Option to Buy Pharmacy

[atran5756]

Hello, I have always looked into getting FI by working and investing in stocks but this opportunity came up to become a partner with the pharmacy I work at.  I am the pharmacy manager there and they want 5 years commitment from me. I have no business background and am lost with some of these terms.

This is the deal in a nutshell...

- we currently take $137,000 in management fees annually but because of cash flow, we leave all the money in the company
- you would be entitled to 10% and it would go into your retained earnings.
- no guarantees but the loan is paid off in 2019 so we should be at a more positive cash flow and look to pay out a portion of management fees on an annual basis
- you would be responsible for the lawyer and accounting fees on the purchase (we have taken care of the fees up till now)
 
Finance
We have asked our accountant to put together a fair evaluation for the current business. Here are some of the points.

EBIDA Value                             $1,377,260      
Less Related party loans       -$575,742   Retained Earnings
Less Bank loans                     -$532,010   
Add NBV (net book value                        $107,205   Assets (inventory)
$376,713      
10 percent                      $37,671      
finance                                $57,574      
Total                              $95,246      

EBIDA was normalized at $275,452
EBIDA Value is 5 times multiple makes it worth $1,377,260. We have seen 6 times earnings for a similar location in Ontario however we wanted to come up with a fair and affordable valuation for you. 
Therefore the purchase price is $95,246 (10% share price plus 10% retained earnings)
We will finance whatever portion you want at a 5% annual interest rate (same as our current loan).The loan will be open ended so it can be paid off at anytime.


I was able to negotiate to buy 15% of the company now and an additional 5% after the 5 years.

I make 156k/year + 5.5k bonus and live in Ontario.
My assets
67k in RRSP
40k in student LOC (prime plus 0.5%)

He also offered my to become the manager of the store after 5 years... (come every 3 months for a few days)  30-40k/year

Would I be able to "RE" after the 5 year commitment? Is there anything I am missing or should know before i make this commitment?  I am just overwhelmed with this offer and there is a lot I don't know about businesses so I want to make sure I am not making a mistake.

[bwall]

There is a lot to digest there in those numbers. . . . ..

At first glance, I'd say to NEVER, NEVER, NEVER, base a purchase price on EBITDA (Earnings Before Taxes Interest Depreciation and Amortization)  earnings. EBITDA can be massaged to give whatever number you want, it could also be called 'bullshit earnings'. You want the GAAP earnings, and only GAAP (Generally Accepted Accounting Principals). And, since we're talking a lot of money here, I'd even ask for the GAAP numbers to be audited, or short of that, I'd spend a few grand for my accountant to audit it. Call it an insurance policy.

In other words, if I really really want to *F* my buyer, I'd base a sale number on EBITDA.

Did I forget to mention how meaningless this EBITDA number is for you?

And, just as food for thought; why are they selling?

[bwall]

One thing I'm not sure on:
Net book value is $107,205 &
Assests (Inventory) is $376,713

Am I reading that right?

[atran5756]

Sorry for the formatting
EBIDA Value                             $1,377,260     
Less Related party loans       -$575,742   Retained Earnings
Less Bank loans                     -$532,010   
Add NBV (net book value        $107,205  Assets (inventory)
                                               $376,713     
10 percent                               $37,671     
finance                                   $57,574     
Total                                      $95,246     

[atran5756]

He said he would let me use his accountant and lawyer and it will be cheaper and less "messy". 

Should I hire my own lawyer and accountant to look at these things?  Would his accountant and lawyer "screw" me over if i'm working for them as well?

He is selling part of the business as he wants a stable person working in his store.  It's in a rural area and it's hard to get a pharmacist to work here. Wants a 5 year commitment from me.

[oldmannickels]

Sorry for the formatting
EBIDA Value                             $1,377,260     
Less Related party loans       -$575,742   Retained Earnings
Less Bank loans                     -$532,010   
Add NBV (net book value        $107,205  Assets (inventory)
                                               $376,713     
10 percent                               $37,671     
finance                                   $57,574     
Total                                      $95,246     

If you are buying 15% of a small company you pretty much have no control over the company and I would want a discount applied accordingly.

