The Pharmacy Buyer’s Guide: Buying a Pharmacy in a Stock Purchase
We welcomed Jeffrey S. Baird, Esq., an attorney and head of the healthcare group for Brown & Fortunato, P.C. as he explains the difference between a stock purchase and an asset purchase when buying a pharmacy. Find out why it’s essential to protect the buyer in a stock purchase.
Did you know that we perform pharmacy accounting financial due diligence here at Sykes & Company, P.A. for clients as they are considering a pharmacy purchase? Watch this episode of The Bottom Line Pharmacy Podcast if you are thinking about buying a pharmacy, and call us.
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If you prefer to read this content, the video transcript is below.
Kendell: Welcome to this episode of Sykes, The Bottom Line Pharmacy Podcast. We’re happy to have a special guest. Go ahead and introduce yourself, Jeff.
Jeff: Okay, thanks Kendell. We’re going to have some fun folks. My name’s Jeff Baird. I’m an attorney, meaning I’m the black sheep of the family. I head up the healthcare group for Brown & Fortunato, a Texas-based law firm. We have 17 full-time healthcare attorneys and we work with pharmacies and other healthcare providers throughout the United States. And we’ve been working with Scotty, Kendell, and Bonnie for many, many years. And it’s always an honor to work with Sykes & Company. They are the best of the best. So, Kendell, it’s my pleasure to be able to do this with you.
Kendell: Yes. And you woke up early this morning to join us. Usually, you’re in Texas, but today, Salt Lake, correct?
Jeff: That’s correct.
Kendell: So, thank you for getting us started early. But you look like you’re ready to rock and roll with this topic.
Jeff: I’ve been up for a while, so we’re good.
Bonnie: We’re so excited to have you with us, Jeff.
Scotty: He is ready. So today, we’re going to be talking about protecting the buyer in a stock purchase, Jeff. This is right up your alley with the M&A transactions you guys are doing all the time, day in and day out. I know we work with you on a lot of those, so why don’t you kind of just start us off.
Scotty: You know, what does that mean? What is a stock purchase and what do you mean by protecting the buyer there?
Jeff: You bet. If I start rambling too much, Scotty, Bonnie, and Kendell, tell me. As an attorney, I charge by the word.
Bonnie: We’ve learned this, and I’m going to do a quick plug for the NCPA Ownership Workshop. Jeff does these alongside us and some others in the industry every three months or so each year. So, this is one of the topics that we touch on, Jeff, a lot with the buyer and with the stock purchase and some other many different topics. But if you were looking to purchase a pharmacy or a start-up, it’s definitely a good place to start.
Jeff: Yeah, ownership has been going on for many, many years, and you talk about getting a lot of bang for the buck. It’s absolutely worth everybody’s time and money, and of all the conferences that I do and speak at, ownership is by far my favorite. It really is a lot of fun.
Going back to your question, Scotty, there are essentially two ways to buy a pharmacy: asset purchase or a stock purchase. And let me just give you the hypothetical. Scotty owns Scotty’s Pharmacy, Inc. So, Scotty Sykes individually owns Scotty’s Pharmacy, Inc. Jeff Baird wants to purchase Scotty’s Pharmacy. I can do so one of two ways. One way is an asset purchase, which is not what we’re going to go into today, but let me give you the cliff notes version. Asset purchase is I set up in my own corporation or LLC. I call it Jeff’s Pharmacy, Inc., and my corporation will just purchase all of the assets from Scotty’s Pharmacy, Inc. My corporation will purchase Scotty’s Pharmacy, Inc.’s inventory, computers, delivery trucks, bubble gum, paper clips, and everything else. Everything will come over to my corporation, but then what happens is, after all the dust settles, Scotty continues to own Scotty’s Pharmacy, Inc., except that it no longer has any assets, just a shell corporation. Everything comes over to my corporation, and I’ve got to go out now and get my own pharmacy license, DEA permit, and NPI. I need to sign up with PBMs and PSAOs and do everything that essentially a start-up pharmacy would have to do. Okay, that’s an asset purchase.
