Preparing for an Exit – Compliance Due Diligence

Guest post by Ryan Girard, CEO of Complia

Consolidation in the cannabis industry is inevitable.  We’ve already seen a few high profile acquisitions in the space including the Helix TCS’ (OTC: HLIX) acquisition of Cannabase and Terra Tech’s (OTC: TRTC) acquisition of Blüm Oakland.  There have also been countless less publicized acquisitions in markets like Colorado where larger established brands have capitalized on opportunities to extend their brands by gobbling up mom and pop operators.

Traditional Considerations

For those businesses that hope to position themselves as attractive acquisition targets, there are countless components of the due diligence process the business should be prepared to address.  Acquirers are wise to understand a wide range of components of the target business including:

• Financial information including financial statements, audits, credit reports, control procedures, and analysis of expenses and margins
• Organizational items such as articles of incorporation/operating agreements, company minutes, and capitalization table
• Assets including inventory, equipment, and real estate
• Intellectual property (patents, branding, process, etc.)
• Tax history including tax returns from previous years at federal, state, and local levels

The traditional due-diligence requirements of buying a business are well established and are very applicable when investing in any industry–cannabis included.  However, there are extraordinarily stringent compliance requirements that are unique to cannabis that may threaten the asset you are purchasing if not taken into consideration.

Cannabis Compliance Considerations

It is far too easy to overlook what may be the most critical component to an acquisition in the cannabis space: regulatory compliance due diligence.  As many cannabis insiders joke, the only industry more regulated than cannabis is nuclear energy.  As a result, it is of the utmost importance acquirers take the time to better understand a target’s compliance standing and history.

Licensing

First and foremost, it is critical to validate the authenticity and standing of all marijuana business licenses from both state and local regulators.  Just recently Cannacea, a marijuana business in Oregon, captured headlines as reports surfaced of Cannacea management fabricating letters from regulators to entice investors.  We’ve also heard reports of operators using tools like Adobe Photoshop to simply produce fake licenses.

States like Colorado offer an online database of license standing.  This is an easy place to start.  However, it is also strongly advisable to call the regulator by phone (or pay them a visit in person) to verify the authenticity of all involved licenses.

Investigatory History

Additionally, it is of critical importance to understand if the target business has had any negative run-ins with regulators in the past.  It is entirely reasonable to ask the the target to provide copies of all inspection records from all applicable regulatory bodies including marijuana regulators, health regulators, fire department officials, law enforcement, OSHA, agriculture departments, and others.

As with licensing, acquirers are strongly encouraged to reach out to regulatory bodies to verify the information provided.  Most regulatory agencies will provide copies of all applicable records for a nominal fee provided the business owner has provided permission.  In some cases, the Freedom of Information Act (FOIA) or local equivalents (such as CORA, the Colorado Open Records Act) can be utilized to dig up additional information.

In the event this research reveals a pending investigation, it would be wise to involve legal representation to ensure that appropriate protections are employed in the event the outcome of the investigation causes damage to the target entity.  Because there is still a rather limited set of enforcement/disciplinary data available from historical investigations, use extreme caution if exploring a deal with an entity that is pending investigation.

Operational Compliance

Regulators aside, it is of critical importance to carefully inspect the business and review business records for any compliance issues that might not yet have been identified by regulators.  In markets with hundreds of marijuana businesses, it’s not uncommon to hear about marijuana businesses that have never received a visit from a marijuana-specific regulator.  As such, regulator inspections records cannot be relied upon as a definitive tool when evaluating a business’ compliance program.

It is advisable to request that the target business furnish a wide range of documentation including:

• Current and previous licenses (for the past three years) and all regulatory filings from the previous year (including license renewal packets, modifications of premises, change of location, change of trade name, change of ownership, etc.).
• Detailed documentation surrounding involved entities, property owners, locations, local licensing authorities, and owners.
• Employee files (which should include applicable compliance documentation including pesticide applicator certificates, food handler certificates, occupational badges, etc.)
• Laboratory test data (including all evidence to support full compliance with applicable and required testing standards – keep a close eye out for pesticide issues!)
• Inventory tracking and appropriate use of required State mandated seed-to-sale tracking tools

Moreover, it is critical that the target business is carefully inspected and vetted for all appropriate on-site compliance requirements including:

• Security systems and associated logs
• Visitor logs and visitor history
• Incident logs
• Required packaging, labeling, and signage
• Compliant facility layout with clearly defined restricted and limited access areas
• Patient records and designations

This is only a small taste of the full breadth of what should be closely examined.

Conclusions

To those business owners hoping to one day sell their business, take proactive steps today to secure your business and maintain comprehensive compliance records.  Your diligent compliance efforts will build value into your business and secure your most valuable asset: the license that allows you to generate revenue.  

Several compliance tools are now available to operators, including Complia, which help business owners keep up with the wide range of components that play into a compliant business.

For those looking to acquire a cannabis business, especially those who don’t have previous industry experience, don’t overlook compliance during the due diligence process.  This is a complex and specialized field that needs very careful attention.  Given the highly complex regulatory environment surrounding cannabis, regulators command a great deal of power and have tremendous influence on operations.

We have only just started to see the tip of the consolidation iceberg.  It’s only a matter of time before we hear more about deals gone bad because of compliance issues.  Don’t let cannabis compliance fall by the wayside and allow your next acquisition to fizzle.

About the author
Ryan Girard is the CEO & Co-Founder of MyComplia.com, the Quickbooks of marijuana compliance software.  Complia’s industry leading, cannabis compliance software provides peace of mind for cannabis operators by securing their business and saving countless hours automating arduous compliance work.

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