In this episode of Over the Counter, Bob Graul and Drew Hegi from First Financial Bank discuss first-time ownership, transitioning into a CEO role, and more.
Drug Topics®: Hello and welcome to Over the Counter, the podcast from Drug Topics®, I’m Gabrielle Ientile.
I am joined by Drew Hegi, loan officer with First Financial Bank, and Bob Graul, business development officer with First Financial Bank. Drew, Bob, thanks for joining me today.
Hegi: Thanks for having me.
Graul: You’re welcome.
Drug Topics®: Before we get started on our topic today, Drew and Bob, can you speak a bit to your professional backgrounds? Drew, I’ll ask you to kick it off.
Hegi: I graduated with a degree in finance from Mississippi State University. I was born and raised in Mississippi, where I live now, and then started a sales career, moved into pharmaceutical sales, worked for AstraZeneca for a little bit, and then got the opportunity to come to the bank and help start our pharmacy lending division back in 2012.
I have been helping the bank originate pharmacy loans for the last 9-plus years. And it's been a good run and certainly love what I do.
Drug Topics®: And Bob?
Graul: Thanks. I'm old, so mine would take a long time if I told you everything, so I'll keep it a little bit brief.
I have a degree in pharmacy, I graduated from Pharmacy School at Philadelphia College of Pharmacy. Over my career, I've worked in nonprofit, hospital, retail.
I owned stores for 25 years in San Diego. After that I worked for McKesson and developed their RxOwnership program for them, their ownership transfer program. Developed, launched and managed it for a number of years, retired again and the bank recruited me to run their SBA lending program for pharmacies. I did that for a number of years. And now I'm semi-retired, and I'm a consultant with a bank. Over the years, I've seen hundreds of deals and put together hundreds of deals for pharmacy owners first time and multiple store owners.
Drug Topics®: Pharmacy ownership can be an attractive choice for pharmacists looking to advance both professionally and financially, but can also be a daunting next step. What do you first recommend to pharmacists who may looking to take a leap and buy their own store, but don’t know where to start?
Graul: Drew, why don’t you start?
Hegi: Yeah, happy to. There's tons of resources out there. If you look around and visit with the right people, they can point you in the right direction. But NCPA does a great job hosting leadership and pharmacy ownership educational weekends, so participating in one of those would be a great start.
Also, talking with your wholesaler, they usually have the big ones, and some of the regional regional ones do as well, have great resources for everything you need to know about partners, pharmacy ownership and have transition teams and checklists to sort of work through, which can be very helpful.
And then develop your set of industry partners. And whether that be banking relationship, finding a bank that specializes in pharmacy lending, like First Financial Bank, or accounting, there's specialty groups that only work with accountants that would be great resources, lawyers, attorneys.
A number of resources like that will be valuable as you work towards getting into ownership and can help you complete due diligence on what you're looking at. But that that would be my advice would be surround yourself with a good team. Bob, would you have anything to add to that?
Graul: Yeah, just a couple things. As far as the pre loan process, getting ready to look to borrow money. One of the critical things is keeping your credit score up. Drew I think we look at what, six 680 or above? Is that what we're looking at, or is it 580? I can't remember.
Hegi: 680. Yeah.
Graul: Yeah. So, keep your credit score up. If you have student debt, don't be deterred, we can work with that.
And secondly, about finding available pharmacies - broaden your horizons a bit.
I've seen a lot of people that are looking to buy a store but they want it within 5 square block radius, and there's no stores, there’s only one store that's not for sale. Be willing to move a bit to find a good available store.
And then if you're in an area with a lot of stores, don't be afraid to drop in, leave your card, indicate to the owner that if they're ever looking to sell you're willing to buy and stress the importance of keeping that store independent. I think that would be, in addition to what Drew said, surrounding yourself with a good team and participating in NCPA and working with your wholesaler.
Prospective owners may also grapple with whether they should start up a pharmacy from scratch or buy an existing one. What are the differences between those two avenues, and which path would you recommend?
Graul: The one thing I would say is that buying a store is a lot more profitable in a shorter period of time than doing a startup. The return on invested capital on a startup is much longer than it is on a purchase.
Just keep in mind when you buy a store, if you made a good choice, you have a built-in cash flow from day 1. Drew, you've seen a lot of these, what's your comments on that?
Hegi: You ask anybody in the industry, they're going say buy an existing is the easier path, just because you have prescriptions the first day you step in there. With a startup, you're going to be working for those and trying to build it over time. And it can be a 1- to 3-year process. If you can find one to buy, that would be the best-case scenario.
