Five Common Problems in California Cannabis M&A Transactions

Now that we’re about two years into California cannabis licensing, our California cannabis attorneys are seeing a huge uptick in mergers and acquisitions in the cannabis space. It’s critical for potential M&A transactions to understand California cannabis laws and regulations and ensure that any M&A contracts are drafted with the regulations in mind. This is especially so for buyers who will have to live with the mistakes of the seller and any defects in the M&A contracts—some of which can be fatal to a cannabis license. For buyers especially, it is very easy to overlook key regulatory requirements in a complex M&A transaction and jeopardize a target business’ license. In this post, I’ll go over some of the biggest problems that our California cannabis attorneys routinely see with M&A transactions.

1. Not Considering the Regulations

The biggest M&A mistake that our California cannabis attorneys see, hands down, is not considering the California cannabis regulations and their requirements from day one. Parties routinely come to an agreement on the commercial terms of a deal, and in some cases even draft contracts without considering the impact of the regulations. We cannot underscore how problematic this can be. Failure to consider the rules from day one may require the parties to re-draft a 60-page contract on the eve of signing—or worse, after signing—because they forgot to address regulations that might result in the loss of a license. Especially for a buyer, who is left holding the bag for any regulatory problems caused by the seller, this can be disastrous.

2. Licenses Cannot be Sold

California cannabis law is very clear that licenses may not be sold or transferred in any way. Nevertheless, our California cannabis attorneys have seen transactions where parties have attempted to sell licenses, which would result in the automatic termination of the license. Most of the time, however, the issues we see are subtler. For example, it’s generally common in M&A for the buyer to offer something as security if the buyer is not paying the full purchase price up front. But because licenses cannot be transferred, they should not be pledged or offered as security. That too could result in loss of the license.

3.  Acquisitions of a Parent Company Can Still Trigger Owner Disclosures

Many cannabis businesses in California are owned by holding companies. Some of them even have three or four levels of corporate ownership before getting to the parent company. Most cannabis deals involve acquiring a parent (which almost always is not licensed), as opposed to the subsidiary licensee. Even though that parent isn’t licensed, the parties to the transaction must still comply with California cannabis regulations. Even in these deals, the buyer must consider that it will still be considered an owner. At least one California cannabis agency explicitly requires identification of equity and non-equity “owners” all the way up the chain to the parent company—no matter how far removed—and has the discretion to require those persons to make full owner disclosures. Failure to consider the requirements of ownership and disclosure timetables could be disastrous for the buyer who will have to scramble to make tight 10–14 day disclosures to the state and who may have missed the local-level pre-closing disclosure requirements.

4. Complete Changes of Ownership at Once are Forbidden

The California cannabis agencies (and most local jurisdictions) do not allow businesses to be sold or transferred entirely at one time. The Bureau of Cannabis Control, for example, requires that at least one original owner remain on the license while the incoming owners are evaluated. In the event of an M&A transaction that results in a complete change of ownership at once, the business could lose its license. Because of this, our California cannabis attorneys have seen a surge in phased deals where only portions of a business are transferred to the buyer at one time. This is probably the biggest area where failure to consider regulations at the outset could result in a lost license.

5. Foreign Buyers Have Even More Potential Problems

Over the last year, we’ve seen more and more foreign companies seeking to invest in any even acquire California cannabis companies. Notwithstanding legal ramifications in the purchaser’s home country (cannabis is still illegal in most countries), there are major impacts in U.S. laws for foreign purchasers. For example, owners of California cannabis businesses must have Social Security numbers (“SSNs”) or Individual Taxpayer Identification (“ITINs”), which foreign purchasers don’t have. ITINs can take months to obtain, so not having one prior to closing can interfere with regulatory disclosures. There are also immigration concerns for cannabis industry participants (see here, here, and here), so a new owner coming to the United States to close a transaction or obtain their required live scan could be barred from entry.  Failure to consider these issues from the outset could obviously result in tremendous problems for foreign investors who could be barred from entry into the US and may jeopardize a license if they can’t make timely disclosures.