M&A Uptick Expected to Continue in 2021: Q&A with Fox Rothschild Partner Melissa Sanders and Associate Jared Schwass

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As the state-by-state markets continue to grow, major players outside the cannabis industry are looking for a way in. And those already with a footprint in the sector are poised to go bigger.

Earlier this month, a blockbuster deal kicked off the 2021 cannabis merger-and-acquisition season, when Ireland-based Jazz Pharmaceuticals inked a $7.2-billion deal to acquire United Kingdom-based GW Pharmaceuticals, the manufacturer of the Food and Drug Administration-approved Epidiolex. It was the biggest handshake yet for the cannabis industry, and it could be just the beginning of what’s to come in a global market still in its infancy.

At Fox Rothschild, a Philadelphia-based law firm with a national cannabis practice group, Partner Melissa Sanders and Associate Jared Schwass told clients there is much more room for businesses to expand in an alert they released Feb. 1.

Sanders advises corporate clients on a wide range of business matters, with a particular focus on mergers and acquisitions, private placements of securities, financing transactions and ownership transition programs. Schwass is an attorney in the corporate department and a member of the firm’s Cannabis Law Practice Group. He advises businesses entering and operating in the legalized cannabis market on regulatory compliance, risk mitigation and business transactions.

“At the end of 2020, we saw an uptick in merger-and-acquisition activity as the industry shook off some pandemic-related instability, and we expect that trend to increase significantly in 2021,” they said in the alert.

“Despite abundant money available to the large multi-state operators (MSOs), most cannabis companies still have relatively limited avenues to raise capital due to the federal illegality of the industry,” they said. “However, that may change soon with the democrats now controlling both houses of Congress and the White House.”

When cannabis is descheduled, Sanders and Schwass said they anticipate an influx of cash into the sector, as previously reluctant investors and institutions enter the market without fear of federal repercussions.

Here, Sanders and Schwass share more about M&A activity trends, anticipations and indicators, and how MSOs and smaller businesses alike can position themselves for possible growth opportunities.                        

Tony Lange: What stood out most about how M&A activities shaped up in the 2020 cannabis industry?

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Melissa Sanders: I think we were seeing a lot of the distressed assets being snapped up. And even outside of the distressed assets, there were some good deals to be had. As we’re moving into 2021, that’s continuing. But I think that with the change in the Senate and legalization potentially on the forefront, additional capital is coming in and we’re going to see more M&A overall.

Jared Schwass: When COVID-19 first hit, there was kind of a lull in activity. Then, when medical necessities and distressed assets became available, that’s when the serial acquirers were buying up. And then we did see, towards the end, a couple of mergers that that were big news. I feel like more of that’s going to happen in 2021.

TL: How much would cannabis legislation at the federal level impact M&A activity?

MS: Federal legislation has some weight. I don’t want to overstate it, because we have to wait and see, but I do think it will bring in some potential money of folks who were still a little hesitant to maybe get into the business and essentially raise capital or put capital into other companies. The actual operators, they’ve already made the bet on cannabis. So, for them, a lot of it has been dependent on where the capital’s at.

JS: In addition to the increased capital that we can see, I believe with the descheduling on the Controlled Substances Act, that we’ll see major players outside of the cannabis industry start looking at trying to get into the industry.

TL: Regardless of the makeup of Congress, what are your anticipations for the rest of 2021?

MS: Regardless of what does happen at the federal level, I think M&A activity is going to be on the upswing. There are still a lot of good deals to be had out there. I also think people are anticipating and hopeful for an economic turnaround. So, deals are going to continue to happen and continue to grow.

I do think that we’re in a little bit of a different position than we were the last time there was this huge amount of M&A activity in the sense that companies are more mature. They’re seeing the things that maybe went wrong or weren’t ideal in former deals. So, although the increase is going to make for more competition for acquirers, I don’t think it’s going to be the same as it was in 2019, when people were really overlooking some real blemishes in companies just to keep growing and get in there. Now people really are looking at the fundamentals of the business and making sure they’ve got the corporate books and things like that.