I say that knowing that personally, I have started 3 pharmacies here in Mississippi with 2 other business partners and they've all been successful. And we've done a bunch of lending for startup pharmacies, and by and large, they've all been successful.
I think with the right plan, the right location, and the right analysis prior to getting started, startups can be a great route and should be considered. It's just a riskier path in general, because you don't know until - projections look great always before you get started, but you never know until you get the store open, and you've spent a bunch of money ordering drugs and building out your location and hiring staff. And then how quickly your prescription is going to come if it is a startup?
I'm a believer in independent pharmacy, I think it's a great way to make a living, I think there's a place for independent pharmacy in every community, so certainly believe in both options.
Graul: And Drew, just to reflect on the, you don't know how it's going to work out, I did have an owner who has started a pharmacy and it was quite successful. But he told me that in the process before he opened, in the days before he opened, he wasn't nervous at all until the night before the opening. And his daughter looked at him and said, “Daddy, what happens if nobody comes tomorrow?” That made him very sleepless the rest of that night.
But you got to remember that when you do a startup that first day you open, you've done no business. So Drew a hit on it, the business plan is critical there and location is a key to that business plan.
One of the things that we've seen very successful over the years is doing what we call a backfill startup where a chain has bought a large independent, there's no other independent competition in that marketplace. Doing a start up in that market ramps up very quickly, so location is your key here.
Drug Topics®: Of course, the most visible obstacle when buying a pharmacy is the financial aspects of it. What are the estimated costs of purchasing a pharmacy and how can pharmacists identify their financing needs from the get-go?
Hegi: You want to familiarize yourself with how, if you're buying a store, how stores are valued in today's marketplace.
When I first started in 2012, I remember reading lots of pharmacy articles, and there's probably 42 different ways to value an independent pharmacy based on prescriptions and percentages of sales, and percentages of inventory plus sales, all kinds of ways to value stores. And that, with margins sort of shrinking over the last several years and direct and indirect remuneration (DIR) fees and the pharmacy benefit manager (PBM) pressures that exist, you want to just sort of hone in on EBITDA, which is an accounting term earnings before interest, taxes, depreciation and amortization, times a multiple between 3 to 3 and a half and then add inventory on top of that.
So you want to get comfortable with how stores are valued, so you don't overpay. One thing you don't want to do in today's market with all those pressures that I mentioned is to overpay for a store.
If you're not financially savvy, find some partners that are that can help you appropriately value a store and then we can help. A lender that specializes in pharmacies is very valuable in terms of both gaining access to the funds that you need, but also making sure that you're getting put in a successful situation.
And then a start-up, of course, is different based on where you are geographically. A start up in New York City versus one in the rural Southeast, sort of where I live Mississippi, it's going to look a lot different.
But we can help you determine what your overhead costs are going to be, adding in the appropriate amount of working capital, deciding what the right amount of initial inventory purchase is going to be sufficient. So usually, for a startup, just to throw a number out there between $400-500,000 is a good roundabout estimate. And then your financing needs for a store purchase is just going to vary depending on how busy the store is. And we can help you with that. But Bob might have a further comment there?
Graul: Yeah, on the cost, Drew hit the start up pretty well, but on the purchase of a pharmacy, typically, the SBA is requiring 10% down payment. There's ways to work with that with carry back loans and other things that we can work with, so we can work with you on that, but you will need money available to invest, you have to have equity to be able to put into it.
And a ballpark number is around 10%, Drew touched on valuation formulas, he mentioned 40 something I've seen over 60 different valuation formulas. Keep in mind that the valuation formula is really just giving you a ballpark of what that store may be worth. The store is only worth what somebody else will pay for it.
But the key to that outside of the valuation formulas is cash flow. When you do a cash flow analysis, the store has to cover your costs and the loan servicing the loan. Cash flow, and you'll hear that a number of times probably, cash flow is king in this industry. Doing a thorough cash flow analysis will tell you whether or not the purchase price is correct or not. Do you agree with that? I think you've seen a lot of those.
Hegi: Yeah, no, I agree. I think you hit the nail on the head there.
Drug Topics®: The search for a pharmacy to buy is a very exciting part of the process. what makes a prospective pharmacy attractive, and on the other side of a coin, what red flags do you advise looking out for?
