Buyer Beware: Five Key Due Diligence Items When Buying a Cannabis Business

Our cannabis business attorneys regularly handle transactions involving the purchase and sale of licensed cannabis businesses. These deals often move fast, with brokers rushing both sides toward closing—frequently without regard for applicable diligence and cannabis regulations. The worst-case scenario is when a company comes to us after executing a seller drafted purchase agreement without having done any due diligence on the purchase. Buyer due diligence is not a luxury—knowing exactly what assets and liabilities you will be acquiring is essential.

While we can’t cover everything in this blog post, below are vie key due diligence items you must understand to help protect yourself and your investment.

1. State and local law and compliance

This is the number one priority. Laws and compliance obligations for cannabis businesses can vary widely by state, county, and city. As with any business, but especially a cannabis business, it is essential to know the state and local licensing/permitting requirements for acquiring, operating, and locating a license. As we have seen many times over the years, buyers sometime discover too late that:

• • The buyer, or a member/shareholder of buyer, is not qualified under state law to hold a license;
  • Local zoning laws will not permit the buyer to locate a cannabis business at their desired location;
  • The license is only pending and has not actually been issued;
  • The cannabis business is facing license revocation for rule violations (in some states violations won’t transfer to the newly acquired license holder, but in others it will); or
  • The local law has recently changed and the business must re-locate to continue operating.

Before buying a cannabis business, at a minimum, you should confirm that:

• • The buyer, or buyers members/shareholders are legally permitted to hold a cannabis license;
  • The business is in good standing with the Secretary of State and any other applicable authority;
  • The cannabis license and related permits are valid; and
  • There is no troubling enforcement history or active disciplinary action.

Failing to verify these items could leave you owning a cannabis business that can’t legally operate.

2. Procedures and restrictions for ownership changes

Cannabis businesses are heavily regulated and there are usually onerous regulatory procedures in place for changes in ownership. Generally, sellers must disclose the buyer (including, buyer’s members, officers, shareholders, etc.), and those individuals must be vetted and approved by regulators. Sometimes these regulatory approvals must occur before a license can be transferred.  This can often take weeks or even months, which is why understanding this timeline is important. Closing a transaction before the license transfer is approved could lead to buyer paying for a license it won’t receive. To prevent such a situation buyers should, at a minimum:

• • Include contingencies tied to regulatory approval—this doesn’t just apply to closing dates;
  • Ensure deposits and earnest money are refundable if approval is denied or delayed; and
  • Build in timelines that account for regulator review periods.

Never rely solely on what a broker or seller says—always confirm the process with your cannabis attorney.

3. Corporate authority

 Disputes over ownership and authority are all too common in this industry, often due to outdated or nonexistent governing corporate documents. We often see buyers who enter into purchase agreements based on nothing more than the word form a single member/shareholder in a multi-owner entity. Generally, the sale of a multi-owner business will require more than just one member/shareholder to approve of the sale. To ensure the sale is authorized by the seller—for both asset and equity sales—buyer must review the corporate records, including, at a minimum, the businesses’:

• • Bylaws or operating agreement;
  • Subscription, Joinder, and/or shareholder agreements;
  • Any contracts affecting equity or control; and
  • Any amendments to the aforementioned documents

It is not enough to accept only what is given to you. You must also receive written confirmation from seller in the purchase agreement that the documents provided are current, valid, and everything that exists. By reviewing these document a buyer will better understand (among other important things):

• • Who within the business must approve of the sale;
  • What steps must be taken for the sale to comply with the corporate documents; and
  • Who within the business has the authority to sign the purchase agreement on behalf of the business.

Ignoring seller’s corporate governance can lead to a legally defective transaction—one that other owners of seller may challenge or refuse to honor.

4. Real property

When buying a business, buyers sometimes overlook the real estate—whether owned or leased—that will be acquired in the transaction. As part of diligence, buyers should request a full list of all real property interests, to understand, at a minimum whether the:

• • Business is locked into a long-term lease;
  • Lease allows for the lessee to transfer or sell its business during the term without prior approval from the landlord;
  • Lease complies with state and local cannabis laws.

If a buyer’s goal is to relocate the business, the lease terms could prevent that—or impose serious penalties. Boilerplate leases often don’t meet cannabis compliance standards, so a careful review is critical.

5. Financial liabilities

 Cannabis businesses, particularly those that started informally, often lack proper documentation. This makes it crucial to vet the company’s financial obligations thoroughly—especially if you’re buying the company itself, not just its assets. Require the seller to disclose all contracts and agreements—written or oral—and include strong representations and warranties in the purchase agreement. This helps ensure:

• • You’re aware of all debts and obligations;
  • Any undisclosed liabilities remain the seller’s responsibility.

Even the best-drafted purchase agreement can’t uncover every risk. Ensuring you conduct diligence on the five topics discussed above will help but will still likely miss important information. That is why involving a knowledgeable cannabis attorney early in the process can save you significant time, money, and heartache in the long-run.