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.