Then, how would you ever get anyone to buy your share if you wanted out?

Do you have the rights or ability to buy their shares if they die or sell to someone else?

Would it be easier to just negotiate some sort of vesting profit sharing plan for you?

[hobbes1]

you need to use your own accountant and business lawyer. you will get screwed if you use the other guy's people. they work for him first and foremost.

you had better take a hard look at the surrounding Rx competition....are there any chain Rx's near or likely to be expanding into your area? If you are the only game in town now, can you sure you will remain so over the next few years?

Who owns the property where the business is located? Your partner? some third party that might raise the rent when you can least afford it?

Good luck!

[Midwest]

Sorry for the formatting
EBIDA Value                             $1,377,260     
Less Related party loans       -$575,742   Retained Earnings
Less Bank loans                     -$532,010   
Add NBV (net book value        $107,205  Assets (inventory)
                                               $376,713     
10 percent                               $37,671     
finance                                   $57,574     
Total                                      $95,246     

If you are buying 15% of a small company you pretty much have no control over the company and I would want a discount applied accordingly.

Then, how would you ever get anyone to buy your share if you wanted out?

Do you have the rights or ability to buy their shares if they die or sell to someone else?

Would it be easier to just negotiate some sort of vesting profit sharing plan for you?

^^ ^^ ^^ ^^ ^^!!!

Hire somebody to take a look @ it for you.

[atran5756]

I forgot to mention that there are 4 other owners excluding myself if I join. So they are going to each sell me part of their shares.

I told him that 5 years is a long commitment and me and my spouse may not be able to do it but we will try. He said that's ok and he will buy back whatever shares we bought.

The business owns the building and housee I am renting from them.

We are the only pharmacy in town and the closest one is 45 minute drive away. There will never be another pharmacy in my town or closer than the 45 min drive.

I will ask about buying others shares if they die or wanted out but I think we are looking to keep this place as long as I am comfortable with managing it.

I have no idea what a vesting profit sharing plan is at all. I will look into it.

Thanks for all of these questions. I would have never thought about them

[wanderin1]

I told him that 5 years is a long commitment and me and my spouse may not be able to do it but we will try.

The sentence above is the most important one of your whole description. An investment can be a great 10 year deal, but a lousy 4 year deal. You need to have the accountant run the numbers for 3, 4 and 5 year timeframes.

This is also the time to take a step back and get clearer about goals. For example, it sounds like your employer’s real goal is to have you make a multi-year work commitment, and your goal is to FIRE quickly while not sacrificing quality of life. There may well be better deals you two can figure out to get each of you what you want.

[bwall]

I think that other people have given good advice about the pitfalls of the deal.

I believe that Warren Buffet uses the Net Book Value as the final yardstick on measuring the value of a company, IIRC. Here, it is $107,205 if I am reading the numbers correctly. So, they are asking you to pay $95k for 10% of something that is worth $107k. And on top of that, it's highly illiquid, meaning how can you sell if you want out? What if lightening strikes and you are incapacitated (or worse)? Who will buy out your wife/heirs? And at what price? Will they be in a good position to negotiate? What if something unforeseen happens and you have to move?

In short, it looks like a great deal for the seller, but not for the buyer.

[atran5756]

Yes I will need to look into all situations. If i leave early if it's even worth it.  My goal is to FIRE but he says the 5 years is non negotiable.  I am 28 right now so when i go through the numbers with my accountant i will see if it's even worth it and if i will be able to FIRE with owning part of this pharmacy

I talked to  them about selling if we want to quit and they said they will buy back my share if we could not stay for the full 5 years.  I will make sure that it's in the contract before signing.  Will have to find a lawyer and accountant to explain everything about this deal to me as I was told rough numbers from the seller but can't always trust them.

[Midwest]

Find an accountant that understands both business valuation and tax.  Owner says he will buy you out in 5 years, but do they have the ability/liquidity?