Now let’s compare that to a stock purchase instead. Let’s see. Here we go. Instead, with the stock purchase, the purchaser is not Jeff’s Pharmacy Inc., but the purchaser is Jeff. The seller is not Scotty’s Pharmacy Inc., but the seller is Scotty. And what he’s doing is he’s selling me a piece of paper. That’s it. And that piece of paper is a stock certificate. And what that means then is that Scotty’s Pharmacy, Inc. just continues on like it always has, just continues to do business and bring in money and take care of customers. The only difference is there’s a new sheriff in town. Scotty is out with all this money that I paid him. He’s now sitting on a beach in Cabo. I amnow the owner of Scotty’s Pharmacy Inc.. And so, I’ve inherited this thing. Lock, stock, and barrel. It is now my baby to do what I want with it. As a general rule, there are some exceptions. But generally speaking, the pharmacy as a going concern that I bought, it will, its pharmacy license stays in place, its DEA permit stays in place, NPI stays in place, PBM and PSAO contracts stay in place. It just continues on. But the only difference is, Scotty’s out, and I’m in as the owner, and that’s it.
Bonnie: Bank accounts too, Jeff. They usually just stay and get switched over to the new owner. Yeah, everything really stays. Yep.
Jeff: Everything stays with the stock purchase; the corporation just continues on like it always has. Certainly, I could get into that. I could get real granular with you, talk about change of ownership notifications, things like that. But just from a 30,000-foot view, that’s how it works.
Scotty: So, we always get a lot of calls about ‘Hey, I’m buying this pharmacy’ from, you know, prospective buyers out there. And, well, you know, it’s always like ‘What are you buying?’ And they don’t know. You know, usually they’re like ‘the pharmacy,’ and we’re like, ‘Well, what are you buying? Are you buying the assets, are you buying the stock?’ So that’s kind of step one. Like, what are you buying in this process? Are you looking to target the assets or, you know?
Jeff: And Scotty, the three of you being CPAs, you know that there are tax ramifications. I mean, we wont’ go into that right now. But you know, there is a big difference from a tax standpoint. And so, always at the very beginning, the buyer and the seller have to decide, will this be a stock purchase or an asset purchase? And let me, it’s basically years, years ago, virtually all of the pharmacy acquisitions that we handled were asset purchases. That’s now changed. Now it seems like most of the pharmacy acquisitions that our law firm handles are stock purchases. And the reason for that is that with an asset purchase, the purchasing corporation, LLC, has to go out and get its own license, numbers, and certificates, and everything else.
Now, from a practical standpoint with an asset purchase, let’s say closing occurs on February 1st. I would likely be able to continue to operate under the pharmacy license and everything else that’s Scotty’s Pharmacy, Scotty’s Pharmacy, Inc. But nevertheless, until I get my own license and permit and everything else, with an asset purchase, there are a bunch of things that my corporation has to do. With the stock purchase, it’s a lot easier because the corporation that I bought just continues on like it always has. Again, there are some steps you have to take with giving change of ownership notifications, but that’s kind of the transition we’ve seen from asset to stock. And I guess one of the main reasons that we’ve seen clients want to engage in stock purchase is that the selling pharmacy has some third-party contracts that are really hard to come by. By purchasing the stock, those third-party payor contracts normally remain intact with the purchasing corporation, with the corporation that has just been purchased.
Bonnie: So one of the things that we see a lot is another question we get when people come to us, maybe they know they’re going to do a stock purchase. So let’s say they’ve gotten that far and they say we’re getting a great deal with this $2 million transaction, $4 million transaction. And we say, ‘Oh, how do you know that?’ And they’re just like, ‘Well, sounds good,’ you know, but tell us about what kind of things you’ve got to look into to actually know if that is a good deal.
Jeff: Absolutely. And I call this due diligence, and I call this kicking the tires. Now, before I go into this, understand, I want to dispel an urban legend. Many people think that if I, Jeff Baird, purchase the stock of Scotty’s Pharmacy Inc., then I, Jeff Baird, have now assumed all of the liabilities of Scotty’s Pharmacy, Inc. That’s not true. I have not. However, the corporation that I bought continues to have those liabilities. And so, if I had…
Scotty: I’m not a pharmacist, so there are probably many of them.
