Licensed cannabis businesses are inherently valuable. In states like Washington, that have caps on the number of licenses that it will issue, the value is higher. But even in states like Oregon, with no restrictions on issuing new licenses, there is value in a business that has already gone through the state and local processes to obtain a marijuana business license. This is part of why the applicant field for cannabis business licenses has included so many players that weren’t ready to actually run the businesses as efficiently and smartly as possible. They knew there would be a way to cash out one way or another. And for private equity investors or other businesses looking to expand, these inefficiently run marijuana businesses are clear acquisition targets.
This is a long way of saying that it doesn’t look like the market for large investments and acquisitions is going away any time soon. In any large transaction, efficient due diligence from both sides is key to moving from initial negotiations to closing. The buyer has to be comfortable that the asset they are acquiring doesn’t have any skeletons in the closet that can tank its value. If you’re on the selling side, or you’re looking to raise money but retain some ownership, it’s incumbent on you to prepare as much as you can so that your business is more attractive to would-be buyers. And you don’t have to wait until a buyer or investor sends over a due diligence questionnaire. If you’re interested in going on the market, you should do some prep-work now so that the transaction will run more smoothly. The faster you can move from initial negotiation to closing, the lower the chance there is of something cropping up between the two that will derail the deal. Here are the big ticket diligence items that any would-be seller should have ready to send to the buyer to ensure the buyer’s peace of mind.:
- Proof of marijuana licensing/compliance. This cannot be in question. Sellers need to have at their immediate disposal a copy of their state business license, including the marijuana business license, any local licenses (like Seattle’s marijuana business license), and information on the next date of renewal and the status of any renewal applications. Additionally, a log of regulatory violations, compliance visits, or a certificate of good standing with the state licensing authority are useful.
- Cap table, proof of entity ownership, owner agreements. This is similar to title transfer on a car or transferring the deed of a house. It can be surprisingly challenging to ensure that the people who are reportedly selling a business entity are, in fact, its owners. States generally don’t require that the names of shareholders or non-managing LLC members be reported, so it is incumbent on the company to track that information through logs, certificates, and executing agreements. If a company has failed to keep that information up to date and organized, it needs to update and formalize it, including executing clean-up documents.
- Contracts and licensing agreements. When shareholders of a corporation or members of an LLC transfer their interest to a new buyer, the company is still subject to its prior obligations. Buyers want to know what those obligations are, whether they are term employment or consulting contracts, IP licensing agreements, or agreements with vendors and suppliers. Even more importantly, certain agreements have “change of ownership” provisions that allow the other party to the contract to either terminate the contract or even block the company sale. They all need to be cleared up front, and the company should maintain an up-to-date folder on these agreements so as to make doing that relatively easy.
- Books and records, debts, working capital. You are going to have a much easier time selling your company if you have up to date books and records that present an accurate financial picture of your company. Buyers need to know up front what debt payment obligations and lines of credit the selling company has as well as how much money the company has in the bank and needs in the bank to pay its ongoing operational costs. This is hard to come up with on the fly, so the best preparation is to always keep your books and records up to date so that you can provide the information to the buyer with a few clicks.
- Litigation and potential claims. If the selling company is being sued or has reason to suspect it is about to be sued, it should be ready to hand that information over to the potential seller up front. It may be painful, but the information is going to come out one way or another, and the selling company doesn’t want to appear to be hiding information that the buyer is going to discover anyway. Sellers maintain control by releasing the information up front on their terms, including explaining the circumstances and risks of the claims.
Preparation for an acquisition or big investment on the seller side is vital for two main reasons. First, the preparation makes the company a more attractive target for investment or acquisition. Buyers feel a thousand times more confident when they feel like they are getting the full picture of a company. Second, and just as important, it protects the original owners and officers of the company from future litigation. If you sell a company subject to a bunch of debt and a bunch of potential litigation claims, the buyer can come back after you for fraud. If you sell shares but it turns out the shareholders don’t have marketable title, you can face huge litigation risks. The due diligence required by buyers will vary from deal to deal, but sellers have an obligation not to withhold information, especially if they have implied the opposite to the buyers. If you prepare properly, however, you will have a much better shot at walking away with both more money and more confidence that the deal won’t come back to bite you.