I often write about various discrete aspects of cannabis M&A transactions. A full list of my posts, along with other Canna Law Blog contributors’ posts, is linked at the bottom of this post. Today, rather than looking at individual elements of a cannabis M&A transaction, I want to walk through what a transaction looks like from start to finish.
Step 1: Find the Deal
It almost sounds too obvious , but the first step in any cannabis M&A transaction is to find a potential deal. Usually, one or both of the parties (buyer and seller) will use a broker or agent to connect them. Sometimes, a buyer will “cold call” or drop in to an active business and try to talk up a deal. Parties may meet at trade shows or other places and begin talks.
When a seller goes to a broker, it usually will give basic information about the terms the seller wants in the sale, most importantly, the desired purchase price. When parties meet face-to-face at a trade show or otherwise, there’s usually way more room for negotiating on big picture terms. This brings me to step 2.
Step 2: Initial Negotiations
Once a prospective buyer and seller meet, the initial negotiations will begin. At this stage, the buyer will try to get information from the seller (short of full-scale diligence) and try to work with the seller to land on the major terms of a transaction – things like purchase price, timing of closing, terms that are unique to that specific transaction, etc. Once that’s done, the parties will move to step 3.
Step 3: LOI
At this point, the buyer usually prepares a term sheet or letter of intent (LOI) that both parties will sign, and that contains the major deal points agreed to in step 2. I wrote a detailed post on LOIs and term sheets here. In a nutshell, they are used as a shorthand way to memorialize the big-picture terms of a deal. It’s good practice to keep them non-binding generally, but to possibly have binding exclusivity and confidentiality provisions to keep the seller from shopping the deal, and state law will dictate what must be said in the LOI to keep it confidential.
Step 4: Initial Diligence
A buyer may start running diligence from the outset of a deal, but things usually pick up between the execution of an LOI and signing of the purchase agreement and other documents. I wrote a post on diligence here. During this time, the buyer will ask the seller written questions and for various kinds of documents. Sometimes the questions come from the buyer itself, and other times they may come from lawyers, accountants, or other advisors. Lawyers will typically review legal documents, while a buyer and its accountants will review the financials.
Based on the responses the buyer receives, it may decide to walk, or to renegotiate certain terms of the deal. For example, if it learns that a former employee is suing the seller for several hundred thousand and that there’s a good change the former employee will win or settle, the buyer will want to decrease the purchase price (or just make sure those claims are resolved by closing).
Step 5: Drafting and Negotiating the Definitive Agreements
Concurrently with the diligence, a buyer’s legal team usually starts the process of drafting the long-form purchase agreement and any other documents to be executed by the parties. There are usually protracted negotiations. Even in a deal that started with a comprehensive term sheet, things are likely to change during the diligence process. Even on relatively small and non-complex deals, there are at least a few rounds of back-and-forth.
Step 6: Pre-Closing Period
After the main purchase agreement is signed, the pre-closing period begins. A purchase agreement will list out each party’s conditions to closing. I wrote about common closing conditions here. Essentially, a party will not be obligated to close unless all of its closing conditions have been met by the end of the pre-closing period, or it waives those conditions.
For example, if a jurisdiction requires agency approval before a change of ownership occurs, that approval will be a condition to closing. If a company has a large unpaid debt, the buyer will condition closing on that debt being paid off.
Sometimes, additional diligence is performed during the pre-close period. This typically happens when there is a reason for the parties to expedite executing a definitive agreement but the buyer still has additional diligence. Or it could happen if there is a protracted pre-closing period and the buyer wants to be satisfied that things haven’t changed.
Step 7: Closing
I wrote a detailed post about closing here. Closing is the process where the deal is carried out. In the most basic example, once all closing conditions have been satisfied, shares will be given to the buyer, and cash will be given to the seller. Any contracts that were required to be signed at closing will also be signed.
Some purchase agreements will set “drop-dead dates”. These are dates selected by the parties to essentially put a deadline on closing. If, for whatever reason, the closing is not consummated by the drop-dead date, one or both parties (depending on the deal), can walk. Drop-dead dates are a good idea to motivate the parties to pursue their closing conditions as quickly as possible.
That said, we’ve seen many situations where the parties are a bit too ambitious in selecting a drop-dead date and need to amend the contract to move it several times. But this is definitely never a guarantee and one party may stand firm on the drop-dead date. So it’s good practice to be as realistic as possible when setting one.
Step 8: Post-Closing Obligations
Purchase agreements may set a host of obligations that necessarily will occur after closing. If, for example, regulators require certain steps to be taken after shares change hands, those steps are often baked into the purchase agreement. If there are post-closing purchase price adjustments (which you can read about in my post here), those will be addressed as well.
As you can see, buying a cannabis business is complicated. This is a huge over-simplification of the process, and I should note that it does not always progress on the same linear path as outlined above. For more cannabis M&A posts, you can see the below, and you should also stay tuned to the Canna Law Blog.
Cannabis M&A: Disclosure Schedules
Cannabis M&A: Common Representations and Warranties
Cannabis M&A: Common Closing Conditions
Cannabis M&A: Purchase Price Adjustments
Five Common Problems in California Cannabis M&A Transactions
Cannabis M&A: Get to Know Your New Landlord
Top Five Things to Know if You’re Building Your Cannabis Empire Through M&A
Cannabis M&A: The Purchase Price and How It’s Paid
Washington Cannabis: Buckle Up for a Brisk 2021 in M&A Activity
Cannabis Mergers and Acquisitions: Preparing for Success
Cannabis M&A and Real Estate Transactions: What is a Closing?
Cannabis Transactions and Letters of Intent
Cannabis Due Diligence Mechanics and Red Flags
Top Five Red Flags for California Cannabis M & A
What You Need to Know When Buying a Cannabis Business, Part 5: Structuring the Purchase
What You Need to Know When Buying a Cannabis Business, Part 4: Working With Brokers
What You Need to Know When Buying a Cannabis Business, Part 3: Hiring Your Lawyer
What You Need to Know When Buying a Cannabis Business, Part 2: The Regulatory Environment
What You Need to Know When Buying a Cannabis Business, Part 1: Overview