As cannabis M&A headlines continue to zip across news feeds at a rapid clip, it becomes harder to avoid including the logistics of deal-making in a solid business model. And if the past 12 months are any indication, the reality and consequences of cannabis mergers and acquisitions will only grow starker.
Here, Dena Jalbert, founder and CEO of Align Business Advisory Services, outlines a few of the fundamentals to the M&A deals she’s helped facilitate in the cannabis space and several takeaways for industry observers curious about all this consolidation happening lately.
“What's different, I think, about cannabis M&A right now is that these big entities that you see are paying significant values and [are] trying to consolidate these smaller, five-minute businesses around the world,” Jalbert says. “They're trying to gain a critical mass, so that as regulation starts to lighten across … the world, as it becomes more mainstream, the market share is just going to grow significantly.”
In the U.S., for instance, companies are geographically limited to particular state-legal markets. The current state of regulation constricts how much a cannabis business can grow. There are only so many people and businesses that can consume a product or service in each market. That’s going to change, though, as cannabis reform continues to sweep across the globe.
The key to both preparing for that trend and embracing it is to have a vision in place and know what your company’s end-game is.
“For M&A, you’re seeing these larger entities come and acquire synergistic businesses,” Jalbert says. “Because the cannabis industry right now is still in its infancy—you know, it's only really been a mainstream business industry for about three to four years—only so many [businesses] have achieved a certain size and scale.” Larger companies are able to meet the ballooning valuations of some of the smaller and mid-sized companies in the cannabis space, and it falls to those target companies, often enough, to navigate proposed transactions.
“They're buying geography,” she says. “They're buying actual cultivators and distributors in various state because they aren't able to get a license there, because there’s only so many.”
How can businesses successfully position themselves on both sides of the table to reap the benefits of the M&A reality in cannabis? Jalbert has several pointers.
1. Build a Vision for Where You’re Taking Your Business
This is a key lesson for all cannabis businesses (and businesses of all stripes, really). Even if M&A is not an inevitability—and it’s not in every case—good business strategies revolve around clear goal-setting. When M&A is on the table for a potential seller, as either an exit ramp or a bridge to a bigger company, that vision is vital.
Jalbert says that she’s often heard from clients—or prospective clients—that a proposed deal has dropped out of the sky and landed in their lap. A large amount of money is conveyed in a voicemail, say, and now it’s up to the business owner to confront this possible deal. If certain goals have been baked into the business model, then there will be a path forward to approach this offer. Otherwise, though, it’s likely that sudden proposals will prompt some fast-action soul-searching: “Should I be selling my business? Is now the time?”
To get out in front of questions like that, it’s paramount to clearly articulate where you and your business are headed. This is a conversation that should involve key executives and any sort of management team that would be assembled if and when an acquisition deal of any ilk does happen.
2. Identify Your Team
You’ll want those people in place well ahead of time, as they’ll be on the front lines of any merger or acquisition talks. Much like the team across the table, they’ll be navigating the consolidation of two cultures and two internal systems.
Likewise, you’ll want to quickly learn about the other team, the team with whom you’ll be dealing in the context of an M&A transaction. Once a proposed deal is under way and two companies are talking, it’s best to get familiar with each other.
“Understand who their leadership is. Understand who’s making decisions,” Jalbert says. “It's a two-way conversation of vetting one another.”
Management teams will often be included in the resulting company; it’s hard enough to fill executive positions with knowledgeable leaders in these early days of the cannabis industry, after all.
Part of the team—part of the core group of interested parties who will have a seat at the table, in a sense—will also include state regulators. In most of the cannabis deals the industry is seeing right now, some sort of license transfer is included in the transaction. This means that the state needs to know who’s buying what.
“When you're evaluating a transaction, and who your ideal counter-party is, you want to make sure it's someone that you will be able to transfer your license to, because each state has varying differences around the who, the what and the where on that,”Jalbert says. “So, they're engaged early in the process, because you want to evaluate the likelihood and ability for the licenses to be able to transfer seamlessly.”
3. Culture Is Key
At the end of the day, a well-rounded M&A deal will more closely resemble a corporate marriage than a straight-forward investment, especially with the increasing complexity of the deals that we’re seeing in the market right now. While the financials are one thing (more on that in a moment), the blending of professional cultures is another—and it’s no less important.
“It's a very liberal industry,” Jalbert says. “If you've got an aggressive, forward-thinking, dynamic small business team, and then they are going to fold into a conservatively structured, bureaucratic, larger organization, that’s not going work. They’re going to clash quickly. And then the buying company is at risk of losing those people.”
Once a deal is done, employees of the newly formed entity are free to move on if it comes to that.
“When a when a seller is not forthcoming about [internal culture], that's a huge red flag,” she says.
A major part of any M&A deal is the integration phase, in which management teams work to blend the two corporate backgrounds into one. This should be done patiently and empathetically as the deal progresses through its various phases of development, including through in-depth interviews with employees and management.
4. Know Your Terms
As noted earlier, cannabis deals are becoming more complex, with more moving parts, simply because the valuations tied to these companies are so volatile at times and because the regulations in which they operate are incredibly rigid. Threading the needle so that buyer and seller reap properly timed benefits—and so that the resulting company lands on firm footing—is no easy task.
A lot of the types of terms that are popping up in these multi-faceted cannabis deals are time-released transactions—terms based on how the company performs six, 12, 24 months down the line after a deal or on how state regulators address the proposed deal.
Jalbert says her firm completed a deal that included a “lagging earn-out” provision, which was protracted to accommodate the license transfer timeline. “We had to restructure the terms to make sure that [the] business didn't suffer because of that, and that there was a clean transition over time,” she says.
5. Focus on Due Diligence
Due diligence is a broad and deep process that comes only after businesses have signed some sort of exclusive contract as they mold a proposed deal. It’s a large portion of the estimated 1,000 hours of work that go into these transactions.
M&A firms will often work with both companies to interview employees, parse financial records and legal documents, and convey a nuanced status report to their client. The due diligence process goes well beyond the preliminary framework developed in what is called a confidential information memorandum (CIM), which comes earlier in the transaction time table, and it includes both the positives about the business in question and the risks that may be discovered.
“If they're not already a public company where you don't have access to their financials, you can certainly request it so that you can understand the financial health of the business,” Jalbert says. “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? Is the company viable?”
“Again, if they won’t share that with you, or if they can't take you through the details in their growth plan, … that's a red flag. Any red flag doesn't mean you should absolutely walk away, but these are the things in this space that we tend to ask for, from a seller diligence perspective.”