once you’ve confirmed that and managed to find a solution, then it’s usually the time to talk to others about it.

Never terminate team members immediately or without proof
Formally disciplining subordinates is only appropriate when you have proof of their negative behaviour. If you decide to terminate someone, make sure you’ve used all the resources you had to help them first. It’s also helpful to document the response you gave them, as your supervisor may ask about it.

Never disrespect toxic team members
Working with a toxic person can be frustrating, as toxicity can cause others to behave in a similar way. Not allowing that to happen is a sign of professionalism, which also helps you position yourself as a role model in the workplace. Whenever you interact with a toxic team member, remember to treat them with respect, just like in any other interaction you have at work.