Pharmacy Succession Tips
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“Succession planning is not just about what you leave behind ... It's also about what lies ahead."
“You built this pharmacy. You watched it grow. You invested sweat equity and money in it. When you decide to exit, why wouldn’t you expect your business to give you something back?”
Early succession planning enables you to:
- Maximize the value of the business and its potential selling price.
- Explore a broader range of succession and ownership transition options.
- Take the time to choose the right team of advisors and acquaint them with the pharmacy business.
- Set up the proper financial goals.
- Have a positive impact on your business’ long-term viability/Legacy.
Succession Planning and Business Transition
The "Earn-out provision"
As a result of working on business transition and succession planning, I am seeing trends arising in the types of deals being made. Most transactions involved the seller either getting most if not all of the purchase price on closing. If there was a deferred payment, it would be for a set amount and on the basis of a holdback for a fairly short period of time on mostly share purchase agreements – perhaps three to six months. Pharmacy owners are finding that buyers are asking for “earn outs” as part of the purchase price. I am going to explain why this is becoming more common and how the earn outs can affect pharmacy owners who are selling their businesses.
An earn out is simply the method by a purchaser who seeks to reduce the risk the purchaser taking on, when purchasing a pharmacy. Of course, when a purchaser reduces its risk, the effect is that the seller takes on more risk. So, from the seller’s perspective, the earn out is not something a seller should agree to right away. The earn out works to reduce risk to the purchaser by allowing the purchaser to pay a lower amount on closing and then “defer payment typically based on future performance” in order to determine whether to pay the seller more money. Effectively, the purchaser is saying to the seller that the business isn’t really worth what the seller believes it is worth, but the purchaser is willing to pay more if things turn out well.
From the seller’s perspective, the problem with an earn out provision is that payment of additional sales proceeds will depend on how the purchaser runs the business. Post closing the new owner will incorporate its own operational standards. If the business succeeds and performs well, then the seller gets more money, but if it doesn’t perform well, the seller gets no additional payments. Therefore, the ability of the seller to get full payment of the purchase price is dependent on the purchaser’s ability to operate the business effectively. Another difficulty with the earn out provision is that it must be drafted clearly and comprehensively in to avoid disputes later. There have been lawsuits surrounding the interpretation of earn out provisions.
Earn out provisions actually come in two forms: (1) the standard earn out and (2) the reverse earn out or “earn in”. The standard earn out provision defines a closing payment and then goes on to state the final price will be the base amount plus the earn out amount, which will be based on a formula going forward. The reverse earn out starts at fixed price which will be reduced based on how the business does after the sale.
Earn out provisions may operate over a three to twelve month period which begins on the closing date of the transaction. The structure of the earn out will be subject to the negotiation and, since every transaction is different, every earn out is different. In the case of a standard earn out, you might see the seller receiving additional payments if certain sales or prescription volume benchmarks are met or certain profits are achieved. Whatever measure for payment is used, a seller will want to ensure that there is no room for manipulation. That is why sellers want earn outs based on top line figures on the financial statements, such as sales,gross sales or prescription volume rather than bottom line figures such as net earnings or profits. Of course purchasers want earn outs based on more bottom line figures. This allows them more flexibility on whether or not the benchmarks were achieved.
There is much more to earn outs, however I hope this unpacks the topic adequetly. The key is for you to obtain the advice of an experienced lawyer so that the best result is achieved for you.