Late last year, full-service law firm Cozen O’Connor advised multi-state cannabis operator Acreage Holdings in its $160-million all-stock acquisition of Form Factory, an Oregon-based cannabis manufacturer, co-packer and distributor.
As consolidation continues across the cannabis industry, these multi-million-dollar deals are becoming more common, and companies considering undertaking an acquisition of this magnitude will need to be prepared to negotiate their terms.
Here, Joseph C. Bedwick, attorney and co-chair of Cozen’s cannabis industry team, outlines the basics of structuring a multi-million-dollar cannabis deal, from deeply understanding the target and the regulations under which it operates to minimizing the tax burden on the transaction.
1. Understand the regulations in the state(s) where the target operates.
Cannabis’s federally illegal status and state-by-state regulations make for an interesting—and oftentimes challenging—acquisition landscape, Bedwick says. Buyers should understand regulations on a state-by-state level where targets operate.
“If you’re acquiring a company—be it a company that operates in one state or a company that operates in multiple states—it is imperative to understand the regulations that govern cannabis in the state(s) that the target operates,” Bedwick says. “That’s important from a number of perspectives.”
In most cannabis M&A deals, the buyer is acquiring a company that holds a cannabis license, and the state’s regulatory body must consent to the license changing hands.
“In structuring considerations in an M&A transaction, one of the most important considerations after you sign a deal is how quickly you can close the deal,” Bedwick says. “If a change of control of a license holder requires the consent of a regulatory body, you can’t close the deal until you get the regulatory consent. So, that’s a key consideration in structuring these deals—understanding the regulations at play in the states in which your target operates.”
While Bedwick has not had a regulatory body deny the change in control in any of his transactions, he has sometimes received follow-up questions from regulators, who want to better understand a transaction.
“Because it is a relatively new industry in many of these states, sometimes the regulators haven’t encountered a change of control yet,” he says. “So, they’re working their way through their own regulations. It’s education—educating the regulators and the regulators educating us on what is required.”
In addition, buyers should be aware of potential licensing caps in states where they do business. If a buyer and a seller each hold a license in a state with a limit on the number of permits that one entity can hold, for example, one party may have to divest a license as a condition to closing the transaction.
“You can’t close a deal where an entity would hold interests in two licenses if the state prohibits dual ownership,” Bedwick says.
2. Know the status of the target’s license.
Before a license changes hands, a buyer should know the status of the target’s license.
Some states will first award a provisional cannabis permit, which is good for an initial period of time, until the licensee demonstrates that it is viable and operational, at which time the state will issue a more permanent license.
“As part of your diligence, you need to know what stage a target’s license is in and whether it has been awarded as a provisional license,” he says. “Sometimes, clients don’t want to close a transaction until they know that the provisional is a permanent permit.”
3. Know your target’s history.
Understanding the regulations under which a target operates and the status of its license may not be enough for a buyer to determine whether the acquisition is a good fit. The next step, Bedwick says, is looking at the target’s operating history.
“Some of these companies … do not have significant operating histories,” he says. “[Understand], does your target [have] an operational business? Has it been operating for any period of time or a lengthy period of time, versus a target that has recently acquired a license and may not have as robust an operating history?”
4. Understand the purchase price.
Next, it is imperative that sellers—and buyers, for that matter—understand the transaction’s price tag.
For example, if a seller is receiving equity in a buyer as part of the purchase price, the seller should understand the nature of the buyer’s business, its assets and its liabilities. This can be more complex than an all-cash transaction, where cash is payable at closing, Bedwick says.
5. Structure the transaction in the most tax-favorable manner.
Acquisitions, regardless of the industry, should be structured in the most tax-favorable manner possible, Bedwick says.
“In almost the very initial conversation I have in any acquisition, I loop in my tax partner to ensure that the structure of the acquisition, … whether you’re representing a buyer or a seller, … is structured in the most favorable manner for your clients on the tax side,” he says. “The most favorable manner is to structure a transaction, to the extent you can, that gets tax-free treatment on the transaction.”
A firm’s tax professionals should be consulted early and often in the process, and buyers should pay close attention to how the target company is structured—whether as a corporation or a pass-through entity like a limited liability company, for example. This will help determine the structure of the transaction, as well, Bedwick says.
6. Consider how you will integrate key employees post-closing.
Retention of key employees should also be considered when negotiating a deal, especially if certain individuals’ employment is integral to the operation of the business.
“That could be a huge factor in some of the permits that are awarded,” Bedwick says. “If a target has employees who have real expertise in the growing and processing of cannabis, for example, you may want some of those employees to enter into employment agreements as a condition to the closing."