Risks and Values Right Under Your Feet: M&A Real Estate Considerations

Welcome to the Cannabis M&A Field Guide from MGO. In this series, our practice leaders and service providers provide guidance for navigating M&A deals in this new phase of the quickly expanding industries of cannabis, hemp, and related products and services. Reporting from the front-lines, our team members are structuring deals, implementing best practices, and magnifying synergies to protect investments and accrete value during post-deal integration. Our guidance on market realities takes into consideration sound accounting principles and financial responsibility to help operators and investors navigate the M&A process, facilitate successful transactions, and maximize value.

In the cannabis and hemp industries, capturing the true value of real estate holdings in an M&A deal can be both elusive and central to the overall success of the transaction. Difficult-to-acquire licenses and permits are essential for operating, which often drives up the “ticket price” of property, ignoring operational and market realities that suppress value in the long run. On the flip side, real estate holdings are sometimes considered “throw-ins” during a large M&A deal. These properties can hold risks and exposures, or, in many cases, are under-utilized and present an opportunity to uncover hidden value.

Both Acquirers and Target companies must take specific steps toward understanding the varied layers of risk and opportunity presented by real estate holdings. In the following, we will address some common scenarios and provide guidance on the best way to ensure fair value throughout an M&A deal.

Real estate as a starting point for enterprise value

Leaders of cannabis and hemp enterprises must understand that real estate should be a focus of the M&A process from the very beginning. All too often, c-suite executives are well-acquainted with detailed financial analyses for other parts of the business, but have a limited or out-of-date idea of their enterprise’s square footage, details of lease agreements, or comparable values in shifting real estate markets. Oftentimes it takes a major business event, like an M&A deal, to spur leadership to reexamine and understand real estate holdings and strategy. Regrettably, and all too often, principals come to that realization post-closing and realize they may have left money on the table.

In an M&A deal, the party that takes a proactive approach to real estate considerations gains an upper-hand in negotiations and calculating value. Real estate holdings can provide immediate opportunities for liquidity, cost-reduction, or revenue generation. At the same time, detailed due diligence can reveal redundant properties, costly debt obligations, unbreakable leases, and other red flags that would undermine value post-closing.

For both sides of the M&A transaction, real estate strategy and valuation should be a core consideration of the overall goals and value drivers of the deal. A direct path to this mindset is to place real estate holdings on the same level of importance as other assets that drive value – human capital, technology, intellectual property, etc. Ensuring that real estate strategy aligns with business goals and objectives will save considerable headaches and potential liabilities in the later stages of negotiating and closing the deal.
Qualify and confirm all real estate data

One of the harmful side-effects of a laissez-faire attitude toward real estate in M&A is that the entire deal can be structured around data that is simply inaccurate or incomplete. This inconsistency is not necessarily the result of an overt deception, but too often it is simply an oversight. Valuations can also be based upon pride and ego, without supporting market data.

Let’s visit a very common M&A scenario: The Target company has real estate data on file from when they purchased or leased the property (which may have been years ago), and that data says headquarters is 20,000 sq. ft. of office space. Perhaps they invested heavily into improvements like custom interiors that did nothing to add value to the real estate. The Target includes that number in the valuation process and the Acquirer assumes it is accurate. Following the deal, the Acquirer moves in and, in the worst case, realizes there is actually only 15,000 sq. ft. of useable space. Or it is equally common that the Acquirer learns the space is actually 25,000 sq. ft. Either way, value has been misrepresented or underreported. M&A deals involve a multitude of figures and calculations, and sometimes things are simply missed. But those small things can have a major impact on value and performance in the long run.

The only solution to this problem is to dedicate resources to qualifying and quantifying data related to real estate holdings. When preparing to sell, Target companies should review all assumptions – square footage, usage percentage, useful life, etc. – and conduct field measurements and physical condition assessments (“PCA’s”). This will help your team understand the value of your holdings and set realistic expectations, and perhaps just as importantly, it saves you from the embarrassment of providing inaccurate numbers exposed during Acquirer’s due diligence—and getting re-traded on price and terms. That reputation will ripple through the marketplace.