Hegi: So we're going to ask for, if you're looking to buy a pharmacy, the initial items that we're going to look for, and we're going to do further due diligence than just these items, but we're going to ask for past 3 years of tax returns on the business and then the most recent financials, which is a PNL and a balance sheet on the business.
We're going to look at trends in terms of sales, in terms of gross profit percentage, in terms of profitability. If you're looking at buying a store, you want to make sure that it doesn't have, you want to see stability there. A lot of times with older sellers that don't update their store appropriately, you might see a decline in revenue, and you might have a plan on how to turn that around, because this owner is not taking advantage of immunizations, they're not doing medication synchronization, they're not doing home delivery. We do see that quite often. But you just want to make sure there's not anything drastically wrong with the business, that the store is making money.
And we can look at reducing expenses in terms of add backs, if that's needed, if you know there's going to be expenses that are going to be eliminated after you take over the business, we can look at that.
But annual prescription counts, how is the business doing year-over-year-over-year in terms of how many prescriptions that are filling? That gross margin is very important. With the way the industry has gone, we're probably putting more emphasis on the most recent tax return, as opposed to what happened in 2017, because it's just a, it's a different world today. And so you're going to really put a lot of emphasis on the 2020 financials.
And as we get into 2021, we make sure that the store keeps good accurate financials, so we can kind of monitor how it's going. But higher volume stores are another thing. You don't want to really have a store that's only doing $1-1.5 million in sales. That just doesn't produce enough money to pay you a fair market salary, pay your loan back and have a little cushion there. So I mean, honestly, the bigger the better. And that might scare some people, because the bigger the pharmacy is, the more money you're going to have to borrow. But that's a lot of times the safer play because there is more money to go around and provides more cushion, and you have more opportunity for profitability. Especially if you're going to make some changes for the better going forward. I guess those 2 things, busy store that has steady financials. Bob, what else would you add? What did I miss?
Graul: You hit it mostly, I think pretty much everything on the head.
As far as the size of the store, if you have a choice between a $3 million store and a $7 million store, don't be scared, take the $7 million store, it's going to work out better in the long run.
Drew mentioned financials, one of the issues that we have when we're looking at financing these is the quality of the financials of the store you're buying. Not only are the financials demonstrating that they're performing, it's also what are the qualities of the financials? Were they prepared by an accountant? Were they done by an in-house software tool? Are they done on a yellow legal tablet? Quality financials are key.
When you're looking at a store, make sure they have good solid financials that go back at least 3 years. Drew also mentioned when you're when you're looking at doing cash flow analysis, and we're looking at the financials, you mentioned add backs. And just to elaborate on that a little bit.
That's basically anything that the current owner’s paying for that you won't have to pay for when you take over. You know, you're looking at perhaps country club dues, automobiles, insurance policies, things like that. My biggest one was, I was working in Texas, and the delivery expenses were huge. And I said, “What are you running a fleet of trucks?” He goes, “No, no, that's my airplane.” I said, “You're writing off an airplane as a delivery vehicle?” And he said “Texas is a big state, boy.” So I said, “That's fine. I got a huge add back for my customer.”
Drug Topics®: Now let’s dive into the details here. What kinds of options are out there for prospective pharmacy owners when it comes to financing and how do they choose the right one for their business?
Yeah, so SBA financing is a great fit for pharmacies, for independent buyers, that are looking to go to the bank and get a loan. Utilizing the SBA program, more times than not, is the best and could be the only option. And I'll explain why.
Hegi: If you think about an independent pharmacy, and maybe one in particular, that leases their office space, maybe on the corner of a strip center, and that's just a leased space, the store may be doing 6 million in sales, it may have $350,000 of inventory included in it. And that business may be worth $1.5-2 million.
Well, from a collateral standpoint, as a traditional bank would look at it, there's really nothing there to go get if the loan was to go bad. There's no property, there's no dirt, there's no real significant equipment unit, you may have a delivery vehicle and a few other things, but there's really there's a strong lack of collateral.
So that's why SBA is a good fit, because the government, Small Business Administration is what SBA stands for, provides a guarantee for the lender that if the loan goes bad, they will cover a percentage of it.
And right now, due to some of the stimulus packages that have been passed by Congress, banks are getting a 90% guarantee on the money that they loan out through SBA program. If we make a million-dollar loan, and the loan goes bad, and unfortunately, we could submit to claim, and we would get $900,000 covered from the government. We would only be risking $100,000 of our money, which is much better than if you didn't have the SBA guarantee, obviously, so that's how we're able to do what we're able to do nationwide.
