Online Pharmacies: Another Avenue to Monetize the Internet, but Buyer Beware

December 18, 2018

Recent months have seen a rise in investors interested in acquiring physical, compounding and online pharmacies, as well as other traditional healthcare providers offering in-house pharmacy services to patients. The pharmacy sector has always proven a prominent area for investment due to the scalability of the business model and access to reimbursement from federal and commercial healthcare programs. As the internet has become monetized and the healthcare industry increasingly moves toward efficient delivery of products and services to patients, it is only natural for pharmacies to grow an online presence.

The online pharmacy sector has grown substantially in recent years, with large brick-and-mortar pharmacies offering drugs direct to the consumer via an online presence, with unconventional internet economy conglomerates making acquisitions to enter the online pharmacy space, and hyper-specialized pharmacies, such as Roman, offering a specific subsector of prescription drugs to a targeted patient population. A number of factors are contributing to interest in online pharmacies, including, most apparently, the following:

  1. Estimates indicating that the online pharmacy market could exceed $200 billion by 2024 — up from $45 billion in 2017 — and growing at almost 18 percent compounded annually
  2. Consumers’ increasing interest and trust in and reliance on obtaining prescription and nonprescription drugs over the internet
  3. Consumers’ ease of access to transparent pricing of drugs

While these factors — and numerous others — will continue to drive exponential growth in the online pharmacy sector, future investors should remain cognizant of the regulatory and legal risks associated with investing in or acquiring any company in the drug distribution space, but particularly in the online pharmacy sector. The following issues could arise during such an acquisition:

1. Change of Ownership of Pharmacy Licenses. Every state requires a pharmacy — either physical or online — to hold some sort of pharmacy license prior to dispensing prescription drugs to patients in the state. It is important to consider whether a target pharmacy is appropriately licensed to conduct business in each state in which it is operating. While every state regulatory body treats its licenses uniquely, it is safe to assume that state pharmacy boards prohibit the transfer of pharmacy licenses. Since licenses are one of the most vital assets to the continuity of a pharmacy business, a potential investor must consider how the structure of a transaction could impact the target’s pharmacy licenses after closing. Regardless of whether the transaction is structured as an asset deal, stock deal or merger, the target pharmacy will be required to submit a pre-closing or post-closing regulatory filing.

Typically, the different requirements can be divided into several buckets, including: (1) states that require a target pharmacy to submit a new license application prior to closing and obtain a new license by the closing date; (2) states that require the target pharmacy to submit either a notice letter or a new license application prior to closing, but do not require a new license to be issued by closing; and (3) states that require a target pharmacy to submit either a notice letter or a new license application within a set time period following the closing.

Regardless of transaction structure, a comprehensive analysis of the target’s pharmacy licenses must be conducted, and a detailed regulatory filing plan put into place to ensure that the target pharmacy may continue operating post-closing without a gap in state licensure.

2. Federal and State Board of Pharmacy Oversight. Numerous federal and state regulatory agencies oversee drug distribution, including the U.S. Food and Drug Administration (FDA), the Drug Enforcement Agency, state boards of pharmacy and, potentially, the state departments of health. While the governing responsibilities of these agencies overlap in many ways, potential investors should understand that each agency separately and individually can conduct regulatory investigations, audits and site visits of pharmacies, any one of which can increase the risk rating of a potential target pharmacy. As with any investment in the healthcare space, investors should strategically pressure test and review the regulatory issues before moving forward.

3. Increased Scrutiny by FDA. Due to the sector’s growth and consumers’ easy access to dangerous drugs via the internet, the FDA continues to scrutinize and monitor online pharmacies to ferret out those that illegally sell prescription drugs, unapproved and counterfeit drugs, and controlled substances. This increased scrutiny most likely reflects the government’s need to address the opioid addiction crisis in the United States and the objectives of the Drug Supply Chain Security Act, aimed at protecting consumers from exposure to counterfeit, stolen, contaminated or otherwise harmful drugs.

Most recently, FDA, in partnership with domestic and international regulatory and law enforcement agencies, issued warning letters on Oct. 23, 2018, to seven pharmacy networks operating a total of 465 websites that offered misbranded and unapproved drugs to consumers. While in this recent operation FDA focused on pharmacies operating illegally and introducing potentially dangerous and counterfeit drugs into the marketplace, the online pharmacy sector essentially has been put on notice that the FDA is actively monitoring the ease with which consumers can access controlled substances and dangerous prescription drugs online.

4. HIPAA and PCI Compliance. In general, all companies should be cognizant of their privacy and security regulatory obligations. By processing patient prescriptions and collecting credit card payments via the online checkout process, online pharmacies have increased regulatory obligations due to obtaining protected health information (PHI) and personally identifiable information from consumers. Potential investors should be aware that the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and the Payment Card Industry (PCI) Data Security Standard separately govern how an online pharmacy is permitted to conduct its business. Each sets out specific regulatory requirements governing the privacy and security of PHI and the acceptance of credit card payments.

5. Pharmacy Practice Compliance. Online pharmacies typically serve patients on a 50-state basis, so potential investors should ensure that the target pharmacy is in compliance with all applicable pharmacy practice requirements of the target’s home state as well as any non-resident state in which it is operating. Some key pharmacy practice compliance requirements include state pharmacist-in-charge (PIC) licensing, pharmacist-technician supervision, prescription labeling, and counseling requirements.

While every state requires a pharmacy to have a PIC licensed in his or her home state as a prerequisite to pharmacy licensure, a handful of states require the PIC to maintain an active pharmacist license in the nonresident state as well. A potential investor interested in an online pharmacy operating in all 50 states, for example, should ensure that the PIC has all required nonresident pharmacist licenses, which typically means the pharmacist passed a pharmacy jurisprudence exam in each state. To further mitigate any business risk related to the PIC, online pharmacies often employ a second pharmacist who maintains the necessary multistate licensure and could step into the PIC role if needed.

Additionally, online pharmacies will need to ensure they are satisfying state-specific pharmacist supervision requirements by having written policies that include minimum pharmacist-to-technician ratios. Pharmacies also should ensure that their prescription labels and counseling procedures are acceptable in each state where they do business.Each of these issues merits consideration by a potential investor before committing to an acquisition in the pharmacy sector.