Bonnie: [laughing] Yeah, that’s a scary situation.
Jeff: [laughing] That’s a good point. And so, you know, let’s say closing occurs on February 1st, and let’s say in August, I discover that, prior to my buying the stock of Scotty’s Pharmacy, Inc., he did some crazy stuff in the past. Now, all of a sudden, this corporation that I bought is getting hit with some audits and investigations and chargebacks and everything else. Well, that’s not my personal problem. They can’t come. Nobody can come after me for that. So, my condominium in Aspen is now protected.
Bonnie: Good. Right.
Scotty: But I didn’t get an invite to that. Did you?
Jeff: To be invited to Bonnie’s house on the lake?
Scotty: The mansion on the lake, yes.
Bonnie: I’m guessing that the issue was probably some shoddy tax work on that example.
Scotty: Are you kidding me? We’ve got the best CPA team around here if I was doing it. Yeah. Now…
Jeff: The Sykes & Company. But what happens is the thing that I bought has got to deal with it. And to use the Texas term, I’m hoping that on February one, when I hand this large check to Scotty, I’m hoping I didn’t buy, to use a Texas term, a pig in a poke. Now, the key is to do your due diligence before closing. And that’s no different than buying a house. If I’m going to buy a house, before I buy anything I’ll hire an inspector to go in and check or look at the electrical wiring, the plumbing, the foundation, termites, and so forth. And if the inspector comes back and says, ‘No, this house is going to be a money pit,’ I’ll walk away. Same thing with due diligence for the pharmacy.
And so what’s going to happen is there are three types of due diligence. One of the most important parts is what I call the financial due diligence. Now, I’m a decent healthcare attorney, but I’m a really bad accountant. And so what that means then, and this is the shout out to Sykes & Company, is that Sykes & Company is the best of the best nationally when it comes to pharmacy. Well, representing pharmacies in the accounting, the accounting space, and so what Sykes does, Sykes & Company, in fact, Bonnie, Scotty, and Kendell, you might want to actually talk about what you look at. There are three types of due diligence: financial, transactional, and healthcare regulatory. I consider financial to be the corporation that I’m buying. I know what the financials that Scotty has given me say, but are they really true? Are they really accurate? And so, Bonnie, I’ll pass it back to you.
Bonnie: Yeah. That’s a perfect example. You can’t just take the financials as gospel or what we see a lot of as maybe we don’t even see a financial to start with. Maybe it’s just the tax return. A lot of people want to say, ‘Here’s the tax return, my tax return.’ Does it really give you a full picture of how that pharmacy’s operating? We like, we think it’s important to get. Yes, financials are great. The tax return, yes, we need that. And then we also like to look at the actual accounting file itself. That’s where the guts and the detail are.
Scotty: Yeah, you want to get in that accounting file.
Bonnie: And you want to make sure they all match and that they’re all right. And, you know, nine times out of ten, we’re seeing that they’re not, you know, and so then there’s an issue. And so that’s a big part of that due diligence you mentioned; it’s really digging into the guts of the books. And if someone really wants to sell that pharmacy, they shouldn’t have any issue with you looking at these things.
Scotty: You know, it’s also important not only to see what’s been going on, how the pharmacy’s been, you know, performing with the accounting file, but it’s also, you know, is the price that’s on the table here reasonable? Is it a fair market value? So on and so forth. There’s so much that you can pull out of this accounting information.
Kendell: Pharmacy accounting is one area that’s maybe more complex than other types of accounting that are out there. So if it’s a CPA firm that maybe that’s their only pharmacy client, they might be, you know, trying their best to reflect an accurate picture. But then when you get in there, there are lots of different variables that you as a buyer might want to take into consideration. How are DIR fees being considered? Are the receivables there? Is inventory reasonable? So there are a lot of different areas that if you’re going to make the biggest investment of your life in that pharmacy, you want to make sure somebody looks at it. And what’s being reflected isn’t just your purchasing off of a gut feeling, but it’s actually what’s going on in the pharmacy at the time that you’re looking to purchase it.
