May 16, 2022

Pitfalls of California Cannabis Business Sales

With nearly a dozen newly legalized state markets expected to activate sales over the next few years, total annual legal sales nationwide are projected to grow at a compound annual growth rate of 16% over the next five years, reaching $43 billion by 2025, according to New Frontier Data.

This projected growth has garnered significant interest from local, national, and even international investors who are anxious to join the ever expanding industry.

For many, this has led to the belief that purchasing a California cannabis business will provide quicker entry into the market. And yes, sometimes, that may be true.

However, as with anything related to cannabis, legal compliance is a significant obstacle to overcome when it comes to either buying or selling a cannabis business in California.

Here are the five most common pitfalls associated with both sides of these transactions.

  1. Difficulty Finalizing a Cannabis License Transfer

There are both legal and practical issues associated with the transfer of cannabis licenses that can quickly jeopardize both the sale and purchase of a cannabis business in California.

Here, cannabis business licenses are technically not “transferable,” which means the seller cannot simply transfer the business outright.

The purchase requires the current license holders to add the potential purchaser(s) to the license, where they will be required to undergo a significant vetting process by the Department of Cannabis Control (DCC), including a criminal background check and disclosure of financial information

If the existing cannabis business owners choose to remain on the license, they must require the potential buyer’s license to be approved by regulators as a condition of the sale.

When reviewing the existing license, buyers must understand that licenses are tied to a specific physical location. That means if the buyer wants to move the business, he, she, or they must go through the entire licensing process again for the new location, which may be subject to different, varying local regulations.

  1. State and Local Compliance Challenges

Sellers must have all licensing, compliance, and operating paperwork available for review.

Without it, they risk not being taken seriously by potential buyers. Or, worse, the deal falling apart at the last minute.

When purchasing an existing cannabis business in California, the buyer must clearly assess whether the owners hold permanent licenses at all levels required by state and local laws.

If the business is operating under a provisional license, the risks associated with a purchase are significantly higher.

They could include:

  • Regulators may not agree to issue a permanent license based on past compliance issues.
  • Significant post-purchase costs associated with the permanent license applications.
  • Environmental impact assessments required by the California Environmental Quality Act (CEQA).

When buyers are considering potential cannabis businesses, due diligence requires they explicitly include proof of licensing and operational compliance in the purchase agreement to limit the potential for future enforcement action, or even license revocation.

  1. Failing to Require or Obtain Proof of Financing

Like all businesses, a successful sale hinges on the buyer being able to afford the purchase.

Whether the buyer is paying cash, enlisting investors, or being financed for the purchase, all cannabis business owners must require proof of funds through audited financial reports before agreeing to any contract terms.

Beware of buyers willing to sign any paperwork without sufficient funds, then use the conditions of a potential business agreement to secure capital.

This allows the seller to avoid agreeing to a deal that will never close.

  1. Pricing the Cannabis Business Too High for Market Conditions

While demand for existing marijuana operations in California is increasingly high, it is crucial that sellers do not price their businesses too high for the current market conditions.

All sellers must commit to the due diligence necessary when analyzing the market and understanding where the demand lies.

If other cannabis operations in the area are selling for one time its gross revenue, it is not likely to sell yours for two times its gross revenue.

Likewise, if the seller’s tax records indicate poor compliance, or outstanding tax liabilities, sale-purchase agreements, liens, encumbrances, or litigation, purchasers can (and should) use this to negotiate a lower purchase price.

  1. Failing to Partner with the Right Cannabis Industry Professionals

Attempting to sell a California cannabis business on your own may seem like the best way to keep the profits from the transaction in your pocket. However, not having the proper legal professionals by your side can lead to a significant waste of time and resources, while introducing potential risks that cannot be reversed.

At Manzuri Law, our talented lawyers have Over 20 years of combined California cannabis and hemp industry experience to help accurately price your operation, facilitate the creation and signing of all legally binding documents, and verify proof of funds that will help vet potential buyers and close the deals.

Contact Our Trusted Cannabis Law Firm Attorneys in California at Manzuri Law for Help Today

Contact one of our California cannabis law firm specialists today by phone at (310) 912-2960 or online to protect your industry interests, no matter which side of the transaction you are on.