From the Acquirer’s side, the details of real estate holdings should come under the same level of scrutiny as financials, control environment, etc. Your due diligence team should commission its own field measurements and PCA, and also seek out market comparables to confirm appraisals. It is simply unsafe and unwise to assume the accuracy of any of these details. Performing your own assessments could reveal a solid basis to re-negotiate the M&A, and will help shape post-merger integration planning.

Tax analysis will reveal risks and opportunities

The maze of tax regimes and regulatory requirements cannabis and hemp operators navigate naturally creates opportunities to maximize efficiencies. This is particularly the case when it comes to enterprise restructuring to navigate the tax burden of 280E.

For example, it may be possible to establish a real estate holding company that is a distinct entity from any “plant-touching” operations. By restructuring the real estate holdings and contributing those assets to this new entity it may be possible to take advantage of additional tax benefits not afforded to the group if owned directly by the “plant-touching” entity. This all assumes a fair market rent is charged between the entities.

Recently, operators have looked to sale/leaseback transactions to help with cash flow needs and thus these types of transactions have gained prominence for cannabis and hemp operators. It is important that these transactions be carefully reviewed prior to execution to ensure they can maintain their tax status as a true sale and subsequent lease, instead of being considered a deferred financing transaction. If a Target company has a sale/leaseback deal established but under audit the facts and circumstances do not hold up, this could open up major tax liabilities for the Acquirer.

When entering into an M&A transaction, it is important that the Acquirer look at the historical and future aspects of the Target’s assets, including the real estate, to maximize efficiencies of these potentially separate operations. It is also equally important to review pre-established agreements/transactions to ensure the appropriate tax classification has been made and that the appropriate facts and circumstances that gave rise to the agreements/transactions have been documented and followed to limit any potential negative exposure in the future.

Contract small print could make or break a deal

An area of particular focus during due diligence should be a review, and close read, of the Target company’s existing property leases and other contracts. There are any number of clauses and agreements that seem harmless and inconsequential on the surface, but can have disastrous effects in difficult situations. In many cases the lease/contract of a property is more important than the details of the property itself. For example, if the non-negotiable rent on a retail location is too high (and scheduled to go higher), there may be no way to ever turn a profit.

The financial distress resulting from the COVID-19 pandemic has brought these issues to the forefront in the real estate industry. Rent payment and occupancy issues are shifting the fundamental economics of many property deals and contracts. If, for example, you are acquiring a commercial location that is under-utilized because of market demand or governmental mandate, you must confirm whether sub-leases or assignments are allowed at below the contract price. If not, you could be stuck with a costly, underperforming asset amid quickly shifting commercial real estate demand.

In many leases and contracts there are Tenant Improvement Allowance conditions that require the landlord to fund certain property improvement projects. If utilizing these terms is part of the Acquirer’s plans, you may need to have frank and open conversations with landlords about whether the funds for these projects are still available, and if those contract obligations will be met. Details like these are often penned during times of financial comfort without consequences to the non-performing party, but a landlord struggling with cash flow may not have the capability to meet contract standards.

These are just a few examples from a multitude of potential real estate contract issues that can emerge. It is recommended to not only examine these contracts very closely, but have dedicated real estate industry experts perform independent assessments that account for broader social, economic, and market realities. That independent analysis will help your executive team formulate a real estate strategy that better aligns with core business objectives.

Dig deep to uncover real value

There are countless scenarios where issues related to real estate make or break an otherwise solid M&A transaction, whether before or after closing the deal. The only path forward is to treat real estate holdings with the same care and attention paid to the other asset classes driving the deal. The cannabis and hemp industries have recently endured micro-boom-and-bust cycles that have left many assets under-performing. As Target companies offload these assets, and Acquirers seek out good deals, both parties must undertake focused efforts to establish the fair value of complex real estate assets and obligations.

