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No Stone Unturned: Due Diligence in Pharmacy Transactions

Due diligence matters in any business transaction, but the thicket of regulations and licensure requirements that govern the pharmacy industry make thorough diligence the most critical part of any deal in that business.

That was the key message delivered by Quarles & Brady partners Amy Cotton Peterson and Jonathan Howard at a discussion on pharmacy transactions at the firm’s 3rd Annual Pharmacy Law Symposium in Chicago. Speaking to a group that included in-house attorneys at international pharmacy chains, compliance officers, regulators and regional pharmacy executives, Peterson and Howard emphasized the need to understand the potential pitfalls lurking in pharmacy transactions.

From unearthing potential liabilities to logging expiration dates on pharmacy permits, pharmacy purchasers can’t afford to leave stones unturned. Buying a pharmacy, or pharmacies, requires an exhaustive review of licenses, local rules and contracts, for starters. Any missed detail could create a cascade of damaging consequences for the buyer, Peterson said.

“Typically the business people come in with a goal – to add revenue or synergies – but you have to look at the potential drawbacks,” Peterson cautioned. “It’s rarely simple.”

For instance, when pharmacies do asset deals – where they purchase particular parts of a business rather than the entire entity – it typically requires filing for new licenses with the state boards where the seller operates. In some cases that can impact the buyer’s ability to bill Medicare and Medicaid after the transaction closes, or to bill retroactively once the licenses are approved, which some states allow but others do not. In any case, the gap in cash flow that could create might be enough to change the price or other deal terms.

That helps explain why pharmacy buyers, unlike purchasers in most businesses, typically prefer stock deals, said Howard, who advises clients on transactions across multiple industries. Because, while stock deals leave the buyer to assume all the seller’s future and historical liabilities, asset deals can nullify critical permits and accreditations.

But even in stock deals, many potential pitfalls lurk in the intricacies of pharmacy operations – particularly when, as is common, the seller is a small or family-owned enterprise. Vendors could be operating on handshake deals, backed only by the seller’s personal relationship.

Even lucrative (and vital) payer contracts can contain clauses that disrupt transactions in surprising ways. Howard recalled an instance where a seller received a significant portion of its revenue through a group purchasing organization (GPO). But a closer look at the contract revealed that the GPO only allowed members who were descendants of a particular nation in the Middle East – which the buyer was not.

“You can never assume everything is fine, no matter how good it looks financially,” Howard said.

And beyond issues that can impact price and other terms, or scuttle deals altogether, diligence can uncover many of the difficulties that purchasers will face after deals close, during integration. It’s vital to know, for example, whether the acquired pharmacy will have the licenses that allow it to continue shipping into relevant states post-close. Or when a pharmacy benefit manager (PBM) buys a pharmacy, as is increasingly common, the new owner will likely have to put in a firewall between the PBM and the acquired business.

Peterson also cautioned that the executives who sponsored a transaction often underestimate the legal issues it could trigger.

“HIPAA and anti-trust rules can come into play more often than you might think,” she said. “And the ramifications from those are often much greater than the business people expected.”

Whatever issues arise during diligence, they’re most often hashed out during the negotiation phase, and they have a big impact on the time it takes to reach agreement on terms. The simplest deals can typically be negotiated in 30 days. But complicated licensing structures can push that out to 100 days or more, as the buyer seeks approvals from various state boards.

Much of the negotiation will usually center on the representations and warranties portion of the sale contract, where the seller makes promises to the buyer about what’s being bought and sold. Pharmacy deals typically include the same business representations – e.g., that the business doesn’t have contractual disputes or employee lawsuits pending – as in other industries. But the fundamental representations, which include licensing and compliance matters, are unique and among the most heavily negotiated elements in pharmacy deals.

There again, the best way for buyers to reach a comfort level with the seller’s promises often boils down to due diligence – of even the most basic kind.

“There’s no substitute for going out and visiting their stores, their offices,” Peterson said. “We want to see what our client is buying.”

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