And the local bank just most of the time doesn't have the SBA experience that a high volume lender like ourselves, First Financial has. So that would be a reason. And they also don't understand pharmacy and the need for cash and working capital. If you can combine the pharmacy experience with somebody that with a bank that really understands SBA, that would be a good fit. But more times than not, 9 out of 10 times an independent buyer is going to use an SBA loan to buy a pharmacy.
Graul: And I'll second that. Having done and worked with local banks, national banks, over many years, when I went to work for First Financial, I discovered what an expert in SBA loans means to the borrower. The quality of the advice and the quality of the processing alone is just really key to getting a smooth SBA experience. So, choosing a bank like First Financial is critical. Thanks, Drew, you did a good job on that one.
Drug Topics®: Once a prospective first-time owner decides to take the plunge and apply for an SBA loan, what do they need to have prepared? What are lenders looking for at this stage in a borrower?
Hegi: Bob mentioned a couple of them that need to be addressed prior, is maintaining your credit score. Obviously, a lender can't do anything once the credit report is pooled and the credit score is sort of reviewed and make sure you have your finances in order and make sure you have cash. Having cash to put toward the down payment. There is a hard and fast rule with SBA loans, that you do have to have a 10% equity injection requirement.
And so whether you start saving, or your parents or other relatives would be able to get you money, that's one thing that you need to have available to you to buy stores to have some cash on hand.
Beyond that, just try to clean up and not have credit card debt of any sort of significant balance out there. You want to have your personal tax returns filed on time. And, it’s easily available to send to a lender, update your resume, and we can we can help with a lot of this stuff.
But yeah, that's basically it, we do all of our applications, through email. And just virtually because we do work nationwide, we can't be present for everyone. So we just work over email and get documents back and forth that way. And we can help.
A lot of pharmacists aren't overly familiar with how to fill out a personal financial statement. We can help walk through that. Also, there's some SBA forms that have to be filled out that we’re very obviously familiar with and can help. And so we're very hands-on, very collaborative approach where the loan officers working with the pharmacist or a prospective buyer applicant, to get everything that we need in. But what we can't help with is personal credit, the amount of debt that you have and the cash on hand, so I would definitely try to prepare yourself in that way.
Graul: I think stepping just one step beyond this question, but it is important is that the cash on hand has to remain identifiable through the whole process until it's required for a down payment. It has to be in an identifiable location at a bank or whatever. You can't dip into that partway through the process.
Make sure that that 10% stays identifiable through the whole stage. Drew kind of touched on it. But one of the differentiators with First Financial and other banks is that when Drew does a loan, once he gets it approved, he stays with you through the whole closing process. I've dealt with banks over the years and, the lender gets you approved and then hand you off to a to a loan operations person who's asking you a bunch of questions they hand you off to another person who's trying to get the SBA approval and they hand you off to another person. We stay with you through the whole process. I was very impressed with that at First Financial, that the loan officer is the one number you need through the whole process.
Drug Topics®: Now, according to the 2020 NCPA Digest report, 30% of independent community pharmacy owners have ownership in 2 or more pharmacies and the average number of pharmacies in which each independent has ownership is 2.1.
Pharmacy owners may constantly be on the lookout for ways to expand and grow their business––and multi-store ownership could be a lucrative way to do that.
What do you see as the biggest benefits/challenges of taking on multi-store ownership versus single-store ownership?
Hegi: Yeah, you mentioned lucrative as you get into other locations, and I would say that's, that's right on. I mean, volume is the key in independent retail pharmacy today, so as you get comfortable with your store that you own currently, and as you get some years under your belt of ownership experience, you're going to want to look to purchase another one.
And we get a lot of repeat customers coming to us and saying, “Hey, I'm ready to buy this second store, my wholesaler mentioned that there's a store 30 miles from here that's about to be for sale, and I'd like to position myself to be able to purchase, purchase that one.” And then you take that one, and you can turn that into a third store in a fourth store. And we've helped many customers do that.
And there's only so much income potential really within an independent pharmacy. To grow that beyond just one store, obviously, is to add other stores. And that's where you can really get into making some decent money and building some equity and some wealth through pharmacy ownership.
Timing is everything, and it's different for different people. And location, how far are you willing to go? Because you’re going to have to rely on someone else to run that store. And how much time are you willing to spend coaching them and developing them, so they know how to run that and operate the store the way you want them to?
