Buying a cannabis business is very different from buying a business in any other industry. In an acquisition, the buyer is acquiring a license that may or may not be held by an entity. Besides the license aspect, the following are the most significant distinctions.
Regulatory approval uncertainty causes delay
Buyers typically need to obtain approval for the license transfer from at least one city and one state administrative agency.
Sometimes multiple cities and multiple state level agencies are involved.
As a result of regulatory uncertainty, deals take a long time to close. What do I mean by regulatory uncertainty? In many smaller cities, the individuals in charge of processing license transfers have never approved a license transfer. Different officials in a given city will provide different directions as to the steps required to transfer or amend a license. The reality is that city officials are often uncertain as to what process to follow and what documentation to request from the buyer.
Even on the state level different licensing analysts within the same agency will require different information and take divergent positions.
This uncertainty always causes delay and makes coordinating local and state approval more challenging.
Negative impact of regulatory uncertainty
The added time required to close creates a variety of risks. The target’s financial condition may worsen significantly from the LOI to closing.
Industry wide events such as the vaping crisis can also have a negative impact on the target as the parties are pursuing regulatory approval.
If the buyer is paying with stock the value of the buyer’s stock may also decline significantly. Recent declines in stock price have had a big impact on Canadian public cannabis companies.
Regulatory complexity requires greater levels of cooperation
The complicated and uncertain regulatory process requires a well-organized and coordinated approach from both buyer and seller. Each side is dependent on the other in terms of moving the process along.
Buyer’s need to decide when and if to take over the point of contact with the governmental entity in order to push things toward a faster approval.
Buyer’s assumption of income tax liability
Many smaller businesses have some unresolved tax liabilities. Cannabis companies, however, tend to have huge tax liabilities sometimes in the millions of dollars. This is caused by a combination of not filing federal tax returns, using inexperienced or overly aggressive CPAs, and blind optimism.
The end result is that any thorough analysis of past tax filings will reveal serious problems and liabilities.
Not only do these liabilities cause problems on a sale event but they can cripple the business if the IRS conducts an audit.
IRS audits in the cannabis space almost always result in the cannabis company having tax liabilities. These are typically unpaid taxes plus penalties and interest which add up very quickly because they are imposed from the time the monies should have been paid.
Buyers need to engage competent CPA firms to assess the scope of the potential tax liability. Correctly assessing the scope of the tax liability is of paramount important in states like California where buyer’s must buy the stock of the licensed entity.
Requiring buyers to buy the shares of a licensed entity forces buyer’s to assume all of the sellers’ liabilities.
Burdensome investor disclosure requirements
Investing in most private companies does not give rise to any disclosure obligations. Cannabis is different because of the license. Depending on the jurisdiction and whether control is changing hands, the investor may be required to provide a livescan, and copy of driver’s license and social security card to city and state regulators.
To make matters worse some jurisdictions, like California, will require legal entities to provide ownership information down to an individual level.
The public nature of this can be a problem for investment funds, professional athletes and anyone in a regulated industry that has restrictions on cannabis use or investment.