June 18, 2019

The Art of Selling a Cannabis Business

“By failing to prepare, you are preparing to fail.” 

  • Benjamin Franklin

Selling a licensed cannabis business is by no means a simple feat – it’s a science and an art.  Due to the industry’s legal and regulatory baggage, the process of selling a cannabis business can be difficult and challenging, so preparation is critical.

If you’re interested in putting your cannabis business on the market, you would be well-advised to conduct a thorough evaluation of your business and the regulatory issues that will likely arise from the sale.  Because of the maze-like regulations on both the state and local level, creative structuring will likely be required in order to ensure a smooth transfer of control of the company. By doing some prep-work now, the sale process will become much more manageable and time-efficient.  And as a general rule of thumb — the faster you can move from initial negotiations to closing, the lower chance the deal will go sideways and fall apart.

In this article, I will explore the top 3 things you should take into account when preparing your business for sale.  Please keep in mind that this list is not exhaustive – these are just 3 of the many considerations you will need to take into account.

1. Get your house in order – conduct due diligence on your business before the buyer does. 

A serious buyer is always going to undertake substantial due diligence before buying a business.   Although the due diligence process can be overwhelming and time consuming — especially for sellers —  conducting your own due diligence before the buyer does will make the process more efficient and result in less transaction costs.    Additionally, when done right, due diligence allows the seller to identify any potential or hidden liabilities and remedy them beforehand to the greatest extent possible, thus enhancing the business’s value prior to negotiations.   If there are skeletons buried in your closet, it’s best to find them now and deal with them first before the buyer discovers them.

The nature and form of the due diligence process will vary depending upon the transaction structure deployed by the parties (i.e., whether the transaction involves an asset or stock sale).  In general though, the most common categories of due diligence include the following:

  • Organizational information and proof of entity ownership – formation or incorporation documents; bylaws or operating agreements; ownership agreements; up-to-date board minutes and cap tables; ledgers; equity certificates; certificates of good standing
  • Financial records – books and records; debts; working capital; balance sheets; income statements; monthly, quarterly and annual reports; audit reports; tax returns
  • Material contracts – past acquisition agreements; management agreements; customer contracts; distribution and supply agreements; loan and other financing agreements; insurance policies; employment contracts and consulting agreements; marketing and advertising agreements; property leases; equipment leases; union contracts and collective bargaining agreements; exclusivity agreements; settlement agreements
  • Regulatory matters and litigation – proof of state and local licensure; application submissions to state or local licensing authorities; copies of pleadings in pending litigation; copies of threatened litigation or notices of violation of any laws or regulations
  • Employment and labor matters – information regarding executives, managers, employees, wages, benefit plans, bonus compensation, vacation, sick time, and any benefits and policies
  • Real property – notes or deeds of trust; property leases; owned or leased equipment; owned or leased vehicles
  • Intellectual property – documentation supporting any copyrights, trademarks, trade names, or patents owned by the selling company or any of its key employees; IP licensing agreements

By preparing the above items beforehand, and properly anticipating and/or remedying any related issues that may arise, you will be better prepared to successfully consummate a sale of your company.   Not only will the sale process go more quickly and smoothly, your good corporate housekeeping will earn the respect of the buyer, thus minimizing the likelihood that a buyer will devalue your business.

2. Identify any regulatory roadblocks.

Any sale of a cannabis business will likely require state and local regulatory approval, meaning the closing of a deal will not happen overnight.  There will need to be a period between signing a purchase agreement and closing the deal where the parties obtain any required approvals from state and local licensing authorities, which will likely include the buyer submitting required LiveScans.

In California, the specifics of how to obtain required local approvals for a new “owner” will depend on the locality in question   Some localities are more strict than others when it comes to selling or assigning a cannabis license, so obtaining regulatory approval can be a very complicated matter.  For example, in West Hollywood, the city’s Municipal Code states that any sale or assignment of a cannabis license (or an attempt to sell or assign a cannabis license) renders the license null and void.   Because West Hollywood’s licensing system was merit-based, the city awarded a limited number of licenses to those businesses that would be operated and/or owned by certain individuals who the city deemed worthy enough.  Therefore, any proposed transfer of ownership to an untested newcomer who was not listed on the initial application would be an uphill battle that would require creative structuring plus the city’s approval.

The City of Los Angeles is another good example.  In L.A., depending on what type of license you are selling, there is a possibility that one or more individuals from the seller’s side will have to stay on the license in an ownership capacity until the company obtains its annual license.  Moreover, if there is a Tier 1 or Tier 2 Social Equity partner involved, any proposed sale or transfer would have to comply with the city’s Social Equity Share rules and be approved by the Los Angeles Department of Cannabis Regulation.

Long story short — gaining an intimate understanding of the state and local regulatory environment is critical for closing a cannabis deal.

3. Be realistic about valuation.  

Our office is often asked this question by clients: How much is my cannabis license worth?

This is a difficult question to answer because valuation is driven by so many fundamentals and every situation is unique.  Simply because another company sold for a certain price, it doesn’t mean that yours is worth the same. Valuations can fluctuate greatly depending on the following key factors:

  • The type of license and the number of those license types available in that locality
  • Ease of transfer of the license from the seller to the buyer
  • Financial performance (revenue, cash flow, profitability, future growth)
  • Company assets (property, leases, equipment)
  • Size and location of the business
  • How well the company has maintained business and financial records
  • Experience of the management team
  • Brand/IP ownership
  • Potential claims or litigation
  • Tax liabilities

There is no one answer to how much a cannabis license is worth.  Valuing a cannabis business can only be done on a case-by-case basis.  At the end of the day, however, the value of your business is only as much as a buyer is willing to pay.

While selling a business in an industry as new as cannabis can be immensely rewarding, it is a complex and difficult undertaking.  This makes it all the more essential to consult with legal and financial specialists with cannabis experience to assist you with the process.  If you’re thinking about potentially selling your licensed business, feel free to contact us to set up a consultation for expert advice.

Disclaimer: This article has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice.