Dispensary consolidation is inevitable, with the strong expected to get stronger by scooping up smaller operators. To learn more about the current state of cannabis retail consolidation, read this post.
If you're in the market to purchase a dispensary business, you're in the right place. This post covers the acquisition process, plus expert advice and red flags to avoid.
The first question: Do you need representation?
A good starting question in any acquisition is whether or not to get representation for your deal. While you can certainly prospect yourself, there are significant advantages to soliciting the help of an investment banker.
Working with an investment banker
Investment bankers, particularly those well-versed in the cannabis industry, make it their business to know all the buyers and sellers. They can also help you structure a deal.
Working with one of these experts saves time and money, plus it spares you some of the hair-pulling frustrations that come with making deals in this colorful, unruly industry.
David Kram has been an investment banker in the cannabis industry for more than a decade. He’s been involved in the purchase or sale of dozens of cannabis licenses and shares his insights actively on LinkedIn.
Investment bankers cut through the noise and save the buyer a ton of time and energy that they would have spent on their own outreach and forming relationships that they don't have.
David Kram, Cannabis M&A and Capital Advisory
Banker benefits and fees
Essentially, an investment banker streamlines the acquisition process and ensures busy executives who may not have a holistic understanding of their target market aren’t wasting time negotiating.
"Time is our only limited resource, especially in business," Kram notes. "If you don't work with someone who can present opportunities to you quickly, you risk missing out on deals."
Bankers have two types of fees:
- Retainers are either paid up front or monthly for the duration of the engagement.
- Success fees are a percentage of the transaction at close.
Retainers can run into the tens of thousands of dollars, while success fees range from 4-7%, though percentages may decrease as deal sizes increase.
Sourcing your own acquisition opportunities
The alternative to working with an investment banker is to source buying opportunities on your own. Depending on your cannabis network and internal team, this is either a massive undertaking or a money-saving, realistic endeavor.
Some online sourcing opportunities already exist in cannabis, such as:
But some of the best deals may not be easy to find on these sites as many are off-market, given the need for discretion when selling an active business with staff and a loyal consumer base.
Investment bankers are plugged into this hidden deal flow and working with them gives you access to lesser-known opportunities.
Finding the right deals
Getting to the point of purchase in a cannabis retail acquisition takes time, due diligence, and repetition. You’re unlikely to land your dream deal on the first attempt.
Set parameters to identify a target list
Before you reach out to retailers, you must set some boundaries to narrow down your search. Identify key acquisition parameters such as:
State(s)/region
License type
Business size
Local competition
Tax level
Financial performance (EBITDA positive or not)
Once you dial in on what types of cannabis businesses you want to target, you can begin reaching out.
Outreach to potential sellers
This step involves creating a prospect list and reaching out to potential sellers, which Kram says should take from 30 to 60 days.
After that, "A buyer would then whittle down the list and select two parties based on the criteria," says Kram. "At this point, we’re looking to discern if the sellers are reasonable in their expectation of value, if they seem to be good people and if we think we can get a deal done."
Finding sellers with realistic expectations isn’t as simple as you might think, and it requires being plugged into the market to understand what the going rate for a particular asset is.
Presenting a Letter of Intent (LOI)
Once you’ve narrowed your list down and found some business owners who are open to your price, it’s time to present them with a letter of intent, or LOI.
A letter of intent is a non-binding agreement between two parties that essentially formalizes interest in an acquisition without holding anyone legally to the numbers quoted or the loose terms outlined. LOIs almost always contain an exclusivity clause for the seller, meaning they can’t court another potential acquirer for the business for the time being.
"If I, the buyer, get the seller to sign an LOI, they’re committing to me for the next 60 days and together we will act in good faith to try to reach a deal," says Kram.
Conducting due diligence
Following sourcing, outreach, and a letter of intent comes a period of due diligence where the buyer determines if the dispensary is worth the investment.
Due diligence is the process of diving into a company’s financials, tax liabilities, legal history and anything else that could influence the sale price, cause the acquirer substantial headaches down the line or thwart the deal entirely.
Diligence typically lasts around 60 days (though it can be much longer) and is kicked off by signing a mutual Non-Disclosure Agreement (NDA) and followed by the presentation of a data room containing key information about the company.
Keep in mind that in cannabis, there are a lot of potential stumbling problems lurking in the diligence period.
Insider advice on due diligence
Industry insiders have seen both sides of cannabis M&A deals. They urge caution when conducting due diligence.
"Back in the day, when these M&A transactions were happening, we used to see companies doing the least amount of due diligence," says Phil Carlson, Managing Director and Investor Relations Lead for KCSA, a strategic communications firm. "Now you have to spend a lot of time doing this and making sure that it’s the right deal out there for you."
During the diligence period, buyers need to pay attention to current performance as well as historicals.
"You should continuously ask for monthly updates to make sure that the dispensary is maintaining its run rate," says Kram.
Run rate refers to a technique for estimating future revenue for an extended duration (typically a year) by considering the revenue generated in the past. If a cannabis operator generated $30,000 in sales during the previous quarter, the projected annual run rate would be $120,000.
"Sometimes these guys already have one foot out the door," Carlson adds. "You want to make sure they’re going to continue to operate and execute as they should so that when you close you have momentum in the right direction."
It’s also good practice to keep your finger on the pulse of the state and local market, as valuations can fluctuate during the diligence period and this could help you negotiate the price down.
For example, California’s 8% drop in legal cannabis sales last year would warrant a re-evaluation of any California cannabis retailers you’re targeting.
The volatility of the cannabis industry means no stone can be left unturned in the diligence phase of acquisition. It also means valuations may change in an instant—keep that in mind before making an offer.
Presenting the initial terms sheet
Should you emerge from the other side of the diligence process still keen to work with this team to acquire the asset, the next step is to present them with the initial terms sheet.
An initial terms sheet outlines the basic terms and provisions for a deal and serves as the foundation for more comprehensive and legally binding agreements to follow.
When the involved parties agree on the terms specified in the term sheet, a final contract that reflects those terms is created.
At this point, the final stretch of diligence is done by lawyers on either side who work out how to transfer ownership of the license with the state and local regulatory counsels.
Definitive documents will come 30-60 days after the LOI is signed. Those documents are binding.
Red flags to avoid in cannabis acquisition deals
The cannabis industry's youth can present problems for acquisition deals.
Some cannabis contracts are already notoriously predatory, but M&A deals are especially tricky, particularly as they pertain to corporate hygiene.
Keep an eye out for these red flags:
🚩 Lack of documentation
Cannabis M&A attorney Julie Herzog stresses the importance of sellers ensuring they have orderly books, SOPs, dispensary org charts, and other forms of documentation which just a few years ago might have landed them in prison.
"They went from writing down as little as possible to having a paper trail for everything,” Herzog told mg Magazine. "We need a receipt for every transaction, we need to know exactly what you are selling."
If a retailer lacks proper documentation, you’ll want to either walk away or build the labor cost of this effort into the purchase price.
🚩 Hidden selling motives
In modern cannabis markets, distressed sales are on the horizon. However, a seller may not disclose their reason for selling so readily.
Regardless of business performance, owners will try to paint their dispensary in a positive light—if you can’t see a clear reason for them to sell, there may be something they aren’t telling you.
🚩 Lack of endurance for a diligent sale
With a decade facilitating deals in the industry, David Kram has met his fair share of eccentrics and warns of potential friction when trying to introduce formal business and legal procedures.
One thing I always try to determine is whether this person can endure a 6 to 12 month diligence process to get a deal done. Is this someone that could be responsive to questions from lawyers? Is this someone who is amenable to negotiation? Is this a person who has experience in business and knows how to present themselves professionally and answer questions clearly, or is this someone who is completely inexperienced, can’t present well and basically doesn't know what they're doing?
David Kram, Cannabis M&A and Capital Advisory
Keep an eye out for entrepreneurs who don’t seem like they can go the distance to make a good deal.
🚩 High employee turnover
The cannabis retail industry already sees higher-than-average employee turnover, but you can learn a lot from a business if it can’t hold onto employees. If workers are heading for the door on a regular basis, there are likely deeper issues at play beyond the cannabis industry’s fast pace, tedious regulations and strict cannabis laws.
🚩 Emotional sellers
The ‘phantom number’ phenomenon happens when previous valuations of a sellers' assets is much higher than what the business is worth today. This sentiment that the business is worth more may lead to emotional sellers who aren’t always easy to work with.
You can curb any unnecessary emotion in the selling process by working with a banker or mediator.
"Bankers help guide buyers and sellers to focus on the realities and remove the emotional component of deal-making, because emotions are one of the biggest reasons why deals don't get done,” says Kram.
The bottom line
We are ushering in a new era of structured commercial cannabis deals. Whether we see mass consolidation this year or in the near future, mergers are inevitable.
Your goal is to end up on the right side of M&A deals and operate in a straight line toward profitability and higher market share. Keep the tips mentioned in this article top of mind in your research, negotiation and finalization of any cannabis business acquisitions.
If you are a cannabis retailer considering a merger or acquisition for your company, I'd love to hear your perspective. Connect with me on Linkedin.
Disclaimer: This post is not meant to provide legal advice. Consult a lawyer or financial professional for advice.