Catch up on previous articles in this series and see what’s coming next…

Greater Than the Sum of its Parts: Keys to Post-Merger Integration

Welcome to the Cannabis M&A Field Guide from MGO. In this series, our practice leaders and service providers provide guidance for navigating M&A deals in this new phase of the quickly expanding industries of cannabis, hemp, and related products and services. Reporting from the front-lines, our team members are structuring deals, implementing best practices, and magnifying synergies to protect investments and accrete value during post-deal integration. Our guidance on market realities takes into consideration sound accounting principles and financial responsibility to help operators and investors navigate the M&A process, facilitate successful transactions, and maximize value.

Imagine a row of dominoes: every block between the first and last must be positioned perfectly, or else the last domino never falls.

Think of M&A transactions in a similar way. The integration of the two entities is both the ultimate goal, and the final phase. But every step between beginning and end must be aligned to facilitate that final result. If there is a failure or distraction at any stage, the whole venture can fail.

This analogy is important because, all too often, we see the integration phase of an M&A deal treated as an afterthought. When, in fact, it is as important as any other stage, and the considerations of integration should play a role throughout the M&A process.

Many cannabis and hemp industry M&A deals are driven by the desire to become vertically integrated, which in some cases, means an entirely distinct business unit will be brought into the fold (e.g., a retailer acquires cultivation/manufacturing facilities). The greater the fundamental differences between Acquirer and Target company, the greater the task of integration. As always, early planning and focused communication represent the only proven and viable path forward.

Integration planning is unique to every organization, and every M&A deal. In the following we will provide the broad strokes of considerations that both sides of the transaction should have in mind throughout the M&A process.

Integration basics: big picture goals

On its face, integration is simple: two companies are coming together to form a combined entity. When structured and executed properly, the ultimate goal can, and should be, making the final entity greater than the sum of its parts. To achieve this, both parties should focus on four key goals:

1. Maintain Momentum – Acquirer and Target company must not allow the M&A deal to significantly disrupt existing operations. Focus should be on a smooth transition that does not interrupt either party so the whole enterprise gains momentum.
2. Build On Each Other – Synergies and opportunities for value creation are typically the drivers of an M&A deal. Never lose focus on these dynamics and lean into them throughout the integration process.
3. Align Cultures and Optimize Organizational Structure – Often culture integration is an afterthought. However, the deal is just the beginning step, what comes after is integration of two different company styles. Establishing shared values and vision will translate into common organizational goals and ultimately faster success.
4. Leverage Efficiencies to Move Forward – The Acquirer is making the deal for a reason, focus on these strategic and tactical advantages to start maximizing value at the onset.

Dedicated and early integration process planning

The first step for ensuring a successful integration is to create a dedicated integration team that will devise a road map for delivering the synergies and efficiencies that were identified, and drove, the M&A deal. The team, as well as the road map, should be focused on delivering the expected value and transformational opportunities.

The road map should describe key activities and decisions throughout essential stages: pre-acquisition; first day following acquisition; weekly goals and metrics; 100 day goals, etc. This road map should address the following:

  • Sustaining ongoing operations for both the acquiring and acquired entities;
  • Satisfying existing customers and business relationships;
  • Identifying the critical decisions that must be made and including when they must be made;
  • Steps toward retaining essential employees;
  • Maintaining labor relations and productivity;
  • Integrating distinct corporate cultures
  • Organizing the processes for delivering the expected value to shareholders.

While an integration road map must be followed, it cannot be rigid. There are certain conditions that will only emerge once the deal is closed and the integration process begins in earnest. The integration team must communicate regularly and prepare contingencies and alternate plans to address unexpected issues.

Managing and avoiding personnel issues

A certain amount of personnel turn-over can be expected following any M&A deal. A lack of communication can cause distrust and dismay among Target company staff, and even among the Acquirer’s ranks. That is why a proactive approach to integrating the Human Resources (HR) function, and managing personnel, must be a high priority during the integration process.

The adjustments that occur in an acquisition can be significant, including changes in leadership styles, decision-making practices, organizational structure, and reporting relationships. All of these modifications can disrupt productivity, negatively impact morale, and decrease employee engagement.

