The cannabis industry investors, business owners and legalization advocates had met before to discuss the legal and regulatory headaches of operating in a world that’s licensed and regulated by states but illegal under federal law.
But what made those at Tuesday’s gathering describe it as a public relations milestone was the location: inside the Capitol complex.
Ohio Republican Rep. David Joyce, one of several members of Congress who dropped in throughout the day, said it was significant because people still have “the wrong idea” about the industry.
As rapid market consolidation continues in the cannabis industry, it is imperative that potential sellers understand how a purchase price will be paid by a buyer in order to negotiate the terms of a deal. This includes understanding how stock is paid, as well as how a buyer might use a clawback or holdback, according to Sabas Carrillo, CEO of Adnant Consulting.
Publicly traded companies may pay for an acquisition in a mixture of cash or stock, or it could be an all-stock transaction, which, for the seller, is essentially like writing a check to invest in the buyer’s company, Carrillo says.
“You have to understand how that benefits you or hurts you when making the decision,” he says. “If you have 100-percent cash, for example, you’re likely to get a smaller purchase price. If you take 100-percent stock, you’re likely to get a little bit more for your company; however, there’s risk in taking stock because the price of the stock could go down. But in the same token, the price of the stock could go up. So, you need to understand that mix.”
Sellers should also understand how clawbacks and holdbacks can affect purchase price when a buyer is paying in stock.
When a buyer doubts the seller’s revenue claims, he or she could institute a clawback, which says that although the buyer will pay a certain amount for the assets, he or she reserves the right to “claw back” some of that purchase price should the actual revenue not meet the seller’s claim.
“Let’s say you represent that your dispensary does $5 million in revenue a year, but I’m in doubt of that,” Carrillo says. “So, I might say, ‘OK, if your dispensary doesn’t do $5 million this year—let’s say it only does $3 million—then I reserve the right to claw back $2 million from that $10-million purchase price.’ Realize that that means you’re tied into … that dispensary for at least the term of the clawback. So, if the term of the clawback is 12 months, then you’re tied to the dispensary actually doing those revenue targets [for 12 months].”
Similarly, a holdback allows a buyer to “hold back” a certain amount of the purchase price until the end of the term.
“I’m going to give you $8 million now, and I’m going to hold back $2 million in value until 12 months later or six months later, until whatever thing I doubt occurs,” Carrillo says.
When accepting stock, sellers should be careful when negotiating when they will receive that stock after the term of the clawback or holdback ends, he adds, as stock prices fluctuate.
“Let’s say I sold my dispensary for $10 million,” Carrillo says. “If I have a holdback—for example, let’s say I’m going to get $8 million in stock when the deal closes and I’m going to get $2 million 12 months later. If that $2 million in stock is issued on the day the transaction closes—let’s just say that’s Jan. 1, 2019— … and my perception is that stock value is going to go up in the next 12 months, it benefits me to have that stock issued on Jan. 1, 2019, and held in escrow. [This is] because, by December, the stock might be a lot higher, and while I am promised $2 million, I didn’t get the benefit of the increase of stock price throughout the year. Conversely, if my perception is that the stock price of the company is going to go down, then maybe I would rather wait until Dec. 31 to have my stock issued. I still get … my $2 million in value, but if the stock price is going up, I want that stock to be issued sooner and held in escrow than later and vice versa.”
There are other nuances relating to stock that must be carefully negotiated, as well, to ensure the seller actually receives the amount promised, Carrillo adds.
For example, there is a distinction between requesting $2 million in stock at some point in the future versus requesting the number of stock shares that is equivalent to $2 million.
“Let’s say, for example, that the publicly traded company that’s buying me, the stock price is $1,” Carrillo says. “So, on Jan. 1, when we close this transaction, I’m supposed to get $2 million in stock, and that means I get two million shares. So, in the agreement, if it says, two million shares, then when that stock is issued, regardless of what the stock price is, I’m getting two million shares. So, if on Jan. 1, I agree to receive two million shares and on that day the value of the stock is $1, it’s $2 million in value. But again, if I have this clawback or holdback and my shares are issued on Dec. 31, if the stock price has gone up, great, I get my two million shares and I benefit from the stock going up. If, conversely, the stock has gone down, I still get my two million shares, it doesn’t matter, but then the value is lower.”
