Today we look at legal side of general awareness in entertaining the idea of investing in the Cannabis Industry. Five crucial legal concerns before buying a cannabis business are:
- State and local law compliance. This is by the number one due diligence item for buyers. State and local law compliance varies greatly by state and by county and by city and you have to know what state and local licensing or permitting is required for a given marijuana business before you purchase it. I cannot tell you how many times we have had buyers come to us thinking they are buying a licensed marijuana business only to find out that the license is only pending and has not actually been issued or that the cannabis business is facing license revocation for rule violations, or that the municipal law has changed and the business must relocate to continue operating. Before buying a cannabis business you should, at minimum, confirm that the company you will be buying is in good standing with the Secretary of State and the regulators and you should review its proof of licensing and permitting and its history of administrative violations, including any written warnings. If you fail to do this, you may find yourself with a cannabis business without a license to legally operate or that is about to lose it.
- State law procedures for ownership changes. Marijuana businesses are heavily regulated and there are onerous state law procedures in place for changes in ownership. Generally, the seller must disclose the buyer to the state and the buyer must be successfully vetted by the relevant regulators. Buyers and sellers of cannabis business cannot undertake these sales like any other business. No matter what any seller or broker may tell you as the buyer about the ease of the transaction, you as the buyer should ensure that the sale can comply with applicable state law requirements for changes in ownership and that the purchase and sale agreement accounts for the timing of performance obligations set forth in that purchase and sale agreement. We have had company’s come to us after the fact that have lost their earnest money for not closing quickly enough on deals where the closing date was impossible to meet from day one.
- Corporate authority. Ownership disputes are common in the marijuana industry because many marijuana operators still neglect (to their detriment) to put their corporate and contractual relationships in writing. We often see cannabis business buyers who (based on the word of a single seller in a multi-owner entity), believe they are free and clear to purchase all the stock in a corporation or all of the membership units in an LLC when they actually are not. Purchasers must get copies of all bylaws and subscription agreements when contemplating buying a corporation and they must get a copy of the current operating agreement for an LLC to know whether the seller has authority to sell their (or all of the) membership interests in the business. Failing to secure this authority will violate the seller’s corporate obligations and the sale can likely be undone. If all of the existing owners do not agree to the buy-out or transfer or there is a right of first refusal on sales or transfers, the buyer (and the seller) are going to have serious issues enforcing the purchase agreement.
- Real property. When you buy a business, you typically buy all of its assets, including any real estate it owns or has an interest in. Buyers therefore need to get a list of all real property owned and leased by the business that is to be sold. Most importantly, you want to know if the company you are seeking to buy is locked into a long-term lease or whether you’ll be able to re-locate it upon buying it. Many buyers have their own property on which they want to run the cannabis business and for these buyers, the ability to move the business can be key. If there is a lease, you want to know its terms and whether you can or want to comply with it. And because boilerplate leases don’t cut it in this industry, you need to make sure that lease sufficiently covers your issues when it comes to state and local law compliance and the federal law conflict.
- Financial liabilities. You want an agreement that requires seller disclosure on every handshake deal with every consultant, investor, and service provider so you know what you’re getting and who you owe. If anything goes wrong, it’s on the seller not you. This should include any instrument that grants a security interest from the cannabis business you are buying to a third party. Even skillfully crafted representations and warranties may not be enough to cover all liabilities, especially if your seller can’t pay them. Every transaction can be a prism, it pays to study every facet and wrinkle of the contract.