To help prevent these negative consequences, an HR integration plan must be established in advance and should include the following steps:

  • Form a dedicated HR integration team — A component of the integration team should be solely responsible for managing personnel issues. They should be focused on mitigating cultural differences, directly and regularly communicating the change process, and retaining and motivating key employees.
  • Communicate upcoming events to all affected employees — Rumors spread rapidly and employees are often anxious due to the perceived job insecurity and uncertainty of their position in the acquiring company. Head off any cancerous rumors by communicating upfront with employees about the upcoming changes due to the acquisition.
  • Address employee concerns regarding retention — The HR integration team must examine the employment contracts of all staff for “change of control” clauses as well as employee stock options. They should then develop and communicate a plan to address these concerns.
  • Assessing corporate culture — The HR integration team must anticipate cultural challenges and take steps to integrate the two cultures. For example, one company may be driven by a sales mentality while another may be focused on innovation. Also, decisions in one company may be top-down while the other may be used to more participative decision-making. An integrated culture approach should be considered to mitigate the shock effect of the merger on the Target company’s staff.
  • Blend HR policies and procedures — This task can be resource and time-intensive, and include stages of legal review. But it is important to make sure all staff of the new entity understand the employee handbook, their benefits, and all other HR functions. Areas of focus include updating and communicating performance management procedures, training and development opportunities, and developing a shared intranet site.
  • Generate a strategy for continuance of benefits — A major point of concern for staff of the Target company will be changes to benefits. In the due diligence stage, the Target company’s benefit packages should be assessed and a pre-integration plan must be put into place that limits disruption of employee health and retirement benefits.

Making systems and processes one

One of the most essential and challenging segments of the integration process will be coordinating and implementing system changes. Particularly, in regard to Information Technology. Technology is pervasive, touching virtually all aspects of a company’s operations, and many of these functions are mission-critical. Because IT is the common denominator among all corporate departments, successful integration is critical to the success of the entire operation.

The following are the key steps to take when integrating IT functions:

  • Form an IT Steering Committee – Like the HR integration team, you should also designate a sub-group of professionals focused solely ensuring the integration of all IT operations.
  • Align corporate governance – Internal controls are essential in any industry, and cannabis and hemp are no exception. The Acquirer will have their own systems in place and the relative strength and compatibility of the Target company’s own system should be a focus of the due diligence process. The next step will be to combine or update the new entity’s policies, practices, and functions.
  • Implement applications and data system – In an ideal environment, the Acquirer and the resulting entity from the M&A deal will share a core information system. Achieving this will require a period of aligning processes and controls and consolidating and eliminating redundant functionality and platforms.
  • IT organization and structure – Key IT functions and responsibilities will need to be combined, assigned, and reorganized to support the mission, vision, and strategy of the combined organization.
  • Establish security and privacy rules – The new, combined IT environment will need clearly defined policies, standards, and responsibilities for ensuring appropriate handling and protection of company data across the organization.

Integration must be a priority – and not an afterthought

It won’t matter how much time and effort is put into the early stages of the M&A process if the post-merger integration is mishandled. You must keep this ultimate goal in mind throughout all stages and proactively plan for the smoothest integration possible. As with all things, every bit of pre-planning will pay dividends in the end. You want to be launching new products, entering new markets, or engaging in the other value drivers that spurred the deal in the first place. The alterna

Structuring Transactions to Maximize Value

Welcome to the Cannabis M&A Field Guide from MGO. In this series, our practice leaders and service providers provide guidance for navigating M&A deals in this new phase of the quickly expanding industries of cannabis, hemp, and related products and services. Reporting from the front-lines, our team members are structuring deals, implementing best practices, and magnifying synergies to protect investments and accrete value during post-deal integration. Our guidance on market realities takes into consideration sound accounting principles and financial responsibility to help operators and investors navigate the M&A process, facilitate successful transactions, and maximize value.

Deal structure can be viewed as the “Terms and Conditions” of an M&A deal. It lays out the rights and obligations of both parties, and provides a roadmap for completing the deal successfully. While deal structures are necessarily complex, they typically fall within three overall strategies, each with distinct advantages and disadvantages: Merger, Asset Acquisition and Stock Purchase.
In the following we will address these options, and common alternatives within each category, and provide guidance on their effectiveness in the cannabis and hemp markets.

