Part 4: Confirm Deal Terms
In the series “Marketing a Cannabis Company for Sale,” Dena Jalbert, walks through the nuances and intricacies involved in preparing a business for sale in the cannabis industry. This article, “Part 4: Confirm Deal Terms,” is part four of a five-part series.
At this point in the process of marketing your cannabis company for sale you have laid the groundwork for finding the ideal buyer for your company including mapping out your strategy, assembling a strong M&A team and identifying profitability and financial trends. Now it’s time to determine how well-aligned you and a potential buyer are on deal terms.
A letter of intent (LOI), sometimes called a memorandum of understanding (MOU), outlines key deal terms and is an initial expression of intent by you and the buyer to move forward on the deal. A LOI is essentially non-binding and acts as a framework that describes how the deal will proceed.
Given the legal, regulatory, tax and valuation complexities of the cannabis industry, less is not more when it comes to LOIs. A LOI that is vague and does not cover key terms can endanger a deal when you and your buyer realize you didn’t agree on principal terms. By contrast, a LOI that is very detailed will help hammer out key terms, saving you time and money in the process of arriving at a definitive agreement.
Getting to the LOI stage of the M&A process is often described as an engagement signaling that both parties are committed to a marriage. Confirming deal terms in a LOI is an important step in the process to ensure that there is agreement on these terms before entering into the lengthy and costly process of performing due diligence and negotiating final contracts.
Your M&A team, including attorney, CPA and advisor, will work with you to understand the proposed material terms outlined in the LOI and ensure there are no deal-breaker issues.
Some of the terms spelled out in a LOI include:
Structure of the Sale
The LOI defines what is being purchased – assets or stock. An asset sale is the purchase of individual assets and liabilities, while a stock sale is the purchase of the owner’s company shares.
If you are selling your company in an asset sale, you would retain possession of the legal entity, while the buyer would purchase individual assets of your company, such as equipment, fixtures, licenses, trade secrets, trade names and inventory
In a stock sale, the buyer purchases the selling shareholders’ stock directly, obtaining ownership in your legal entity and assuming all of the known and unknown liabilities of the business. In other words, instead of choosing specific assets and liabilities to acquire, the buyer purchases an ownership stake in your entire business.
Many cannabis businesses are purchased for a mix of stock and cash, and it is important for you to understand the implications of the stock part of the deal. Because valuations are currently highly inflated in the cannabis industry, there is a real risk that the shares issued as payment for your business will devalue in the future. However, if the market remains strong, you could realize a big payoff. Your payoff will depend on the market, so understanding the terms around when and how you can sell those shares is important. Your M&A advisor will make sure you are clear on terms, so you know what to expect from a worst case/best case scenario.
The LOI will include the amount that the buyer proposes to pay for your business as well as the timing and manner of payment (how much will be paid at closing versus post-closing and whether any post-closing earnout payments are contingent on future events and/or performance targets).
It is important to work with your M&A team to understand what these earnout events and/or performance metrics are and what autonomy and resources you will have to hit those metrics.
A LOI can also include a description of the buyer’s intentions for key employees to remain with the company after the deal closes, including defining roles and compensation levels for these employees. In cannabis M&A, it is common for the buyer to specify that deal closing is contingent on certain employees signing employment contracts and noncompete agreements. Buyers want to retain top talent, recognizing that the cannabis industry is a young industry with a scarcity of experienced employees.
A description of any regulatory approvals or third-party consents that will be required will also be included in a LOI. As the seller you will need to provide representations and warranties about all consents and approvals, as this will be a condition to the transaction closing. It is particularly important that your M&A team have experience in the cannabis industry in order to advise you on the developing regulatory landscape in the industry and what approvals and third-party consents should be part of the LOI.
A high-level summary of the scope of your indemnification obligations to the buyer is also often part of a LOI. These terms allocate risk between the buyer and seller. The complex legal environment in the cannabis industry impacts the allocation of this risk with buyers sometimes requiring that losses from representations made about your business not be subject to regular caps, deductibles and other indemnification. You should work with your M&A team to gain a clear understanding of the indemnification obligations outlined in the LOI, including the amount of time you will be liable for these representations.
A signed LOI is a significant milestone in the M&A process, confirming understanding, expressing commitment to the transaction, and setting ground rules for future negotiations.
Once you have a signed LOI, you are well on your way to selling your cannabis company.
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