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Corporate & Tax

The Unique Challenges of Cannabis M&A Deals

By Sarah Richmond

The cannabis industry has gained such broad acceptance over recent years that it’s hard to remember that recreational cannabis was not legal in any US state until 2012, when ballot measures were approved in Colorado and Washington. Today, recreational cannabis is legal in 23 states and medical cannabis is legal in 38. The cannabis M&A landscape has seen significant growth over that same short period, bringing with it unique challenges that make it significantly different and more complicated than deals in any other sector.

The primary challenge, of course, is the fact that marijuana is classified as a Schedule I substance under the Controlled Substances Act (along with heroin and LSD). This federal illegality has resulted in cannabis companies being denied access to the traditional banking system, creating a ripple effect throughout almost all major deal terms in this space. Because loans from FDIC-insured banks have been unavailable, and traditional private equity and VC funds have shied away from this industry, cannabis companies have had to rely on local banks and alternative financing sources, making it hard to raise enough capital to fund cash acquisitions. As a result, in the typical cannabis M&A deal, buyer stock and promissory notes often constitute a significant portion of the purchase price, which is in contrast to other types of M&A deals where all-cash deals are typical.

While non-cannabis M&A deals often provide for part of the purchase price to be placed in escrow for a period following the closing, these terms are rare in cannabis transactions, where the parties are unable to access the escrow agent services of big national banks. And while there has been a recent trend in non-cannabis M&A deals for buyers to purchase reps and warranties insurance to transfer certain post-closing risks to their insurers, that trend is non-existent in cannabis transactions, where insurance companies are wary of federal punishment and don’t offer the same coverage.

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The complications resulting from the federal illegality of cannabis are exacerbated by the constantly evolving, complex, and often contradictory laws and regulations across the different states, and even across counties and cities within the same state. In many states, it is illegal to transfer a cannabis license independently of the entire business, and so transfers can only be effectuated through the sale of equity. Some states limit the number of cannabis licenses a single company can own. Or a state might prohibit the sale of 100% of the equity in a cannabis company in a single transaction. In some states, a company may not undergo a change in control for a specified number of years after obtaining its license. And some states require that the majority owners of cannabis companies must be residents of that state. The list of unique regulations impacting cannabis M&A deals is endless.

Compliance with these inconsistent and ever-changing state and local regulatory regimes is often the primary driver for how cannabis M&A deals are structured, and can create significant uncertainty in what might otherwise be a straight-forward transaction. But having led scores of M&A transactions on both the buy and sell sides involving close to 20 state regulatory regimes, at least I can say that the work is never boring!

What does the future hold for cannabis M&A? Many industry participants are expecting the eventual passage of the SAFE Banking Act, which would permit FDIC-insured banks to provide services to companies in the cannabis space. In addition to solving issues like the inability to use credit cards at dispensaries, the passage of this legislation should make it easier for cannabis companies to obtain loans to fund both operations and acquisitions. After President Biden issued his Statement on Marijuana Reform, many people started holding out hope that marijuana would be de-scheduled, effectively legalizing it across the country and streamlining much of the state-by-state complexity that plagues these transactions. However, current conventional wisdom is that federal legalization is unlikely to happen in the near future. Until that time, would-be buyers and sellers of cannabis companies, and their service providers, are wise to keep these unique challenges in mind.

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