Key considerations of an M&A structure

Before we get to the actual M&A structure options, it is worth addressing a couple essential factors that play a role in the value of an M&A deal for both sides. Each transaction structure has a unique relationship to these factors and may be advantageous or disadvantageous to both parties.

Transfer of Liabilities: Any company in the legally complex and highly-regulated cannabis and hemp industries bears a certain number of liabilities. When a company is acquired in a stock deal or is merged with, in most cases, the resulting entity takes on those liabilities. The one exception being asset deals, where a buyer purchases all or select assets instead of the equity of the target. In asset deals, liabilities are not required to be transferred.

Shareholder/Third-Party Consent: A layer of complexity for all transaction structures is presented by the need to get consent from related parties. Some degree of shareholder consent is a requirement for mergers and stock/share purchase agreements, and depending on the Target company, getting consent may be smooth, or so difficult it derails negotiations.

Beyond that initial line of consent, deals are likely to require “third party” consent from the Target company’s existing contract holders – which can include suppliers, landlords, employee unions, etc. This is a particularly important consideration in deals where a “change of control” occurs. When the Target company is dissolved as part of the transaction process, the Acquirer is typically required to re-negotiate or enter into new contracts with third parties. Non-tangible assets, including intellectual property, trademarks and patents, and operating licenses, present a further layer of complexity where the Acquirer is often required to have the ownership of those assets formally transferred to the new entity.

Tax Impact: The structure of a deal will ultimately determine which aspects are taxed and which are tax-free. For example, asset acquisitions and stock/share purchases have tax consequences for both the Acquirer and Target companies. However, some merger types can be structured so that at least a part of the sale proceeds can be tax-deferred.

As this can have a significant impact on the ROI of any deal, a deep dive into tax implications (and liabilities) is a must. In the following, we will address the tax implications of each structure in broad strokes, but for more detail please see our article on M&A Tax Implications (COMING SOON).

Asset acquisitions

In this structure, the Acquirer identifies specific or all assets held by the Target company, which can include equipment, real estate, leases, inventory, equipment and patents, and pays an agreed-upon value, in cash and/or stock, for those assets. The Target company may continue operation after the deal.
This is one of the most common transaction structures, as the Acquirer can identify the specific assets that match their business plan and avoid burdensome or undesirable aspects of the Target company. From the Target company’s perspective, they can offload under-performing/non-core assets or streamline operations, and either continue operating, pivot, or unwind their company.
For the cannabis industry, asset sales are often preferred as many companies are still working out their operational specifics and the exchange of assets can be mutually beneficial.

Advantages/Disadvantages

Transfer of Liabilities: One of the strongest advantages of an asset deal structure is that the process of negotiating the assets for sale will include discussion of related liabilities. In many cases, the Acquirer can avoid taking on certain liabilities, depending on the types of assets discussed. This gives the Acquirer an added line of defense for protecting itself against inherited liabilities.

Shareholder/Third-Party Consent: Asset acquisitions are unique among the M&A transaction structures in that they do not necessarily require a stockholder majority agreement to conduct the deal.

However, because the entire Target company entity is not transferred in the deal, consent of third-parties can be a major roadblock. Unfortunately, as stated in our M&A Strategy article, many cannabis markets licenses are inextricably linked to the organization/ownership group that applied for and received the license. This means that acquiring an asset, for example a cultivation facility, does not necessarily mean the license to operate the facility can be included in the deal, and would likely require re-application or negotiation with regulatory authorities.

Tax Impact: A major consideration is the potential tax implications of an asset deal. Both the Acquirer and Target company will face immediate tax consequences following the deal. The Acquirer has a slight advantage in that a “step-up” in basis typically occurs, allowing the acquirer to depreciate the assets following the deal. Whereas the Target company is liable for the corporate tax of the sale and will also pay taxes on dividends from the sale.

Stock/share purchase

In some ways, a stock/share purchase is a more efficient version of a merger. In this structure, the acquiring company simply purchases the ownership shares of the Target business. The companies do not necessarily merge and the Target company retains its name, structure, operations and business contracts. The Target business simply has a new ownership group.

Advantages/Disadvantages

Transfer of Liabilities: Since the entirety of the company comes under new ownership, all related liabilities are also transferred.

