Selling a Medical, Dental or Pharmaceutical Distributor

Supplier agreements come first

The right to sell certain manufacturers' products is often the most valuable asset in the company, and often the least portable. A distributor may hold an authorized agreement with a dental equipment maker, a surgical supply manufacturer or a generic drug producer. Some of those agreements say they end if ownership changes. Others need the manufacturer's written consent before they can be assigned, and a few allow the manufacturer to walk away with thirty days of notice. A buyer will want to read every one of them, and the buyer's lender will read them too.

For that reason we ask an owner early which lines make up most of the gross profit and what each agreement says about a sale. If one manufacturer accounts for much of the margin and the agreement can be ended on short notice, a buyer will either discount the price or require the manufacturer's blessing before closing. Calls to manufacturers are best made after a buyer is serious, and with a plan, since a distributor usually wants to keep these relationships warm. Where the company also sells private label products under its own name, buyers tend to value that, because the margin is better and the line cannot be pulled by someone else.

Customers and how they buy

Buyers sort the customer base by type. Dental practices and medical clinics tend to reorder consumables on a steady rhythm. Pharmacies and hospitals may buy through group purchasing contracts that set prices ahead of time. Surgery centers and long-term care facilities have their own patterns. A buyer wants sales by customer and by product line for several years, and wants to know how many accounts reorder on their own versus how many depend on a rep calling each week.

The reps matter. In this trade a sales rep with a territory often holds the relationship, and when that person leaves, accounts follow. Buyers ask how reps are paid, whether they have signed non-solicitation agreements, and how long they have been in the territory. Rules on how far those agreements can reach vary by state, and your attorney confirms what applies. The post on customer concentration describes what buyers do when a few accounts make up a large share of sales.

Contract pricing is a second thing a buyer examines. If a large account buys under a fixed price agreement and costs have risen, margin on that account may have shrunk without anyone noticing. Expect a buyer to ask for gross margin by customer as well as in total.

Inventory is a large part of the price

A distributor carries a lot of stock, and a buyer will not pay the same for every shelf. Product that is close to its expiration date, product that was discontinued, items that have not sold in a year and anything damaged or recalled is worth less than its cost and sometimes nothing. Buyers want an inventory listing with quantities, cost, lot numbers and expiration dates, and they want to count it themselves before closing. Our post on earnouts, holdbacks and working capital covers how inventory and receivables are handled in the price, since the deal normally includes enough working capital to run the business on the first day.

Cold chain and controlled product storage raise the bar. Refrigerated vaccines, biologics and temperature sensitive supplies require monitoring equipment and records. Controlled substances require locked storage, counts and logs. A buyer reviews those records with care, because a gap in them is a compliance problem the new owner would inherit.

Receivables are the other half of working capital. Medical and dental customers usually pay on terms, and a buyer will look at the aging report to see who pays late and whether any large balance is unlikely to be collected.

Licenses, registrations and traceability

Distributors of these products hold licenses at the state level, and often at the federal level, and some hold separate registrations for controlled substances or for selling to pharmacies. Rules vary by state, and your attorney confirms what applies to your company. What a buyer needs to know is which license each location holds, whether it belongs to the company or to a named person, whether a change of ownership requires a notice or a new application, and how long that takes. A lender does not want a closing date that depends on a license that may take months.

Distributors are also expected to keep records that trace product from the source to the customer, and to have a written procedure for recalls and suspect product. Buyers ask for these procedures, the last several audit or inspection reports, and the results of any recall the company handled. A clean history there raises confidence. A history of corrections that were never closed out gives a buyer a reason to slow down.

If the company has a responsible person or designated representative named on a license, expect the buyer to ask what happens to the license if that person leaves.

What a buyer will ask for

The usual financial file applies, which means tax returns, monthly profit and loss statements, a balance sheet, and an add-back schedule. Our add-backs post explains how adjustments are judged. On top of that a buyer asks for a sales report by customer, product and rep, gross margin by manufacturer, inventory and receivables reports, the fleet and equipment list, the lease on the warehouse, and insurance including product liability and cargo coverage. They ask for the list of employees with pay and tenure, and for any union or temporary labor arrangements.

Delivery matters too. Many distributors run their own trucks and drivers, others use couriers. A buyer will look at driver records, vehicle titles and maintenance, and whether delivery costs are priced into what customers pay.

What has to transfer

The list is long. The supplier agreements, the licenses and registrations, the warehouse lease, vehicles, the customer contracts and group purchasing arrangements, the software that holds orders and lot tracking, the website and ordering portal, vendor credit accounts, and the people. The lease deserves attention early, because a warehouse built out for cold storage is not easy to replace. See the lease post for how landlords respond.

What tends to sink a sale

Deals in this trade fail when a major manufacturer declines to approve the new owner, when a license transfer takes longer than the financing allows, when the inventory count comes in well below the books, when a few rep-held accounts leave, or when the owner is the person every manufacturer calls. A late-found compliance problem in storage or records is another, and a buyer cannot price what nobody has looked at.

Getting the company ready

Read every supplier agreement and write down what each says about a change of ownership. Clean the inventory by marking or clearing short-dated and slow product and getting counts to match the books. Get reps under written agreements. Close out open corrections from inspections. Put the licenses, the named responsible persons and the renewal dates in one binder. Give a second person a seat in the manufacturer relationships so the owner is not the only voice.

At Business Advisors of America we start with a valuation from your own numbers, prepare the materials a buyer and lender will want, and screen buyers before they learn who you are. If you are considering selling a medical, dental or pharmaceutical distributor, a short call is a good first step.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.