5 more building blocks for business success

The recent “The Business of Wealth Creation for Pharmacy Owners” conference in Toronto addressed a wide range of topics to help independent pharmacy owners navigate an increasingly complex business landscape. This article takes a closer look at best practices for contractual agreements, taxes, wealth planning and more. A separate article on wealth management, retirement planning and business succession is also available.

The event was co-presented by Intropharm & Associates and KJ Harrison Investors, a team of pharmacy business advisors that has served Canadian independent pharmacy owners since 1999. All proceeds from the event went to the Canadian Foundation for Pharmacy.

1. Pay attention to legal matters

Spence outlined the benefits and risks of the following contracts:

• Wholesale supply agreements usually leave little room for negotiation, in part because of the limited competition among wholesalers. Still, it’s important to “know your obligation and your rights,” said Spence, particularly when it comes to security (in case of payment default). “When you grant security, you’re basically providing a mortgage on your pharmacy assets.”
• Banking arrangements are increasingly trying to negotiate stricter covenants and loan security. Spence said that pharmacist-owners should limit security requirements as much as they can and try to keep personal assets out of the equation. And beware of over-complexity. “I have had clients get very complicated banking arrangements thrown at them, and the cost of putting them in place and adhering to all of the covenants can be quite high,” he explained.
• Third-party payor agreements provide benefits but offer limited room for negotiation, Spence said. Downsides include the potential for audits and stringent document retention policies.
• Banner agreements come with the benefits of financial support, branding and loyalty programs; however, they also restrict the owner’s autonomy, may increase costs by requiring compliance with the banner’s standards, and may grant the banner the right of first refusal when it comes time to sell the business—potentially restricting the market for the pharmacy.
• Leases also require careful management, Spence said. Lenders typically require that a store’s lease term be at least as long as a loan’s amortization period; therefore, seek an extension whenever negotiating a lease renewal, recommended Spence.

2. Be strategic about wealth planning

It’s important to start wealth planning early and take into account major life inflection points such as marriage, starting a family, divorce, or selling the business. The process involves the optimization of business and retirement assets (for instance, by maximizing savings plan contributions and ensuring the business asset mix preserves qualification for the lifetime capital gains exemption), the collection of income and expense information, projections of income and expenses in retirement, and the analysis of risks and outcomes under different scenarios.

Other elements of strategic wealth planning include:

• Income projections Estimating future income and understanding how to replace lost income after selling a business.
• Expense management Evaluating and often challenging spending habits to align them with savings goals.
• Investment strategies Diversifying investments and understanding market conditions.

3. Structure for tax efficiency

The Canada Tax Act is extensive “and it changes all the time,” noted Spence. Navigating tax efficiency requires expert advice—especially regarding corporate structure, which can significantly affect how much tax a business owner pays.

One key issue is how business income is taxed. For family businesses, stricter rules around split income have made paying dividends to family members less appealing.. Another option is to establish a holding company that can receive and grow income from a business on a tax-deferred basis, Spence noted.

The sale of a business can carry major tax implications. Fortunately, Canada’s lifetime capital gains exemption allows up to $1.25 million in tax-free gains for qualifying businesses. To qualify, at least 90% of assets must be “active” (i.e., essential to operations) at the time of sale, and at least 50% must have been active for the previous two years.

It pays to plan ahead, emphasized Spence, especially if family members are shareholders. Owners can implement estate freezes to allocate future growth to new common shares for heirs, allowing them to claim the capital gains exemption upon sale.

Trusts are another tool to enhance tax efficiency and transfer income to beneficiaries. However, Spence warned that trusts are complex, costly, and time-limited— and getting it wrong can mean paying more taxes. Therefore, they must be carefully structured to align with the owner’s estate plan.

4. Think like an investor

Key considerations include:

• Manage risk When business owners reach the stage where capital preservation is more important than growth, they need to pay more attention to mitigating risk and diversifying investments. “Wealth is created by concentrating risk,” Martini said, “but [after you sell], you’re at a stage in your life where you must diversify risk.”
• Understand market dynamics Investors are subject to the movements of financial markets. A key driver are interest rates, which affect asset prices and financing costs. Investors must also be prepared to ride out and minimize the impact of market corrections, said Martini.
• Maximize growth and minimize taxes Take advantage of tax-efficient vehicles such as registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs).
• Allocate assets according to your goals Stocks, bonds, real assets (like property) and cash (or cash-equivalents like money market funds) have different expected returns—and different levels of risk. The traditional 60/40 portfolio (60% equities and 40% fixed income) may be tried-and-true, but it might not be right for you and your family.

5. Protect the future

From a seller’s perspective, the growing interest from corporate pharmacy and private equity firms to acquire pharmacies may appear to be good news. Yet this may have an adverse effect on independent pharmacy over the long term.

The next generation of pharmacy owners face several challenges, noted Jaczko. One is the cost of capital, which has risen in recent years along with interest rates. And while pharmacy education in Canada must focus on clinical training, it should not do so at the expense of teaching business acumen, including how to own a pharmacy.

Jaczko outlined three ways to help preserve the future of independent pharmacy:

• Mentorship programs to connect young pharmacists with experienced owners to foster interest in pharmacy ownership.
• Awareness campaigns by pharmacy associations to promote the benefits of community pharmacy ownership and highlight successful role models.
• Educational reforms to balance clinical training with business education.