Shareholder/Third Party Consent: To complete a stock deal, the Acquirer needs shareholder approval, which is not problematic in many circumstances. But if the deal is for 100% of a company and/or the Target company has a plenitude of minority shareholders, getting shareholder approval can be difficult, and in some cases, make a deal impossible.

Because assets and contracts remain in the name of the Target company, third party consent is typically not required unless the relevant contracts contain specific prohibitions against assignment when there is a change of control.

Tax Impact: The primary concern for this deal is the unequal tax burdens for the Acquirer vs the Shareholders of the Target company. This structure is ideal for Target company shareholders because it avoids the double taxation that typically occurs with asset sales. Whereas Acquirers face several potentially unfavorable tax outcomes. Firstly, the Target company’s assets do not get adjusted to fair market value, and instead, continue with their historical tax basis. This denies the Acquirer any benefits from depreciation or amortization of the assets (although admittedly not as important in the cannabis industry due to 280E). Additionally, the Acquirer inherits any tax liabilities and uncertain tax positions from the Target company, raising the risk profile of the transaction.

Three types of mergers

1: Direct merger

In the most straight-forward option, the Acquiring company simply acquires the entirety of the target company, including all assets and liabilities. Target company shareholders are either bought out of their shares with cash, promissory notes, or given compensatory shares of the Acquiring company. The Target company is then considered dissolved upon completion of the deal.

2: Forward indirect merger

Also known as a forward triangular merger, the Acquiring company merges the Target company into a subsidiary of the Acquirer. The Target company is dissolved upon completion of the deal.

3: Reverse indirect merger

The third merger option is called the reverse triangular merger. In this deal the Acquirer uses a wholly-owned subsidiary to merge with the Target company. In this instance, the Target company is the surviving entity.

This is one of the most common merger types because not only is the Acquirer protected from certain liabilities due to the use of the subsidiary, but the Target company’s assets and contracts are preserved. In the cannabis industry, this is particularly advantageous because Acquirers can avoid a lot of red tape when entering a new market by simply taking up the licenses and business deals of the Target company.

Advantages/Disadvantages

Transfer of Liabilities: In option #1, the acquirer assumes all liabilities from the Target company. Options #2 and #3, provide some protection as the use of the subsidiary helps shield the Acquirer from certain liabilities.

Shareholder/Third Party Consent: Mergers can be performed without 100% shareholder approval. Typically, the Acquirer and Target company leadership will determine a mutually acceptable stockholder approval threshold.

Options #1 and #2, where the Target company is ultimately dissolved, will require re-negotiation of certain contracts and licenses. Whereas in option #3, as long as the Target company remains in operation, the contracts and licenses will likely remain intact, barring any “change of control” conditions.

Tax Impact: Ultimately, the tax implications of the merger options are complex and depend on whether cash or shares are used. Some mergers and reorganizations can be structured so that at least a part of the sale proceeds, in the form of acquirer’s stock, can receive tax-deferred treatment.

In conclusion

Each deal structure comes with its own tax advantages (or disadvantages), business continuity implications, and legal requirements. All of these factors must be considered and balanced during the negotiating process.

Catch up on previous articles in this series and see what’s coming next…

Emergency Cannabis QR Requirements

In February, the California Bureau of Cannabis Control (CBCC) announced the implementation of a new regulation mandating that cannabis retailers and delivery services have a Quick Response (QR) code certificate “in plain sight” on their windows and a copy in their delivery vehicles.

According to the CBCC press release, the emergency regulations are meant to address the vaping crisis: “The emergency regulations are designed to help consumers identify licensed cannabis retail stores, assist law enforcement, and support the legal cannabis market, where products such as vape cartridges are routinely tested to protect public health and safety.”

The code certificate needs to be posted within three feet of any public entrance to a cannabis dispensary or “in a locked display case mounted on the outside wall of the premises.” In addition to paper, the QR code certificate can be printed on glass, metal, or other material. It needs to be 8 ½ inches by 11 inches, the size of a standard sheet of paper. The code itself needs to be 3.75 inches by 3.75 inches.

