Part 1 - M&A readiness – Corporate Hygiene
Mergers and Acquisitions have long been a strategic growth tool for companies looking to enter new market, expand a product portfolio and acquire talent to scale the buyer’s business. Cannabis, despite its limited legal operating history, is no different in this regard as market leaders GTI, Curaleaf and Cresco have utilized M&A to close a combined X deals creating nearly $10b in shareholder value. So while the tightening of the capital markets in 2020 has reduced the amount of M&A in cannabis there hope that 2021 will bode well for the industry and the rumored “cash on the sidelines” will flow into cannabis and increase M&A activity. So the question becomes, if an MSO or well-funded private company comes knocking, and you like the valuation and terms, can you close the deal?
Over the past 2 years MSOs have refined their ability to make an offer (a Letter of Intent) with limited due diligence. However, the path to Closing the transaction is much longer and can often take 9-12 months, if it even closes. One common reason for this is that the seller is not prepared or cannot provide comfort to the buyer during due diligence that the transaction has a manageable risk profile. So if you are a seller and you want to entertain M&A either today or in the future you must focus on your Corporate Hygiene. Consider that in an M&A transaction the Due Diligence performed by the buyer will typically review 150-200 documents in order to sign the Definitive Agreement. This will include three years of historical financials, shareholder information, vendor and employee agreements, facility leases or real property agreements and much more. Operators who are ill-prepared to provide this information will struggle to close a transaction that passes the reporting requirements of publicly traded companies on the CSE or the TSX.
Operators that wish to exit their cannabis business at some point in the future need to invest time and money shoring up their corporate hygiene. Let’s take the financial statements. Given the complexity of cannabis regulations it is rare to see a cannabis seller with audited financials. In fact, it is more likely that a company is virtually un-auditable. Most cannabis entrepreneurs see the time and expense associated with an audit and choose to “kick that can down the road”. This is understandable but there are other less expensive and time consuming options that can provide the buyer with comfort. Options include having your financial statements “reviewed” or “compiled” by an independent CPA that will likely flag a number of potential areas of financial reporting concerns that can be addressed prior to engaging an M&A process. Reviewed or compiled financials do not require the auditor to verify the information and subsequently there is no guarantee of the accuracy of the data but it will provide buyers with confidence when evaluating a company.
Of course corporate hygiene extends to all facets of the business. One particular focus of buyer analysis is compliance and licensing. Cannabis operators are all aware of the challenges thrust upon them by local and state regulators and suffice to say that all of these regulations are a works in progress that can change quickly – often every two years when new elected officials implement their cannabis policies. The most challenging aspect to closing a transaction is the transfer of the license(s). Some states are known to take 6-9 months after the Definitive Agreement is signed (often a 6-month process itself) to process the transaction. Sellers must understand that the Buyers will hire the top legal compliance teams with domain expertise to dig into all the nuances of license transfer and sellers should be intimately familiar with the local agencies and their process and requirements. Complex license transfer may not completely derail a deal but there is little benefit to entertain an M&A transaction if your compliance and licenses are not stable.
Of course financial and compliance are the key areas, or table stakes, to closing a deal. But corporate hygiene also extends to numerous complex areas. Many companies have multiple entities for strategic purposes but those entities have to have well defined cost allocations when money is moving around. Inventory is another item that is often overvalued as many products may be bordering on obsolete or subject to a substantial write-down. These are seemingly minor issues but once the buyer does its due diligence there may be ample reason for a purchase price reduction if these items are not tracked well and always buttoned up. This will rear its ugly head near Closing in the form of Working Capital adjustments and can often have a significant impact on the compensation received by the seller.
Cannabis companies who are interested in selling should invest the time to build address issues of corporate hygiene so that when the timing is right they are able to capitalize on their market readiness to entertain offers from buyers knowing that you can actually close. The length of time it takes to sell your business and the kind of deal you structure are in direct relation to how well you've prepared your business for sale and the degree to which you've made the acquisition process easy for the buyers. Put another way, if you make your business attractive to the right buyers and "smooth the path" to buying by removing obstacles, then you're far more likely to sell for agreeable terms and close the sale quickly (or at all).