5 Ways To Gain High Ground While Selling a Cannabis Company

By Sherrill Corbett and Jessica A. Morgan

Notwithstanding federal law, a sign of the maturing cannabis and CBD markets is the sharp rise in M&A activity to build scale and market share. Marijuana Business Daily notes that as of August 2019, 233 M&A transactions were completed in the U.S. compared to 185 at the same point in 2018.

Deals are moving fast, and it’s an exciting environment to be working in. Yet it’s wise to keep in mind just how young the legal recreational cannabis and CBD industry actually is. Every player, from the sole grow operation to the billion dollar front runner, is effectively operating within a startup environment.

In most aspects, M&A in the cannabis space is as simple or as complex as any other M&A transaction. There are areas in which a regulated company in the cannabis/CBD industry can expect to undergo closer scrutiny from a buyer and, from our experience other areas, in which sellers should be cautious.

Advanced preparation in the following five areas will help a seller enter into negotiations from a solid starting point.

1: Structure

The M&A structure (asset v. stock sale v. merger) will in part be driven by the nuances of its state regulatory scheme, i.e. different timing and approval requirements from regulators.

In this space where rules and interpretations change with little to no warning, making sure you have counsel that is up-to-date on requirements will save money and time and reduce the risk of the deal falling apart. Knowing the requirements in advance will form the basis of the structure of any transaction.

2: Competition

Buyers will want to examine all active contracts to evaluate whether third-party consents are required and the terms and conditions (including pricing) and its impact on post-closing operations and performance. Especially when a strategic buyer is involved, this disclosure must be handled carefully since the contracts can provide the buyer with insight into the seller's customer list and pricing.

It is important to work with your lawyers to maintain strict procedures and restrictions on when and to whom such highly confidential seller information is disclosed in the diligence process.

3: Buyer diligence

For a variety of reasons, sellers may be asked to take forms of consideration other than cash. In this scenario, it is imperative that the seller investigate the buyer. Buyer diligence includes reviewing all publicly accessible information, and also requesting non-public information – under NDA if necessary. Knowing the financial health and business prospects of the buyer will reduce post-sale surprises.

Other considerations that impact the value of the consideration are trading restrictions, limitations on buyer stock, and fluctuations in stock price.

4: Intellectual property

Trade secrets and licensing options help a cannabis business thrive and differentiate, so it’s no surprise that intellectual property often powers a cannabis company’s valuation.

Among the most prized assets of a cannabis business are its licensing agreements, both incoming and outgoing. Prior to entering into any sale conversation, sellers should organize a licensing portfolio in such a way that the buyer is clear on license terms, rights, and how the rights will transfer to a new owner.

To protect IP assets, it is common practice for owners to utilize NDAs and invention and assignment agreements with employees and independent contractors alike. An owner should be prepared to:

  •     Share who holds rights to inventions created or conceptualized by an employee of the company.
  •     Provide proof that such rights have been transferred to the seller.
  •     Share how or if the rights will transfer to a new owner.
  •     Indicate what will happen if that employee leaves the business.

5: Employees

Buyers want clarity around whether they are acquiring employees of the company, or if the business is highly reliant on independent contractors. Properly documenting, classifying, and satisfying payroll requirements should be a priority.

This often overlooked obligation in the startup world can negatively impact deal negotiations. Making sure this is properly handled from the start can save time and money in a transaction.

There are strong feelings about the rapid rise of consolidation and what that means for this young and dynamic industry. The pace of M&A in the cannabis sector is not going to slow any time soon, and overall there is great opportunity for cannabis business owners in Oregon.

On the sell side, a business that is prepared to be acquired can open negotiations from a stronger position, will be perceived as a less risky acquisition, and will ultimately navigate a smoother transaction process that has less chance of falling apart.

Tonkon Torp has guided many cannabis-based businesses through strategic buy and sell transactions. Contact Sherrill Corbett, Jessica A. Morgan or an attorney in our Cannabis Industry Group to learn more about how we can help your company grow.

Posted in
Filed under