Five steps that founders of marijuana businesses can take to make their companies more attractive to potential suitors
As merger and acquisition activity accelerates across the cannabis industry, many companies are discovering that they don’t need a for-sale sign in the window to be a takeover target.
The flurry of M&A activity, which is on pace to double this year, is giving more company founders a chance to cash out at an attractive price after years of working 24/7 to build their businesses. It also can provide founders with a hefty pot of cash to launch their next venture.
“I never imagined that I would sell this company just two years after we launched it,” said Mason Levy, co-founder of cannabis tech app WeGrow, an educational platform for home growers. “I was dead set on being with the company for decades.”
That plan changed after the company was approached by VividGro, a Rhode Island lighting solutions firm that had been using the WeGrow platform for its customers and wanted the technology for its own use. After months of negotiating, legal work and financial audits, Levy and business partner Rodolfo Ramirez sold to VividGro for an undisclosed price.
“It gave us a nice cash infusion,” Levy said of what prompted the partners to sell. Additionally, the deal allowed the team to focus full time on their chatbot tech startup, Swivl.
For well-positioned companies, the M&A landscape provides an opportunity to take their businesses to the next level.
As more companies become potential acquisition targets, here are five key steps businesses and their founders should consider before a buyer comes knocking on the door.
1. Seek Competing Suitors
For firms on the selling side, creating competition among prospective buyers is critical to commanding the best price, said Scott Greiper, president of Viridian Capital Advisors, a New York company that tracks M&A activity and represents buyers and sellers across the industry.
“You never want to engage just one buyer initially,” Greiper said. “When we launch an assignment representing a seller, we put together a universe of buyers – 50 to 60, that is large enough to create competition.”
Second to competition, he added, is time.
“You cannot allow a buyer to wait you out so you become a desperate seller,” he said. “At the end of the day, you want this to be a very diligent process that stays in the timeline of finishing due diligence but creates a sense of urgency. That’s how you can push to get a better price.”
2. Build Your Brand
At Terra Tech, a publicly traded cannabis company with retail and production facilities in California and Nevada, leaders have been vocal about making their business an appealing takeover target – under the right conditions.
“In a perfect world, we’ll be able to uplist on the Nasdaq or NYSE and get real investment banks behind us and truly capitalize these companies. But right now, I have to stay flexible, because that’s policy-driven and something I can’t control,” said Derek Peterson, Terra Tech’s CEO. “We’re either going to be stand-alone, or we’ll try to position to be the most attractive takeover target there is.”
Key to that strategy, Peterson said, is creating “barriers to entry for the competition” through branding and market saturation.
Afzal Hasan, CEO at Ontario, Canada-based CannaRoyalty, agreed. In April, the firm acquired California-based FloraCal, a grower of high-end flower product, in a deal valued at more than $5 million.
“FloraCal has been on the market for a number of years, and there has consistently been high demand for their products,” Hasan said. “Most importantly, when we looked at their sales it became clear that because of their product branding and consistency, consumers are willing to pay more for their premium product.”
Both CEOs suggested the following to boost your firm’s appeal:
- Beef up your brand. As the price of cannabis declines, brands become critical to commanding higher consumer demand and price. Product consistency and authenticity are key attributes to building a strong brand.
- Embed your business and products in key markets that will be attractive to potential suitors. Once there, saturate the market to deter competitors from swooping in.
Put another way: “It’s as simple as if you have the best-looking house on the block in a great neighborhood, you’re going to command a higher price,” Peterson said. “It’s not rocket science, but the execution of that strategy is where the work comes in.”
3. Know Your Worth
Knowing your company’s value and the price you would accept to sell it is critical, said Patrick Rea, co-founder and CEO at Colorado-based business accelerator CanopyBoulder.
“It sounds simple, but it takes a lot of work,” he said.
Rea suggests factoring in the following when considering your firm’s valuation:
- Price out the opportunity. What is your firm’s potential cash flow? It’s the line item acquirers are often most interested in. Accountants and business brokers can help you crunch these numbers using common ratios that take into account the possible revenue multiple or profit multiple to price your company, depending on the particular business sector.
- Compare other deals. If your firm is a hot M&A target, it’s likely others in your sector are, too. Take note of deals involving companies comparable to yours.
- Build a network of investment bankers and brokers that are actively engaged in deals in your sector or market.
- Network closely with other entrepreneurs and business owners in your sector.
- Talk up your company’s valuation on a regular basis when speaking with investors and executives at other businesses.
“The big mistake is to never talk about your worth and valuation and then surprise stakeholders when you bring it up,” Rea said.