Jeff: So that’s the financial due diligence. You have somebody like Sykes & Company go in and, I call it, really scrubbing the books. And let’s make sure that when the seller says to me, ‘Look, my pharmacy gross is this, my net profit is this, my EBITDA (earnings before interest taxes, depreciation, amortization), and such and such,’ that’s very well and good. But let’s, to quote President Reagan, we can trust but verify. And so let’s really get down and verify what they’re telling us. Okay? We put that aside, and then we have what I call the transactional due diligence. And that’s where, as the attorney, as the attorneys, you know, let’s, we’re buying this corporation lock, stock, and barrel as a going concern. Well, let’s make sure the articles of incorporation are in good standing with the Secretary of State’s office. Let’s make sure that it has paid its franchise taxes to the state. Let’s make sure that the organizational documents of the corporation are properly set up. You know, let’s just order what’s called a UCC lien search. Let’s find out if any banks have any liens against the assets of the corporation. These are some of the steps for what I call the transactional due diligence. And then you have what’s called health care due diligence, because remember, with the stock purchase, this corporation I bought is mine, warts and all. And so, I’ve got to know what it’s doing. Well, from a health care regulatory standpoint, one question I’ve got is, you know, Scotty’s Pharmacy, Inc., shows wonderful revenue and profits. But I want to take a look at how it as a corporation gets its referrals from hospitals, doctors, and others. Is it paying kickbacks? Is it paying prohibited inducements? Is it doing things that are against the law? Meaning that once I take the corporation over, I’ve got to stop doing those things, and then all of a sudden, my income goes out the window. And so, you know, I need to make sure that the business model of this corporation that I’m buying is not violating any state or federal anti-fraud laws.
In addition to that, it is likely that most, if not all of the PBM contracts will stay in place with the corporation that I just bought. However, let’s make sure, we need to look at the contracts and see if they are going to stay in place, and it is highly likely that we have to give advance notice to the various PBMs saying, ‘Hey, I’m about to buy the stock to Scotty’s Pharmacy. I’m letting you know in advance.’ That’s really important.
Oh, and then that gives the third tranche [obligation] when it comes to healthcare regulatory due diligence. Let’s just make sure that the pharmacy license for Scotty’s Pharmacy, Inc. is okay. You know, the state of North Carolina, for example, where Scotty is, is the state pharmacy board okay with his pharmacy license? What about his NPI? Is that in good shape? What about his DEA permit? Is that also in good shape? I just want to make sure that whatever it is that’s a part of this corporation after February one, after I’m now the proud owner, I want to make sure I don’t have to deal with problems with the state board or the DEA. So those are the three categories of due diligence. And again, that’s like having a home inspector inspecting your home. He’s going to inspect plumbing, electricity, and foundation. Here for the pharmacy, we’re inspecting finances, corporate setup, and then the healthcare regulatory.
Bonnie: And Jeff, let me just ask this real quick. Jeff, I know I’ve heard you mention in a lot of the transactions we work with, your group with you guys do add sometimes some verbiage there in the contracts that protects against some of this stuff as far as maybe holding back some funds from closing to protect for a certain period of time if something does arise.
Jeff: Yeah, that’s very important Bonnie, the two most important provisions in a stock purchase agreement in my mind are, number one, representations and warranties, otherwise known as reps and warranties, and indemnification. And that’s where when I’m buying the stock of Scotty’s Pharmacy, Inc., Scotty individually is making certain promises in the contract. He’s saying, ‘Jeff, I represent to you that everything I’m about to tell you is true, that I’m running a compliant pharmacy. I’m not having any problems with any governmental agencies. I’m doing everything the right way.’ And so those are his promises to me. And then we have the indemnification section that says, “Oh, but if after closing, I find out that that’s not true, then Scotty’s liable, he needs to pay me money.”
But that’s very well and good but attorneys like that, there’s a slogan that attorneys use, and it’s called possession is 9/10 of the law. Well, here’s an example.