You'll definitely be stretched in different ways. But yeah, most of the time, we see business owners wanting to do that, stepping away from the counter being more of a manager in terms of helping and developing other stores and other pharmacists run and operate their pharmacies. And so it's a natural next step, and I think one that all pharmacy owners should look at.
Graul: A couple things that Drew mentioned. Location. If your stores or if you have multiple stores in there, within a reasonable distance, you really can develop some significant economies of scale, sharing personnel between stores, sharing inventory between stores, buying opportunities, that type of thing.
Having looked at hundreds of business deals over the years, I will definitely say that multi-store owners are more profitable than single store owners 99% of the time. One of the things you mentioned was the transition of what you're doing from being an owner-operator, where most of your time is filling prescriptions, and part of your time is running a business to becoming more of a CEO - less time on the case, less time filling prescriptions, more time focusing on business.
I found after I got into it, that my business knowledge coming from pharmacy school was limited, and so I ended up going back to school at night and getting an MBA, which helped a lot.
I don't recommend everybody gets an MBA, but taking some business classes, doing some research on business is really good idea, because you will become more of a businessperson than you will be a pharmacist after a while. You still spend some time filling prescriptions, but majority of your time we'll be running a business.
There's a lot of different ways to structure your business, whether they're all under one corporate umbrella, LLC, or whether they're in separate ones. Do any of your employees have ownership in the multiple stores that you get into? Make sure you have a good accounting firm, and a good attorney to help develop the structure of your business.
The biggest key though, is the psychological transition of going from being a line pharmacist to being a CEO, and be ready to do that.
Drug Topics®: For existing owners who have been through the process already of buying a pharmacy and now want to step into multi-store ownership: Are there any different considerations or financing needs when it comes to buying a second, third, or fourth store?
Hegi: I think it just goes back to volume and probably location. You're not going to want the headaches at a second store if it's not a busy store, because it's not going to be worth your time and energy and investment, because there's just not enough money to go around.
I would say the volume piece is probably even more critical on the second store. You don't want to settle for the smaller pharmacies, you want to go for the ones that are doing higher volume.
And then, are you willing to travel 4-5 hours away, or is it a smaller radius, and you want to stay within 60 miles of your location. So those are personal choices. And it just depends on who's going to be there to help you and what kind of team members that you can put in those stores, or that are already in those stores that you can sort of lean on as you're not there.
But you just want to be selective when you're looking at second, third fourth stores.
Graul: Hey Drew, can we use the equity in the first store as part of the loan process?
Hegi: You can. That's a good benefit of using SBA.
If you own 100% of the pharmacy that you work at now, and you're going to buy a second store and own 100% of it, and you're willing to pledge your existing store as a co borrower on this new loan, then SBA would view that as an expansion of an existing business, which does not have the 10% requirement.
You actually can get into a loan with much less money down, maybe 3-5%, something like that. It’s ivery flexible, there's no hard and fast rule.
You can leverage your current store to have a lesser down payment, which a lot of times is attractive to pharmacy owners. So that is one way to do that.
Drug Topics®: And unfortunately, many business owners are experiencing significant challenges amid the COVID-19 pandemic. What do you recommend to pharmacy owners whose businesses are facing hardships right now?
Hegi: To be adaptive. It's challenging times across the board, but pharmacies have really done well through the pandemic.
They've really gone above and beyond to help their customers. Some of the stories that we've heard are inspiring and how they've thought outside the box and it's actually been good for pharmacies that did not have a delivery program to implement one that's going help expand their business. Taking advantage of the front few parking spaces in the store to use as curbside delivery options and customer service has really been increased and they've been able to outperform chains a lot of times, and word gets out about that.
I think COVID has been a unique opportunity that a lot of pharmacies have been able to take advantage of, even though it's been very challenging, there's also been some positives to report there as well.
Graul: And I think what we saw initially, or what I saw in talking to a lot of pharmacies very early on, and then as the situation carried on was that there was initial dip in prescription volume, because the acute need prescriptions just weren't being written. Dental prescriptions, elective surgeries, people going to emergency room for this, that and the other, whereas the maintenance prescriptions may remain constant.
But then as people discovered that they could get out and get to a pharmacy successfully, especially the independents, which we're developing drive-thru’s, curbside pickup, and that type of thing, volume picked back up. And independent pharmacists tend to be owners who are very community oriented, so they were involved in a lot of different community projects, helping the community through this pandemic, so I think they've done quite well and are continuing to flourish in this situation.
Drug Topics®: Drew, Bob, thank you so much for joining me today.