Five More Tips for Cannabis Companies Thinking About Selling

By David Lechner and Charles S. Alovisetti
Selling a business can be a complicated and life-changing event. The stakes can be even higher when doing deals in the nascent legal cannabis industry.

Last week, we offered our first five tips for cannabis operators who are thinking of selling their businesses. Here are five additional tips, including some that touch on important regulatory issues. Please keep in mind these are just ten of the many considerations you will need to take into account. Selling a cannabis business can be rewarding, but it is a challenging process, so make sure you are prepared.

1. Know your (buyers’) limits. The kind of cannabis business you own, and the state and locality in which you are located, will influence the universe of potential buyers of your business. In Colorado, for example, a public company cannot currently own a licensed business. There is a new law that could change this rule working its way through the legislature that would go into effect on November 1, 2019. This kind of regulatory change can have dramatic effects on valuations and exit opportunities – markets that do not permit direct investments from MSOs (such as Colorado and Washington State) have seen dramatically different M&A landscapes from those where publicly traded companies can own licenses. The recently announced transactions between Cresco Labs and Origin House (USD $820 million) and between Harvest and Verano (USD $850 million), show the drastic differences in scale between MSO driven M&A (largely driven by their ability to use their public stock as currency) and the intrastate deals.

For ancillary businesses, the analysis is much easier. The only real restriction for buyers is their comfort level with violating federal law. To be sure, this does narrow the number of potential buyers, but there are more companies willing to acquire an ancillary business than companies that are open to buying a licensed entity.

2. Are we there yet? If you hold cannabis licenses, any sale of your business will likely require regulatory approval, meaning that you will not be able to simply sign and close a deal at the same time. There will need to be period between signing and closing where you obtain any required approvals. The specifics of this analysis will depend on the states and localities in question. In addition, for a multi-state operation, regulatory approval can be a very complicated matter and should be analyzed prior to starting any sale process. However, if timing is critical for a deal, there are ways to structure a transaction to speed things up. For example, it’s often possible to purchase a non-licensed IP holding company of a cannabis business without regulatory approval. And IP licensing deals, depending on the details and state in question, can often be put in place without pre-approval. Again, understanding the regulatory environment is critical for pulling together cannabis deals.

3. Are you exposed? Selling a cannabis business does not mean that you are free and clear of all obligations. If your business is subject to pass-through taxation (as is common for many cannabis businesses set up as LLCs) tax obligations, notably 280E, fall directly on the owners. That means you cannot just sell your business and walk away assuming you are free and clear of all obligations (except for representations made to your acquirers). The IRS could audit the business and come back to you with a significant tax bill down the line – plan accordingly.

4. Show me the money…or not. When shopping a cannabis company, it is important to understand that acquisition financing is almost non-existent in the cannabis industry. That means it is far more common to see alternative ways of financing deals – seller notes and all-stock acquisitions. So be prepared to get offers that only provide for a small amount of cash at closing.

5. Look out over the horizon. 
Cannabis business owners need to pay attention to the legislative process as new bills pass every session that impact cannabis M&A. In addition to the example of Colorado mentioned above, Maryland is another state where a business trying to ink a cannabis deal needs to be aware of recent changes. A new bill, SB 426, which takes effect on July 1, limits the number of cannabis licenses a person can own or control (as opposed to the existing law which only expressly prohibited the number of licenses the state could issue to a person). This law means several the highly acquisitive MSOs will not be able to purchase additional businesses or, in the typical workaround, set up management agreements with those businesses.

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