The regulatory change was pursued by the CBCC to allow consumers and law enforcement officials to be able to quickly discern the origin of a product and ensure its safety after the code is scanned. QR codes will help consumers know they are purchasing a product from a vendor in the legal market.

The cartridges that caused the illnesses that led to the vaping crisis last year originated in the underground market. As of February 18th, 2020, the CDC reported 2,807 cases of illness associated with e-cigarettes across the U.S. and 68 cases resulted in deaths, with four of those in California.

“The proposed regulations will help consumers avoid purchasing cannabis goods from unlicensed businesses by providing a simple way to confirm licensure immediately before entering the premises or receiving a delivery,” said CBCC Chief Lori Ajax.

Unfortunately, illegal cartridges with a lethal amount of Vitamin E look nearly identical to those from legal retailers, as do underground sellers who maintain brick and mortar stores. And because they are underground, they do not comply with regulations. Recent estimates have shown that in California, the underground black market is more than twice the size of the legal market.

Those with smartphones will be able to scan the QR codes to ensure the product comes from a licensed retailer. When they scan the code, it will send them to the BCC’s License Search database where they will be able to see the business license number, license type, its official name, contact information, business structure, premise address, license status, issue date, expiration date, and activities.

In addition, you can see whether the business holds a license for adult use, medical, or both. The database also includes phone numbers and email addresses for all the businesses. In addition, you can see if they hold multiple licenses. Many of the businesses also have links to their respective websites. Active licenses are listed along with those who are suspended, canceled, revoked, inactive, or expired.

While the emergency regulations present another regulatory hurdle for compliant California cannabis businesses, the silver lining is that legal market operators can now advertise their compliance with safety standards – an additional edge in the battle to win market share from black market operators.

California Governor Issues Exec Order on Vaping

On September 16th, California Governor Gavin Newsome issued Executive Order N-18-9, the first state-wide effort to address emerging issues related to e-cigarette and cannabis vape use. The move by Gov. Newsom follows a report issued by the CDC earlier this month linking a number of deaths and other severe health concerns to vaping and electronic cigarette use.

Breaking down Gov. Newsom’s Executive Order

The California Executive Order opens with a bulleted list of facts and assumptions related to the growing use of vaping devices in California. Following are some of the more interesting points related to the cannabis industry (paraphrased from the executive order):

  • Vaping devices are the most commonly used tobacco product in California;
  • 80 percent of high school-aged tobacco users vape;
  • In 2018, 10.9% of high school students reported using e-cigarettes, and 14.7% reported using cannabis (ed: no detail provided on whether they vaped cannabis);
  • There are no manufacturing standards for non-cannabis vape products;
  • A clinical syndrome has emerged that connects respiratory failure to the use of illegally obtained cannabis products, cause of the syndrome remains unknown.
    The Executive Order goes on to list of Gov. Newsom’s multi-point plan to address the emerging vape issue. Key points include (paraphrased from executive order):
  • The California Department of Public Health (CDPH) is ordered to create recommendations for reducing the use of vape products by persons under the age of 21. Those recommendations should include health warnings for packaging and retail locations, increased enforcement of illegal vape sales, and establishing standards for measuring levels of nicotine and incorporating it into the calculation of taxes on vape products. Due 10/14/19
  • CDPH to allocate $20 million in funding to educational campaigns on the risks of vaping.
  • The California Department of Tax and Fee Administration (CDTFA) is ordered to provide recommendations for cracking down on the sale and use of illegal vaping products, particularly among under-age users. Due 10/29/19

The bad news for cannabis companies

In the weeks following the CDC report on the dangers of vaping, a media firestorm has emerged with more reports of vaping related deaths and illnesses. The negative media attention on vaping will almost certainly produce a public backlash, which could negatively affect sales numbers for e-cigarettes, and to a lesser extent for cannabis vaping products and oils. Further legislation is almost certainly in the works across the nation. Flavored e-cigarettes have already been banned (via Executive Order) in Michigan and similar measures are in the works for New York State and the city of Chicago.

As a result, sales forecasts and valuations for cannabis companies manufacturing or selling vape products, cartridges, and oils should account for a potential dip in public demand and limits on access in coming months.