Therefore, if a seller believes the stock price will go up, he or she should denote in the contract the number of shares received versus the dollar value. Conversely, if a seller believes the stock price will go down, he or she should denote the dollar value and not the number of shares.
“All of those little things should be thought about because you might sell your company for $10 million, but if you benefit from the upside of the stock, you can actually do way better than just your $10 million,” Carrillo says.
SeanPavonePhoto/Adobe Stock
Massachusetts Regulators Delay Canadian Acquisition of Sira Naturals
The Cannabis Control Commission is seeking more information from Cannabis Strategies Acquisition Corp. before approving the transaction.
The Massachusetts Cannabis Control Commission was all set to approve a Canadian company’s acquisition of Sira Naturals, but regulators pumped the brakes and called for greater scrutiny into the deal—and into similar deals moving forward.
In October 2018, Toronto-based Cannabis Strategies Acquisition Corp. announced that it would acquire Sira Naturals. The company trades on the Nasdaq, and its management team combined the Sira Naturals news with acquisitions of four other cannabis businesses in Nevada and Colorado. Cannabis Strategies Acquisition Corp. is a SPAC, which means that it leverages public investments for private equity transactions.
Sira Naturals holds vertically integrated licenses, and currently operates three dispensaries in the state.
The request to change ownership is a sensitive topic in Massachusetts and elsewhere right now, in light of rapid market consolidation and especially in light of a recent Boston Globereport on major companies asserting ownership of more than the allowable number of cannabis business in the state. Regulatory approval is needed to complete these M&A transactions in the cannabis space, and recent debates over the expanding scope of ownership for some multi-state operators has prompted questions about who’s moving into a particular state-legal cannabis market.
At its May 16 meeting, the state’s Cannabis Control Commission pushed back on Cannabis Strategies Acquisition Corp. During the debate over the recommendation to approve this transaction, commissioners decide to pursue even more records from the Canadian company.
Commissioner Shaleen Title said, “It’s in the public’s interest to scrutinize these transactions.”
She requested that the commission seek “all legal documents that address this transfers of ownership, whether public or not.”
Prior to the meeting, the commission’s leadership team had performed its required due diligence on the transaction and offered a recommendation to approve the deal.
“In this instance, I want to thank the staff,” she said. “I believe that you’ve gone above and beyond to review this transaction, to review hundreds of documents. I have full confidence in the staff, and I appreciate it. But as I look ahead, as this is the first time we reviewed a transaction like this, I’m thinking about establishing a fair and consistent process and I’m not sure that this is sustainable. The reason I’m focused on the process is because there is a long queue of these changes to be reviewed.”
The commission dug into what Title was looking for, pointing out that investor contracts and management agreements had already been requested. The group questioned what a “practical” request for legal documents—beyond what has already been released to the commission—would look like.
Chairman Steve Hoffman circumscribed Title’s amendment a bit, specifying that the commission would request all documents relevant to ownership, control and cap limitations. “We want these documents because we have specific issues or specific things that we’re concerned about and we want to make sure we’re comfortable with before taking a vote,” he said.
The other question became one of timelines: At what point does the process of regulatory scrutiny need to give way to a timely vote on the matter?
“We are not bound by any external deadline on this,” Hoffman said. “I think, however, in our decision-making, we should be cognizant that these deals do—some of them do have timelines, [and] that we will be causing economic impact if don’t approve or disapprove within a certain timeline.”
The commission delayed the vote on the change of ownership, and allowed Cannabis Strategic Acquisitions Corp. to return with more corporate documents within a week.
The commission will meet again May 30.
The commission also debated whether to bring in a third-party agency to probe these change-of-ownership acquisition deals.
Executive Director Shawn Collins, whose team oversees the due diligence process on changes of ownership, said that any third-party investigation into an acquisition would match the level of detail that his staff is already putting into the work. And the investigations into changes of ownership are just one portion of those staffers’ workload, which also includes facility inspections and application evaluations. He did say, however, that adding a layer of scrutiny would increase his team’s “bandwidth, scalability and the ability the turn around [investigations] faster.”
