We handle a lot of cannabis M & A in our Los Angeles, San Francisco, Seattle and Portland offices. Over the years, it’s become pretty clear that in robustly regulated cannabis states, the secondary market for buying and selling businesses really peaks (after initial legalization) as local and state governments finally begin to settle their local control entitlement processes, and once the state rules governing cannabis businesses are less volatile. In California specifically, our cannabis business attorneys have worked on a good amount of cannabis M & A deals since the implementation of the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”)– especially in Los Angeles, Long Beach, Santa Ana, Santa Barbara, San Diego, San Francisco, the Emerald Triangle, and Oakland.
Lately though, there’s been a massive uptick in our firm’s M & A practice for cannabis businesses in a multitude of states. Below is an outline as to why this is happening.
- Limited number of licensed businesses.
Securing a cannabis license in any state is no picnic. Setting aside the federal illegality of cannabis (which has its own business and legal risks), licensees not only have to deal with the shifting state regulatory landscape, but they must also constantly navigate local control from city to city and county to county. Licensees also have to meet numerous strict local and state requirements for their location, daily operations, finances, owners, financial interest holders, true parties of interest, and their employees. To further complicate things, certain states (mainly on the east coast) only allow a limited number of licenses for which applicants compete, and the expense of the application process in those states can force an applicant to expend six figures or more with no guarantee of licensure. Other states have become so saturated with applicants that they’ve suspended their licensing window indefinitely (see Oregon), or they only had a limited licensing window in the first place (see Washington). Even in California, where the barriers to licensing are very low on the state level, the majority of cities and counties still ban commercial cannabis activity.
All of these human, political and regulatory factors have had one practical effect on industry: The number of licensed cannabis entities existing today is very limited and will be slow to grow and expand in states with legalization. In turn, just by virtue of holding a license, your cannabis business holds inherent value to strategic and financial buyers.
- Survival plan.
Getting a cannabis license is a bit of a hollow victory because no matter how difficult the road to licensure has been, your entity now faces the far greater challenge of securing revenues and turning profits. Many licensees underestimate this side of the game, and they truly believe that cannabis will just sell itself with no tactical thinking or business effort. Oftentimes, due to poor planning or general lack of sophistication on the business side, cannabis partnerships break up and businesses run out of money. Sometimes, licensed businesses go belly up before operations really commence.
Some cannabis operators are happy (even eager) to abandon the business at this stage of great stress. Depending on the market, they may find buyers willing to pay hundreds of thousands or even millions for their newly-minted cannabis businesses that’s slowly becoming distressed (though it’s no secret that most cannabis business valuations are still squirrelly at best). On the other hand, other cannabis businesses in this situation will look around and find similarly-minded peers to potentially combine with them on a cash-free basis via a share swap, thus increasing their licensing portfolio and the likelihood of finding new finances and surviving the start-up stage– exponentially increasing their valuation.
- Growth plan.
After surviving the start-up phase, cannabis businesses should start evaluating themselves against their peers and competitors, thinking about ways to increase their market share. Here, businesses may begin thinking about acquiring a competitor or an entity that can add to a vertical integrated structure, improve the supply chain, add to the brand portfolio, ultimately expanding the geographical reach of the business and brand. Purchasing an operational entity will likely be cheaper than starting new operations and applying for a very hard-to-get license for those operations. Therefore, existing cannabis entities that actually sustain operations will likely be approached with an offer of an acquisition, a share swap, or some other offer of an acquisition or a combination transaction. In addition, in preparation for the larger corporate players entering the cannabis industry, some cannabis companies will choose to merge to make themselves a more attractive target for a liquidity or an exit event.
- Exit/liquidation plan.
The holy grail of most entrepreneurs is an “EXIT.” The basic formula is: Create it, build it, grow it, capitalize on it, rinse and repeat. It’s no different in the cannabis industry. Many cannabis businesses do not intend to compete in the marketplace or create a lasting legacy. Instead, the usual goal is to sell the business off to a larger corporate player. Some of these cannabis businesses are beginning to realize that vision after witnessing multi-million dollar acquisitions by Acreage and investments by Altria. As a result, many licensed cannabis businesses will likely go through some kind of M & A transaction in the next year or two. Because of the clear race to the bottom for cannabis on pricing, we have no doubt that bigger companies will quickly start to eat up distressed cannabis operators for better or worse (which is already happening in certain states).
In my upcoming blog posts, I’ll be detailing what buyers and sellers need to do and consider regarding deal mechanics for state and local licensing ownership changes, defaults, closing covenants, and indemnities and liabilities for successful M & A in cannabis.
For now, and for more on cannabis M & A, check out the following blog posts:
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