4. Implement Good Governance
For companies actively seeking a buyer, having corporate governance basics in order is a must, Rea said.
“You want to make sure your lawyer is engaged if there are any votes, actions or adjustments to your financials. And make sure everything is well documented,” he said. “If not, it’s a signal to an acquirer that something may be out of line.”
A potential acquirer will likely pause if the following controls or considerations are unaccounted for:
- Updated audited financials: Avoid creating headaches for your potential acquirer by having your financial house in order; that includes updated balance sheets and audited financials.
- Corporate governance controls: Be prepared to show that you have strong controls in place, including updated board minutes and documentation of all board votes and decisions.
- Good shareholder communications: Whether you have a wide shareholder base or a large shareholder, be prepared to show that you’ve been in regular contact with your key investors or shareholders.
5. Hire a Broker
Beyond the team of auditors, accountants and attorneys needed to help craft your deal, a business broker can be an invaluable asset, Rea said.
He noted that tapping a broker as the chief point person can be especially helpful for founders who may continue to want to play a role in the business after it’s sold.
“Think of it as a sports agent negotiating on your behalf,” he said. “It’s always good to have someone else be the tip of the spear, so you can avoid any bad blood post-deal.”
Be particularly choosy when hiring a business broker. Cannabis has legal and regulatory baggage that makes it different from any mainstream industry.
“Cannabis is not a normal market. It’s 30(-plus) markets across the U.S. that all have different laws to abide by,” Greiper said. “You really want someone that has significant experience in the space and understands the challenges of buying and selling companies in this industry.”
When choosing a broker, Greiper said:
- Ensure the broker is licensed by the Financial Industry Regulatory Authority, which governs best practices and regulates broker-dealers.
- Seek experience. Consider the number of deals any broker has completed in the cannabis space but be sure to ask to speak with past clients.
- Keep an eye on cost. Be aware that most brokers require retainer fees that can range from $25,000 to $75,000, depending on the size of your firm. That can be in addition to “success fees,” which are paid out once the company is sold. Those costs can range from 2% to 5% of the price paid for your firm.
Beyond creating competition among buyers, brokers are critical in helping carry out the due diligence needed to ensure the potential acquirer is the right fit and helping outline the deal structure to ensure you get the best price, Greiper said.
“Cash up front is the most important factor,” he said. “If they’re offering stock: Is it public or private? What carries the most value to you?”
Many buyers will push to work in certain benchmarks that trigger payment to a seller at the end of the deal, Greiper said.
“The structure of those considerations is critical,” he said. “Is the bar that the seller’s business has to double in a year to achieve the earnout? That’s probably not a great deal.”
M&A activity spikes
The first half of 2018 delivered an unprecedented spike in merger and acquisition activity, with nearly 150 deals announced across the cannabis industry, according to Viridian Capital Advisors, which tracks the sector’s investment activity in the United States and Canada.
That’s almost double the activity during the same period last year.
Among the top deals:
- MedMen Enterprises signed a $53 million deal to acquire a Florida-based cultivator and secured the right to open up to two dozen dispensaries across the state. The acquisition of Treadwell Simpson Partnership catapults MedMen – operator of 18 cannabis facilities in California, Nevada and New York – into Florida’s growing medical marijuana market, which is poised to become one of the nation’s largest.
- Kush Bottles closed a deal worth more than $3.2 million to buy Colorado-based Summit Innovations, a purveyor of hydrocarbon gas used by marijuana extract producers.
- British Columbia-based cultivator Emerald Health Therapeuticssigned a deal worth $68.3 million (CA$90 million) to buy rival cannabis producer Agro-Biotech. The agreement expands Emerald’s footprint into Quebec, Canada’s second-largest province.
- Aurora Cannabis inked a deal to acquire rival Canadian cannabis producer MedReleaf in a transaction valued at $2.5 billion (CA$3.2 billion), creating one of the largest marijuana companies in the world.
Deals among Canadian cannabis firms dominated the first half of the year’s activity and delivered the highest valuations as companies hustled to prepare for the country’s impending adult-use market, said Harrison Phillips, vice president at Viridian Capital Advisors.
“But the U.S. is the endgame for many operators because of the size of the market potential,” he said.
The desire for a U.S. footprint and recent spike in capital raises is a strong signal that more investment is on the horizon, Phillips said. Through the first half of the year, cannabis firms across the globe raised more than $4 billion – more than triple the amount of funding in 2017.
“The U.S. is still relatively untapped, and we’re far from the scale and magnitude that this industry could be operating at,” he said. “We expect that there is going to be significantly more capital coming into this space.”
– Lisa Bernard-Kuhn
