Buying a cannabis business does not occur in a matter of days, and transactions fall apart for a variety of reasons, as we discussed in Part 1 of this blog series focused on the buy-side of a cannabis M&A transaction. In Part 2, we focused on the regulatory environment, discussing concepts that first-time buyers and their attorneys should be aware of. In Part 3, we looked into things to consider when hiring your cannabis attorney. In Part 4, we discussed brokers – whether and how to use them to their best utility. Today, we discuss how to structure the transaction and why the transaction structure matters.
Acquisitions of cannabis businesses are typically structured as either a purchase of (1) assets or (2) equity interests (including a merger scenario), with an initial closing and a final closing. Due to potentially extensive known and unknown liabilities in the target company, asset purchases are the rule unless a cannabis license is not permitted to be assigned or assumed by a buyer, as is the case in California, where the purchase of equity interests is almost universally used.
The Pace of Proceeding to Closing
The highly regulated nature of the cannabis marketplace creates an often slow-moving environment for transactions, which first time buyers (or first time sellers) and their counsel may not expect. Depending on the state, a typical acquisition timeline may range from as few as two months to as many as 12 months after the buyer and seller are prepared to close the transaction.
An acquisition can close on the shorter end of the time range if the buyer already owns a license in the target market and is merely expanding its market presence by acquiring another license. Transactions that stretch to a year and beyond often involve one or more of the following:
- Significant undisclosed regulatory violations in the target company.
- A pattern of regulatory violations in the target company.
- A pattern of regulatory violations in the buyer company or its key personnel.
- The buyer’s inability to satisfy the state’s licensing requirements, including providing satisfactory proof of funds from legal or permitted sources.
Why Two Closings?
A cannabis transaction will also often have two closings for regulatory reasons. Although some parties may prefer to wait until the entire transaction has been approved by the state regulatory body to close a deal, most buyers and sellers are anxious to complete as much of the transaction as possible as soon as possible.
Where the closing of the acquisition will be split into two components, the first closing will occur after:
- Due diligence is completed.
- The transaction documents are fully negotiated and drafted.
- The buyer’s financing is arranged.
In the initial closing, the seller will transfer to the buyer as many of the seller’s business assets as permitted without regulatory approval, generally leaving only the license or the licensed entity to be transferred at the second closing.
The purpose of this structure is to provide the buyer all of the financial benefit and a significant level of the responsibility for operating the business from the initial closing. Once the second and final closing occurs, often months after the initial closing, the buyer obtains all the benefits and responsibilities of owning the acquired business retroactive to the date of the initial closing. This is all described in the transaction agreements, often requiring a spreadsheet to lay out monthly expenditures and expected revenue to be settled up at the second closing.
This uncertainty regarding the closing timeline, however, rarely slows down a motivated buyer and seller, and the industry players and their counsel routinely adapt transactions to fit the facts of a particular acquisition.
In the next post we’ll take a closer look at more items to consider when structuring the purchase.