Scotty: Is that a Texas term as well? I think we’re on number five for Texas terms. I’m counting.
Jeff: Yeah, that’s a universal one. But how this works is I could give today, I could give Bonnie a $10 million promissory note. So now I am legally obligated to pay Bonnie $10 million. So what?
Bonnie: He’s not going to pay.
Scotty: Got to sell that house in Aspen.
Jeff: We don’t have debtor’s prisons. Well, there’s nothing she can do to me. So I don’t possess $10 million. Same thing with Scotty. He’s got these, he’s making these promises in the stock purchase agreement. But then after closing, I find out that some of these promises are not true. And Scotty therefore owes me a bunch of money. Well, he can just look at me and say, ‘I don’t have it’. That doesn’t do me any good. And so what you said, Bonnie, you know, in terms of a hold back, possession is 9/10 of the law. So if the purchase price is, I don’t know, $1 million, I would love to pay $800,000 at closing and then hold back $200,000. So if sometime after closing, I find out that what Scotty told me is not true, then something to go against, offset against. Possession is 9/10 of the law. It’s really important to possess, as a buyer, possess some of the seller’s money.
Bonnie: The IRS is a little slow, so two years would probably be good to hold back for those tax returns, in case there was any…
Jeff: These are just the basic steps that the buyer can take to protect itself.
Scotty: The IRS, I mean, they’re almost three years behind.
Jeff: I mean, and this is just a negotiating point. You know, if I’m representing the buyer, I like for the hold back to be five years. Okay, I’m representing the seller. I want the hold back to be three months.
Bonnie: Depends on what side you’re on.
Jeff: That’s right. That’s exactly right.
Kendell: And how early on can someone start to get a, get together a team to kind of start this due diligence process? Is this something you kind of get people involved right in the final hour, right before you sign, you get somebody to come in and check on it? And what part of the negotiation process do you usually, a potential buyer start to have people involved, others outside?
Jeff: Yeah, that’s a good question, Kendell. And one of the answers I’m about to give you is self-serving, but it’s really important that the buyer get in place at the beginning, the CPA, such as Sykes & Company, the attorneys, such as Brown & Fortunato, and a bank, you know, whatever bank that the buyer wants to use. Let’s get the team in place at the beginning so that the buyer can avoid mistakes. We have all seen, I think all four of us have seen many times where the buyer tries to do it on the cheap and tries to do it without an attorney or without a CPA or tries to deal with a local CPA or attorney that doesn’t have experience in the pharmacy acquisition space. And then all of a sudden in the 11th hour, they want to close. And now problems have arisen, and then they call Sykes & Company, they call Brown & Fortunato, and say, ‘Oh my gosh, what do we do?’and it’s kind of a fire drill kind of a mess. And so, it’s better to get us in place at the very beginning.
I’ll just give you one example. [pause] Sykes & Company knows who these folks are because they referred them to us, but we have some folks who are buying a pharmacy and they’re using a real smart local attorney. And, you know, good people, very honest. But, you know, they signed everything, and they are ready to close, and all of a sudden, they looked around, said, ‘Oh my gosh, I guess there are some healthcare regulatory things that we need to do.’ And so, they called us, and now we’re jumping in. I think Sykes & Company is also working with them, just trying to, you know, we have to do a big time out there. Everybody just back off. Let’s catch our breath, and let’s work through these issues. Well, it would have been a lot easier if Sykes & Company and Brown & Fortunato had been brought in at the beginning.
Scotty: This is, you know, it’s one of the biggest transactions you’ll ever do. You want to, you know, don’t want to go out there and just wing it? I mean, come on. Suck it up, do it right, and get it done correctly, and save you some headache down the road.
Bonnie: And Jeff, I think you would agree that the due diligence portion is definitely, it’s always important, but probably definitely more important for a stock purchase than the asset purchase.