With an increasing pace of M&A moves around the cannabis industry, and with the Massachusetts Cannabis Control Commission already taking the lead on debating and scrutinizing those market forces, any lasting trends that emerge from conversations over ownership changes will be worth watching in all corners of the cannabis industry.
“For me, this is about fairness and consistency—not necessarily just this one,” Title said.
Photo courtesy of Jace Rivera
How Green Prairie Farms’ Jace Rivera Works: Cannabis Workspace
In this installment, CBT presents an up-close look at the tools and habits behind the Oklahoma medical cannabis cultivator’s job.
One word to describe your cultivation style: Natural
Indoor, outdoor, greenhouse or a combination: Primarily indoor, with some outdoor cultivation
Can you share a bit of your background and how you and your company got to the present day?
Cannabis has been in my family since the 1920s. My great-grandpa supported our family supplementing his coal miners’ wages [by] cultivating cannabis. I have been cultivating cannabis since 2006. It was mostly for family medicine and enjoyment. Our company started in 2015 as primary caregivers for children with cancer. We very quickly became overwhelmed with patients in need of “clean medicine.” I started providing education on the non-common methods of ingestion and the benefits of acidic cannabinoids, [and] this opened up a whole new way to help patients. Meeting Bryan Wachsman [and] John and Cassie Stinchcomb in 2018, I was given the opportunity to expand and bring our products and knowledge to Green Prairie Farms.
What tool or software in your cultivation space can you not live without?
Green Prairie Farms’ space is extremely simple. Keep It Simple (KIS) is the motto! I would say that my 40x jewelers loupe is one of the tools I could not live without! An essential tool in a good integrated pest management (IPM) program. When consulting, I tell all of the growers this is their number one tool to use!
What purchase of $100 or less has most positively impacted your business in the last six months?
Can’t get much in the cannabis industry for $100 or less. How about 20 pounds of salmon? It was used to make 1.5 gallons of fish amino acids (FAA). This Korean Natural Farming (KNF) input is being used at Green Prairie Farms’ grow in Tulsa, Okla. This batch of FAA will be enough for over 1,400 gallons—not bad for under $100!
What cultivation technique are you most interested in right now, and what are you actively studying (the most)?
KNF and JADAM Natural Farming have been my focus of cultivation and study for the last six years. I actively participate in local herb walks and do many collections of indigenous microorganisms (IMO) a year. I read a ton! Fermentation techniques are another topic of interest.
How has a failure, or apparent failure, set you up for later success? Do you have a “favorite failure” of yours?
Everyone runs into problems when growing cannabis; it’s how you deal with them that makes you a better grower. I have learned to respond and prevent many of the common and difficult pests and diseases associated with cannabis cultivation. I came up with the saying, “An ounce of prevention yields pounds.”
My favorite failure has been going through my transition from the use of any commercial products to being 99-percent sustainable in my growing technique. I have killed a lot of plants learning! I now am able to cultivate beautiful, healthy plants that produce amazing, clean medicine. I make all of the nutrients and pest management amendments that are used with a high focus on organic inputs.
What advice would you give to a smart, driven grower about to enter the legal, regulated industry? What advice should they ignore?
No. 1: Educate yourself. That is my answer for both questions. Any person entering the industry usually finds out that it is not all it seems and the best thing you can do is not be ignorant to the law and compliance regulations. I mean, after all, it is up to us to up hold this legal privilege.
There are a lot of really good people in this industry—I mean, really good. They will help you learn valuable secrets to the game and get you involved in some amazing activities. But there are a lot of shady people that will do whatever it takes to make a dollar. That includes illegal activities that can stir up trouble for the individual, company and industry.
How do you deal with burnout?
I do my best to review the expectations. It is easy to get burned out if you can’t see the light at the end of the tunnel. Setting checkpoints is another tool I like to use. It seems to give the little victories that make the big picture clear.
How do you motivate your employees/team?
I first and foremost believe in showing your appreciation for the work people do. A little gratitude goes a long way! The best manager I ever worked for told us, “I am only as good as the people that work for me. Please let me know if you need anything.” He told us that every week in staff meetings and always followed through.