[atran5756]

The owner says that they will buy me out if we decide we cannot stay for the full 5 year term. Otherwise I will own 20% and retain the earnings.  The owner also owns 4 or 5 other pharmacies and has quite a bit of equity so I don't think that will be a problem selling it back to them.

[Midwest]

Obviously you are on the ground, but finding liquidity to buyout a partner is a frequent issue we encounter.  Good luck either way!

[atran5756]

Thank you for all of your responses and insights! I am going to look for a lawyer and an accountant and will follow up with you guys if you would like to know what happens!

[SeattleCPA]

There is a lot to digest there in those numbers. . . . ..

At first glance, I'd say to NEVER, NEVER, NEVER, base a purchase price on EBITDA (Earnings Before Taxes Interest Depreciation and Amortization)  earnings. EBITDA can be massaged to give whatever number you want, it could also be called 'bullshit earnings'. You want the GAAP earnings, and only GAAP (Generally Accepted Accounting Principals). And, since we're talking a lot of money here, I'd even ask for the GAAP numbers to be audited, or short of that, I'd spend a few grand for my accountant to audit it. Call it an insurance policy.

In other words, if I really really want to *F* my buyer, I'd base a sale number on EBITDA.

Did I forget to mention how meaningless this EBITDA number is for you?

And, just as food for thought; why are they selling?

I disagree with this. Small businesses get sold as a multiple of EBITDA or something similar, seller's discretionary cashflow.

You can fiddle with GAAP earnings. You can't fake cash flow.

BTW, I haven't read all the posts in this thread, but five times cash flow seems pretty expensive--especially for a minority ownership interest. I don't know the typical multiple for a pharmacy--though that info should be easily available to your accountant--but 2.5 times EBITDA or EBITDAS (where "S" stands for the buyer's salary) is the average multiple for a small business based on the BizComps database. At five times cash flow, that's pricey... you see businesses sold at that multiple but usually only when you have an extraordinarily interested buyer.

One final comment: I don't know Canadian tax law (it sounds like you're in Canada) but in US you would not buy stock in the company you'd buy assets. Buying stock would be a terrible approach because you'd lose ability to depreciate or amortize the assets you're buying. (I mention this for sake of other people reading this...)

Good luck. But you need to be careful. (I would also think a local accountant and/or attorney would be invaluable to you.

[bh2115]

Sorry for the formatting
EBIDA Value                             $1,377,260     
Less Related party loans       -$575,742   Retained Earnings
Less Bank loans                     -$532,010   
Add NBV (net book value        $107,205  Assets (inventory)
                                               $376,713     
10 percent                               $37,671     
finance                                   $57,574     
Total                                      $95,246     

First of all, I agree with everyone else that you should get an independent accountant and lawyer to look at this because you are really mixing up some financial concepts in this breakdown and it just makes no sense to me. I'll do my best to interpret what you've provided but the key here is EBITDA is an income/cash flow calculation that has nothing to do with the balance sheet.

Balance Sheet: A = L+E - In this case (attempting you interpret your items) you have $532K in Liabilities and $575K in Equity making your Assets $1.1M + $0.1M of inventory ($1.2M).
Cash Flow/Income Statement: Normalized EBITDA of $275K*5x= $1.35M
Valuation Asking Price: $376K?

The couple most common valuation approaches are price/book and an EBITDA multiple. First, EBITDA is a very common valuation technique and 5x is usually a generous multiple (I'd be asking myself why are they giving me this as you're essentially earning 20%). Further if they have $275K in EBITDA and are valuing the company at $376K you are getting it for 1-2x EBITDA. Something doesn't make sense here...

Next is Price to Book. If you liquidated the company today the book value would be $575K. They are valuing the business below the liquidation value of the company (376K/575K)=~0.6.

So based on my interpretations of the numbers it's a great deal but I'm guessing I'm either misinterpreting something or the numbers are incorrect - conclusion, get an accountant!