Rates, risks and your pharmacy’s value: Part 2

In a previous article, we discussed the way rising interest rates undermine the value of any business, including a pharmacy. We also, however, suggested that pharmacist-owners – rather than throw up their hands in defeat – can take a few concrete steps toward supporting the value of their business by identifying and mitigating risk.

Remember our valuation formula: Value = Annual Cash Flow divided by Risk Rate. One way to increase value, of course, is to try to increase cash flow. That could be attempted by cutting costs and waste – often good ideas – or by raising prices, although the pharmacy’s ability to do so (without losing customers) might be severely constrained. The other option, and the one we’ll discuss further here, is to lower the business’s risk rate. In the big picture, higher interest rates are just one of several risks to valuation, since they raise the buyer’s cost of capital (equal to their expected rate of return). And there’s not much – actually, not anything – a pharmacist-owner can do about monetary policy. But there are other risks that can be managed and, therefore, reduced.

What are they? Here are five that we often come across in our transaction advisory work with pharmacist-owners:

• Recurring revenue risk
  Is your pharmacy’s revenue steady from one year to the next, or does it fluctuate wildly? Businesses that can boast predictable revenues almost always attract interested buyers, while those with volatile revenue streams often get saddled with higher risk rates. If your business is in the latter group, what are the factors driving the volatility and how can you mitigate them? For instance, are there seasonal opportunities to smooth out front-of-store sales during slow periods, or can you make use of limited time offers (LTOs) to drive revenue and increase return visits? In the dispensary, could an appointment-based model lead to more predictable recurring revenues? What about medication synchronization?

• Concentration risk
  Just as a community that depends on one employer or industry is vulnerable to changing economic circumstances, so too are individual pharmacies vulnerable if they depend on a concentrated customer or patient base. If a pharmacy relies on a handful of prescribers to generate revenue, what happens when those customers relocate, retire or find a different pharmacy? Clinic-based pharmacy practices, for example, can be particularly subject to such risks, as can pharmacies that rely heavily on contract-based revenue from healthcare institutions like congregate care homes. Yet any pharmacist-owner could benefit from taking a long, hard look at their customer base and considering ways to diversify it. Could different front-of-store offerings attract new customers? Could relocation or expansion, if feasible? Could different marketing efforts pull in more and/or different sources of revenue?

• Accounting risk
  Reliable financial records help assure a potential buyer that your pharmacy is what you say it is. Poor financial information – with inconsistent or improperly applied accounting practices – will trigger skepticism in a wary buyer. The better the information you can provide, the lower the risk the buyer will apply to the business and the more they will be willing to pay for it. Professional accounting advice is imperative.

• Audit risk
  The risk of being audited – by narcotics inspectors, third-party payors, tax authorities or, in some jurisdictions, professional service provision monitors – soars in an environment of poor record-keeping and/or financial/operational mismanagement. An audit, or even an elevated risk of an audit, undermines the value of the business. To avoid that, narcotics-tracking procedures need to be up to snuff; professional services rendered need to be well documented; staff need to be trained properly on handling third-party payor transactions; tax audit risk and potential liabilities need to be fully addressed with the aid of a qualified accountant.

• Transfer risk
  Does your pharmacy operate smoothly when you’re not around? Do you rely on a single technician or pharmacist to keep the lights on? If so, what happens when you sell the business? If you or your key personnel would no longer be there under a new owner and the remaining staff are poorly trained, unmotivated or insufficiently delegated, then that can undermine value of the pharmacy. On the other hand, well-trained and dedicated staff can make the transfer of the business much smoother for the new owner, while increasing customer retention. Taking steps to reduce transfer risk can make a big difference to the price a potential buyer would be willing to pay.

Obviously, rising interest rates are a challenge for any business owner, and to pharmacist-owners who have been preparing to sell, the new rate environment might seem like very bad news. But that is no reason to give up on trying to maximize the market value of their pharmacies. With a proper understanding and identification of risks – and with a commitment to reducing them wherever possible – pharmacist-owners can often take a few simple steps to get the most out of their equity when it comes time to sell, whatever central banks do.