-Melissa Sanders, Fox Rothschild partner 

JS: To add to that, regardless of what happens in Congress and the Senate, I think that M&A activity is going to still continue. We’re going to see a significant activity in that area, and there’s going to be a lot of consolidation in the coming years.

TL: Do you think small-scale cannabis businesses are a dying breed?

MS: I personally don’t think so, because there is a market for these independent companies and independent brands. That market is going to remain in cannabis and other industries. I do think that it’s going to be a lot harder for them to survive and compete, but I don't think it’s a dying breed.

We’re still seeing a lot of small, one-off acquisitions. A lot of them are actually growing but not looking to necessarily become a huge MSO, although some of them are.

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JS: I don’t think it’s dying. I think it’s difficult, especially the small farmers up in Northern California are struggling. But I think through struggle comes perseverance. There is something to be said about these small farms and these small kind of craft brands that there still is a market for them, and there will continue to be a market for them.

TL: How can some of the small-scale cannabis businesses make themselves attractable for sale, if that’s the path they want to go?

MS: If they want to make themselves attractive, the biggest thing is getting everything in order, making sure they’ve got records or descriptions, depending on how old the company is; there was a time when companies weren’t keeping great records. If they don’t have them, they don't have them, but getting whatever they do have in order, looking at where there are holes to the extent that they’re fixable, to work on those, and also just getting kind of all of their paperwork in order to make sure they’re tracking things will help. When an acquirer comes in, they’re going to want to do a lot of due diligence on the business and legal side. And, so, being able to present those materials quickly is important.

JS: I second that. Clean books are very important so there’s no questions on ownership or taxes or anything like that. And, generally speaking, good cashflow, not a lot of debt on the books, that type of stuff is important too.

TL: How can MSOs stay on top of the competitive M&A market so they can take advantage of opportunities as they arise?

MS: That’s a good question. A lot of it is just staying on top of who all of the operators are in the areas that make sense for you strategically. I think MSOs are going to acquire strategically this year, and making sure that they understand who the players are in each market, and whether those players might be open to sale, can help them approach the right people at the right time.

JS: Knowing who to acquire, what licenses, where, what states are opening up and doing your own market research is valuable in making sure that if you want to enter into a market in a different state, that that’s going to work for your business. Just doing your own due diligence and research in the market is essential to taking advantage of those opportunities.

TL: What sparks companies to decide whether a merger is right for them, or they’re better off pursing an acquisition?

MS: The same deal could really, in most cases, be structured as a merger or an acquisition just depending on certain legal points and tax points. I think we are seeing a lot of the larger deals as mergers, in large part because it’s going to be stock-for-stock and not a lot of cash. A lot of the stock deals are more merger-oriented and a lot of the cash deals may be structured as acquisitions, but that’s not 100% across the board. And definitely the smaller one-off deals, those are almost always structured as acquisitions and not mergers.

JS: Generally speaking, the bigger deals are to be more of a merger, when two bigger companies come together, whereas when you have a bigger company looking to just expand its market in a specific area, just buying a small business here and there, those are going to be obviously acquisitions.

TL: What states or regions do you forecast being hotbeds for M&A activity in the U.S.?

MS: I do think states that recently passed adult-use legalization, especially those that previously had medical programs, a lot of times there are going to be procedures for them to convert their companies, and those states will probably see M&A activity.

JS: California has a bunch of independent operators, and I believe the market is right for consolidation if companies can find synergies within themselves. Regardless of what happens in Congress, I think that we’re going to see continued M&A activity just because the market, the industry itself, is in its infancy and people are growing. But if the federal government decides to deschedule or legalize cannabis this year, I believe we will see a significant uptick in that activity.

Editor’s Note: This interview has been edited for style, length and clarity.