Jeff: Well, that’s a good point, Bonnie, because with an asset purchase, when Jeff’s Pharmacy, Inc. is buying the inventory and the computer, paper clips from Scotty’s Pharmacy, Inc., my corporation is not inheriting any liability. So whatever crazy stuff that Scotty’s Pharmacy, Inc. did before closing, that’s not my problem. On the other hand, with the stock purchase, if I’m now the proud owner of this corporation that has been in existence for the last eight years and it has done some crazy things in the past, that’s not my, that is now my problem because I’ve just paid $2 million for this thing and I don’t want that $2 million to be a total waste. So I’ve got to go in now and clean up the mess. And so due diligence with an asset purchase here is important, but duediligence for the stock purchase is really, really important.
Bonnie: I have a question. I’ve heard you use this term many times. So, is livestock and barrel also a Texas term?
Scotty: Did you say livestock?
Bonnie: Is it livestock?
Kendell: Lock. Lock, stock, and barrel.
Bonnie: I don’t know.
Jeff: Lock, stock, and barrel. Yeah. I don’t know if that’s a Texas term or that’s a universal term. Lock, stock, and barrel.
Bonnie: You know, Ollin’s favorite is that mark-to-market thing that we still haven’t figured out, Jeff.
Scotty: Well, that’s an Ollin term there.
Jeff: Yeah, Ollin’s probably the smartest person I know.
Bonnie: Every time you say it, is it lock, stock, and barrel?
Jeff: Lock, stock, and barrel.
Bonnie: I think of Ollin’s mark-to-market.
Jeff: You know Ollin is one of my best friends, and he’s one of the smartest guys I know. He surrounds himself with smart people, and he’s talking mark-to-market. And I just think he pulled it out of thin air.
Bonnie: I did Google it. It’s there.
Jeff: It’s there? So I guess I’ve got to accept it.
Scotty: We studied that extensively in college.
Bonnie: Really? I don’t remember mark to market.
Scotty: Mark to market accounting
Kendell: Usually, Jeff, we finish it off with the bottom line. So it’s kind of like your key takeaway or your one item you would want listeners to think about at the end. So we all take turns giving one sentence.
Bonnie: I got one.
Kendell: Go ahead. Bonnie, get us started.
Scotty: Start us off, Bonnie.
Bonnie: Mine is, call Jeff. That’s it. I’m serious. Like you guys, if you’re looking to buy the pharmacy, especially a stock purchase, call Jeff.
Kendell: I think mine’s is there’s, I think buying a pharmacy is likely going to be your biggest investment, and generally speaking, the cheap route with something like that is it’s just not worth it. It’s not worth the risk that’s involved in how much you can end up paying in the long run just because of one of so many factors going wrong can really cost you. It could be one of several things. So just go ahead and do the due diligence to get it done right.
Jeff: Kendell, that was more than one sentence.
Bonnie: And it was many different topics, but good job. Overachiever.
Jeff: From my standpoint, I guess there are two things, and that is number one, to piggyback on what Kendell said, bring in your team at the beginning. You know Sykes & Company or Brown & Fortunato, we’re not going to overdo it at the beginning. I mean, we’re going to do the minimum necessary at the beginning just to make sure that you’re going down the right path. And then if you’re going down the right path, we could jump in with, you know, with all fours, but make sure you get your team in place at the beginning. And then number two, due diligence is just critical. Let’s just make sure… I am okay with a client with the stock purchase inheriting some skeletons. I’m fine with that as long as we know what the skeletons are in advance. No surprises. Scotty, what about you?
Scotty: Yeah, I couldn’t have said it any better myself, Jeff. So I’ll just say this. Don’t mess with Texas.
Kendell: I love it.
Scotty: That’s my bottom line.
Bonnie: Lock, stock, and barrel.
Scotty: I’m going to end it on a Texas term.
Bonnie: What was the new one we learned?
Kendell: All hat and no cattle.
Scotty: Well, Jeff, we appreciate you coming on and blessing us with your time and appreciate the partnership we have with you guys. And it’s always a pleasure to have you. Good to see you, and hope it’s a great year for you guys.
Jeff: You too, Scotty. And from our standpoint, Brown & Fortunato, we love working with your team. You’re friends. I trust you guys. You guys are the best of the best. But other than that, you guys are the best of the best.
Bonnie: We’ll see you at the next workshop.
Jeff: You got it.