These Are the Best Practices for Purchasing a Secondary Cannabis Business License
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Cannabis business owners seeking to sell their operations on the secondary market are sitting in the catbird seat, experts say. Multistate operators wishing to expand their footprints are fueling demand, as are investors entering the market anticipating federal marijuana reform.
“With $1.6 billion in capital raised in January alone, public cannabis companies now have a lot of cash on their books, so I think we are going to see a lot of mergers and acquisitions this year,” said Charles Alovisetti, a partner at Denver-based cannabis law firm Vicente Sederberg.
There is an “optimistic expectation of accelerated federal cannabis reform now that the Democrats control the White House and Congress,” added Jade Green, founder and CEO of Seattle-based CannaMLS, a nationwide listing service for marijuana properties.
At the request of Marijuana Business Magazine, Green looked at the activity of buyers and sellers contacting CannaMLS in the first six weeks of 2021 compared to the same period in 2020. The increase in activity, Green said, was “incredible.”
Interest from buyers jumped 427 percent between January 2020 and January 2021, and seller interest rose by 500 percent, according to CannaMLS records. In the first two weeks of February, buyer interest was up 500 percent from the same period in 2020.
Alovisetti, who is based in Vicente Sederberg’s Boston office and is licensed to practice law in Colorado, Massachusetts and New York, said he expects that special purpose acquisition companies, also known as SPACs, will be major players in buying private cannabis firms this year and bringing them public.
Know What You’re Signing Up For
While demand for existing marijuana operations perhaps has never been hotter, experts said there are tips and red flags that both sides should be aware of before agreeing to acquisitions.
For example, it is crucial that sellers don’t price their operations too high.
“A lot of sellers think their business is special and deserves a premium price. If other dispensaries in your city are selling for 1X gross revenue, you should realize you are not likely to sell your dispensary for 2X gross revenue,” said marijuana attorney Alex Freedman, founder and principal of Los Angeles-based Freedman Strategic Consulting.
For help pricing your business, interview brokers to find out what your business is worth and how they will help sell it. Lawyers and credit lenders well-versed in local, state and federal marijuana laws will be helpful in vetting potential buyers and closing the deal.
Buying an existing marijuana license from an ongoing MJ business is especially daunting for newbies, according to Green.
“For investors interested in purchasing a license on the secondary market, I would first advise (that clients be) 100 percent sure they are ready to enter the cannabis industry at all,” Green said. She noted that the industry is a “highly complex, ultra-fragmented, federally illegal business that can take years to understand—let alone successfully operate in.”
“From IRS rule 280E (that prohibits tax write-offs) to a complete lack of interstate commerce, there are plenty of challenges that aren’t common in any other multibillion-dollar industry,” Green pointed out.
Just buying an MJ license can be a time-consuming task, which will include a criminal background check.
“Most jurisdictions require background checks for new owners,” Freedman noted.
“Often, the most difficult part of buying a license is just the lengthy wait to get a response from regulators,” added Freedman, who previously served as general counsel to Los Angeles’ Department of Cannabis Regulation and Cannabis Regulation Commission.
There can be real advantages to buying a turnkey operation as opposed to starting one from nothing.
“When you build from scratch, you face many headwinds in the form of entitlements, regulatory agencies and construction timelines,“ said Christopher Stefan, a Denver-based cannabis broker and principal of Desarollo Real Estate.
“In cannabis, all of these things take twice as long as in a conventional transaction, and things tend to drag out,” Stefan said. “Buying a cannabis business gives the buyer the benefit of time, which accrues to the bottom line.”
Heavy Hitters Arrive
Although some individual investors look to get into the marijuana industry, Alovisetti predicted most of the acquisitions this year will be by multistate operators looking either to enter new markets or expand their footprints in states where they already have operations.
In January, Chicago-based Cresco Labs announced it was entering the Florida market by buying Bluma Wellness in a deal valued at $213 million.
“We identified Bluma as having the right tools and key advantages for growth,” Cresco CEO Charles Bachtell said in a news release, citing the company’s “proven track record” and management team as advantages of the purchase.
While not all deals will be the size of the Bluma acquisition, experts provided these tips for prospective marijuana investors:
Hire an experienced lawyer, broker and even an investment broker familiar with state and local marijuana licensing regulations, said Green, founder of CannaMLS.
Do your own due diligence, starting by carefully reviewing state and local rules governing the cannabis sector. “I often see buyers take the word of the sellers,” said attorney and consultant Freedman. “The seller obviously is motivated to make the deal seem as easy to close as possible and might not fully explain all of the challenges involved in transferring the license.”
Stick to basics such as growth, profitability and management, Stefan said. And don’t “throw healthy skepticism out the window.”
Don’t assume you have the “secret sauce” to drive sales higher than the market allows. “I’ve seen buyers pay twice the market rate for a dispensary license based on their belief they could quintuple the dispensary’s revenue only to later find such growth wasn’t possible based on the competitive landscape in the city,” Freedman said.
Don’t believe your own PR, Stefan argued. “Too often, people who have been successful in other industries think their strategy will work in cannabis and are proven wrong,” he said. That trap can easily be avoided by consulting with cannabis-industry veterans.
For sellers, advice ranges from pricing your property right to having all your financial disclosures in order. Things you need to consider before putting your marijuana operation on the market include:
- Hire an experienced broker who can not only sell your property but also create advertising materials, facilitate the signing of documents such as nondisclosure agreements and verify proof of funds, Green said.
- Insist potential buyers offer proof of funds before putting a property under contract. “Proof of funds is usually the best way for a seller to avoid agreeing to deals that will never close,” Freedman said. “Many buyers sign term sheets without sufficient funds and then use the term sheet to attract capital.”
- Have audited financials available, said Alovisetti, who has structured deals in numerous states with medical and adult-use marijuana industries. He noted smaller marijuana companies might have their financial data saved using accounting software such as QuickBooks, but that won’t be acceptable to a sophisticated buyer.
- Create a presentation deck that includes detailed financials for potential buyers to review. Make the minutes of board meetings available, Alovisetti added, so prospective buyers understand your corporate strategy.
Broker Stefan echoed the importance of pricing the property right, even in a hot market.
“It is a terrible mistake to overprice and overexpose your asset, as it will lead to a longer sales timeline and potentially less proceeds,” Stefan said. “A properly priced asset can attract multiple parties, creating an auction environment that will drive up the price naturally.”
Beware of Red Flags
Both buyers and sellers need to be looking out for danger signs. Ignorance of regulations regarding the transfer of license ownership and licenses that are not are in good standing are red flags, Green said.
Additionally, liens, encumbrances or litigation could end up being costly headaches.
“I’ve seen many buyers who, a year after buying the license, discover millions of dollars in undisclosed tax liabilities or have to fend off lawsuits from individuals claiming to have an ownership interest in the business based on a deal done a half-decade earlier,” Freedman said.
Stefan said a way to avoid those potential problems is to buy the assets of the business rather than the business itself. An experienced real estate attorney or a knowledgeable commercial real estate broker should be able to structure the contract to avoid future liabilities, he said.
“You need to know who you are doing business with, what they have done in the past and how their other businesses have gone,” Stefan said. “I have had clients who are charming people with powerful public personas that have a trail of unpaid lenders, investors and landlords that were never asked to give a reference.”