I would never ask an employee to do a job I would not be willing to do myself. It is always a huge motivator when somebody gets in there and does the work with you.
What keeps you awake at night?
I have chronic refractory insomnia, so I usually don’t sleep much anyway. My brain doesn’t shut off so it can be hard to get a good night’s sleep. I miss our son; he passed away from a heroin overdose in 2018. He was 23.
What helps you sleep at night?
Reading and hash. I prefer heavy indica varieties; however, I usually just end up super high and not tired! I do not take any prescription medication for my insomnia, although it has been prescribed and recommended.
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When Bankruptcy is Not an Option, What Relief is Available for a Down-and-Out Cannabis Business?
Much like the banking system and IRS Code 280E, debt relief presents unique challenges to the cannabis industry.
Cannabis businesses facing insurmountable debts don’t have access to the typical forms of relief that management teams in other industries might seek, like federal bankruptcy court. This is an emergent problem, as the industry matures to the point that debt becomes a deepening concern for some.
Paul Carey, partner at Mirick O’Connell, says that bankruptcy courts have generally taken a hardline stance against working with businesses and individuals that have even a whiff of the cannabis industry.
Carey
“If there’s enough of a cannabis taint to it, the courts will dismiss the case and/or deny confirmation of any plan because of a number of reasons under the bankruptcy code,” Carey says. Because cannabis remains a Schedule-I substances in the eyes of the federal government, U.S. bankruptcy trustees can’t administer the assets of a debtor without violation federal law. Liquidation and reorganization plans must be proposed “in good faith,” which is to say in a legal manner.
For cannabis businesses, it’s a non-starter.
While there’s not much case law on the books to inform the matter beyond that simple fact, the public record shows how rigid the courts’ stance is on this topic. “The courts have pretty much universally said that a direct participant in the cannabis industry is not going to be eligible for relief in the bankruptcy court,” Carey says.
“Direct participant” can mean growers, manufacturers and distributors, of course, but the specter of any cannabis sales whatsoever can affect the prospects of a bankruptcy filing.
In Florida, for instance, a property owner filed a Chapter 11 bankruptcy case. One of three tenants in the debtor’s commercial building was a cannabis business awaiting approval from the state of Florida to grow and sell medical marijuana. The debtor’s proposal to reorganize assets hinged heavily on whether that medical cannabis business tenant would be approved by the state and thus able to pay rent. Medical cannabis income, then, was a part of the landlord’s bankruptcy relief plan.
According to the court in that case: “[A] bankruptcy plan that proposed to be funded through income generated by the sale of marijuana products cannot be confirmed unless the business generating the income is legal under both state and federal law.”
The court didn’t dismiss the case outright, but instead gave the property owner two weeks to come up with a plan that didn’t involve medical cannabis sales. “The court found that a bankruptcy plan that proposed it to be funded through income generated by the sale of marijuana products cannot be confirmed,” Carey says.
“Until there’s a federal solution to this states-law issue, I don’t know that you’re going to have the direct players—the suppliers, growers—be able to have bankruptcy relief,” Carey says.
There are alternatives for debt-strapped cannabis businesses. Management teams can file for receivership with a state court (in a state that has legalized cannabis for adult-use or medical purposes, of course). This process comes with less legal force than a federal bankruptcy proceeding, but state fiduciaries do act like U.S. bankruptcy trustees—administering assets will reorganizing debt or liquidating.
Also using the state courts system, cannabis businesses may pursue an assignment for the benefit of the creditor. This set-up is similar to bankruptcy, where a state assignee is “charged with the responsibility of gathering all of the Assignor’s assets and selling the Assignor’s right, title and interest in those assets,” according to the American Bar Association. (Assignments for the benefit of the creditor are not available as a legal option in every state.)
There’s always the out-of-court restructuring agreement, as well, Carey points out. Those operating in the cannabis industry know the inherent financial risks; thus, in some cases, creditors may be willing to work out some sort of arrangement by offering relief and continuing to do business with the debtor company.
Legislative Map
Cannabis Business Times’ interactive legislative map is another tool to help cultivators quickly navigate state cannabis laws and find news relevant to their markets. View More
Melissa Schiller
Eric Sandy
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