Part 5: Due Diligence
In the series “Marketing a Cannabis Company for Sale,” Dena Jalbert, walks through the nuances and intricacies involved in preparing a business for sale in the cannabis industry. This article, “Part 5: Due Diligence,” is part five of a five-part series.
Completing the first four phases of marketing your cannabis company for sale including mapping out your strategy, assembling a strong mergers and acquisitions team, identifying profitability and financial trends and confirming deal terms means you are now ready for the due diligence phase of M&A.
In general, the due diligence process involves your potential buyer investigating, evaluating and assessing your cannabis company in as much detail as possible prior to completing a deal. This process examines whether or not the “marriage” of the two companies is a good fit, and ultimately impacts the success or failure of any deal.
Due diligence represents a significant portion of the estimated 1,000 hours of work that goes into selling a company and usually starts six months after your first meeting with a potential buyer. Be prepared for this process to last anywhere from 30 days to, in some complex cases, more than 90 days.
Sellers should do their own due diligence
Most people usually think of due diligence in terms of a buyer’s analysis of a target company. However, as a seller, it is a good practice to do your own due diligence on a potential buyer. If your buyer is not a public company, you won’t have access to their financials, but you should certainly request them so that you can understand the financial health of the acquiring business. You should also be sure that your buyer is clear about their intent. If they won’t share that information with you or if they can’t take you through the details of their growth plans for your cannabis company, this is a red flag signaling you should walk away from the deal.
It is particularly important to vet your buyer and all the details of the proposed deal because, in the cannabis industry, 90% of leadership stays on after the sale closes. You should be sure to ask questions about your role, autonomy in business, and strategic plans for the business so that you can feel comfortable in this marriage of companies.
Additionally, make sure you review documentation that describes how the business would run after the sale. If you’re being given equity in a company now as an employee or as a member of the leadership team, you need to know: What’s the potential value of that in the future? Is this worth what they’re saying?
Nuances of due diligence in the cannabis industry
Due diligence in the cannabis industry can be very complex, and you should be prepared to see your business put under a microscope by a buyer seeking to understand every aspect of how your cannabis business works. Some of the nuanced areas of cannabis company due diligence that, as a seller, you should pay particular attention to include taxation, licensing and people.
- Taxation – It’s important for you to have your financial records in order to prepare for due diligence. Taxation in the cannabis industry is intricate. There are federal and state rules and complexities around what you can deduct as well as complexities around payroll taxes. Your cannabis company, like all companies in the industry, is taxed heavily and it is not uncommon to run into tax issues that should be handled by accounting professionals well-versed in the industry. Make sure that you and/or your accountant can answer the following questions related to taxation: Has your company filed accurate tax returns? Has your company paid all of its local, state and federal taxes? Is your company at risk for an IRS audit? Could there be a large tax liability?
Many M&A transactions in the cannabis industry are stock transactions, which means tax liabilities can be carried forward to the buyer after the deal closes. You and your accountant should review your company’s tax returns and financial information to ensure that you don’t have any tax liabilities that could be a deal-breaker for your potential buyer.
- Licensing – Licensing is another issue that your buyer will scrutinize as part of the due diligence process. Your buyer will want to know what stage your license is in and whether it is a provisional license. Some states issue temporary permits for cannabis businesses that are valid until the licensee demonstrates that it is viable and operational, at which time the state will issue a more permanent license. Your buyer may not want to close a transaction until they know that the temporary license is a permanent permit, or they may want to insert a provision in the agreement indicating that a specified amount of funds will be escrowed until the temporary permit becomes a final license to do business.
In preparation for due diligence, you should make sure you have all the required state and local permits your company needs to operate and are compliant with all state and local regulations.
- People – As part of your due diligence on a potential buyer you should look at their integration plan. If you’ve got an aggressive, forward-thinking, dynamic small business team that will be folded into a conservatively structured, bureaucratic, larger organization post sale, that’s not going work. You will want to be sure that both your team and the buyer’s team are compatible and everyone is committed to the longevity and future growth of the business.
People are a key asset in the nascent cannabis industry because there is very little institutional knowledge available. Experience is in short supply, and as a seller, you should be highlighting your team and their expertise as an asset during the due diligence phase. Buyers will want to keep key people and may even make retaining this talent as a requirement to deal closure.
In marketing your cannabis business for sale, you can successfully navigate the intensive due diligence phase of M&A with preparation. Advance planning of your responses to diligence questions on everything from licensing to taxation to people to financial, legal and market issues can go a long way toward maintaining deal momentum and getting your company sold.
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