Five Tips for Cannabis Companies Thinking of Selling

Guest submission By David Lechner and Charles S. Alovisetti

Legal cannabis sector fundamentals have strengthened in recent months thanks to new markets coming online and rising sales in existing markets. As a result, there has been a wealth of M&A activity lately, as existing operators increase their pace of acquisitions and new investors flock to the industry, buoyed by these investment opportunities. This has led to smaller operators selling their businesses to the larger players who are looking to consolidate or enter the market or both. This can be a smart move if properly executed, but there are also plenty of ways in which it can go awry.

Here are five crucial tips for operators thinking about selling their businesses in the coming years. This is the first part of a two-part series. In part two, we will provide five additional tips focused on the regulatory issues cannabis companies need to understand.

1. Be on the ‘up and up’. Because of some of the negative perceptions related to the legal cannabis sector, it is of utmost importance that you have been operating your business according to state law. Skeletons in the closet will come back to haunt you, leading to buyers completely walking away or at the very least, a big discount on valuation. If you’re out of compliance, get back into compliance before going on the market.

2. Cheap advisors are costly. Good bankers, lawyers, and accountants are worth it. These are the players you’re putting on the field, and you are only as strong as the weakest link. Do you need the most expensive player at every position? No, but if you hire a lesser-known accounting firm for your audit, for example, it could reduce the buyer’s perceived value of your business.

3. Get your house in order before engaging. Often small companies aren’t ready to go through a full transaction lifecycle when they engage with potential buyers. They may have gotten an inbound offer out of the blue that they want to move forward on. But they stumble when it comes time to proceed into diligence and detailed discussions. The first order of business should be to get audited financials from a real accounting firm. Ideally three years, minimum two. This is particularly important if you want to be acquired by a public company (as many licensed businesses in Colorado are currently contemplating). If a public company makes an acquisition that is considered significant according to the Securities Exchange Commission, then the acquiring company needs to file target and pro forma financial statements within 75 days of closing – this will prove an issue if the target (i.e., you) doesn’t have audited financials in place.

4. Time kills deals. You want to minimize your time in the market and in the diligence phase. Get your house in order and set up a data room that contains all the documents that buyers will want to review (IP, technology, financials, etc.). Have someone with M&A experience (e.g. a current or former investment banker), run you through diligence – it’s better if you know where your skeletons are buried now before buyers discover them. If you need to halt a process for three months waiting for a key item to be resolved, or to find some important document, buyers will lose interest. And then there are exogenous events that can spook the markets (e.g., trade wars), the longer your process hangs out there, the greater the risk it goes sideways and falls apart.

5. Be realistic with valuation. Simply because Company X sold for a certain multiple, it doesn’t mean that yours is worth the same. Valuation is driven by fundamentals – size (revenue), diversification (different geographies, diverse set of customers and product lines), and financial performance (historical performance, ‘cleanliness’ of financials, profitability, future growth). A company with $1b of revenue will have a higher multiple (e.g. price to sales) than one with just $50m of revenue. Similarly, a public company’s multiple will be higher than that for a private company due to these factors and as a private operator, you’ll need to temper your expectations.

David Lechner is a Chief Financial Officer with $25 billion of M&A and capital markets work. He consults with clients on due diligence, acquisitions, integrations, financial reporting, and operational improvements. Originally from Toronto, he now resides in Denver with his family.

Charles Alovisetti is a partner and chair of the corporate practice group at Vicente Sederberg LLP, a national law firm focused exclusively on the cannabis industry. He assists licensed and ancillary cannabis businesses with corporate legal matters, and he has experience working with clients on a broad range of transactions.

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