The biggest concern for the cannabis industry is that cannabis vaping gets lumped in with the dangers of e-cigarette use, despite cannabis products having no nicotine or the other toxic chemicals associated with cigarette use. To date, none of the reported illnesses or deaths have been conclusively connected to legally produced cannabis vape products (although in one case of death in Oregon, a cannabis vape product is being investigated as a possible cause). The lingering issue is that “bad actor” illegal cannabis producers could be producing toxic, unregulated products that put the entire industry in the sights of lawmakers and regulators.

A nearly guaranteed outcome is that lawmakers and regulators will increase the oversight of legal cannabis producers. Further manufacturing, testing, packaging and marketing laws are likely to result, increasing the regulatory burden for cannabis companies based in California and throughout the US.

The “good” news for the cannabis industry

While the initial takeaway from laws and executive orders designed to curb vape-use have a number of negative business impacts on the cannabis industry, there is some silver lining for legally-operating and compliant cannabis businesses.

  • The Focus is on E-Cigarettes – As alluded to above, health officials, lawmakers and regulators are primarily focused on the widespread use of e-cigarettes, focusing especially on under-age use and the marketing of flavored oils (perceived as targeting young users).
  • Legally Compliant Cannabis Companies May Have Less to Worry About – Similar to the previous point, health officials and other investigators are focusing on illegally purchased vape products and e-cigarette products produced in a largely un-regulated environment. Cannabis companies fully compliant with state regulations, which include laws governing manufacturing, testing, packaging and selling cannabis products, are not currently the primary target of investigations. This could, in fact, present an opportunity for compliant companies to differentiate themselves and market the testing and quality control procedures their products undergo before hitting the market.
  • Vaping is Just One of Many Cannabis Consumption Methods – While vaping cannabis has becoming increasingly popular in recent years, a number of other consumption methods are also gaining widespread use. Edibles, tinctures, and topicals are fast-growing cannabis products finding defining new markets. Cannabis companies with diverse product lines may want to consider a strategic pivot away from vaping products in the interim and focus on less “stigmatized” products.

The science is still out

The ultimate take-away from the CDC’s report and subsequent investigations is that no direct causal relationships between vaping and potentially deadly respiratory illnesses have been proven. The CDC is advising the public against vaping until the science is clear and cracking down on illegally-produced and unregulated vaping products is a common sense step for public safety.

Cannabis companies and investors need not panic (yet) on the fate of cannabis vaping. We are certain to see changes in the coming months, especially in regard to regulations for manufacturing, marketing and selling vape products, but compliant companies have little to worry about in the near-term as long as they continue to update controls and follow regulations.

Cannabis Regulatory Round-Up – SAFE Act, STATES Act, New York, New Jersey and more

The legal, legislative, and regulatory landscape of cannabis in North America is dynamic and if there has been one constant since pioneering states implemented a legal ‘seed-to-sale’ adult-use market in 2014, it is change. And it is unrelenting.

To help cannabis entrepreneurs and investors keep up with the fast pace of change in the cannabis industry we will be providing monthly summaries of the latest regulatory and legislative news to provide a snapshot of latest happenings while also highlighting matters of interest looking forward.

This month the focus is on prominent federal legislative activity (e.g. the SAFE Act and the STATES Act), state legalization measures (e.g. NJ, NY, IL, and others), and two bills in Colorado that have the potential to attract out-of-state investment to that market.

Changes in federal cannabis legislation

With control of the House of Representatives being transferred to the Democratic party, several bills that have the potential to profoundly impact the cannabis landscape have advanced in Congress.  For example, the last week of March saw the House Financial Services Committee move forward the Secure And Fair Enforcement (SAFE) Banking Act to a full House vote, reportedly “within weeks.” Following the momentum of the House bill, U.S. Sens. Jeff Merkley (D-OR) and Cory Gardner (R-CO) have introduced the companion bill in the Senate.

The latest SAFE iteration addresses the cannabis banking crisis and includes amendments that offer protection to insurance companies and other financial services companies.

The banking issue is long-standing and predates even the implementation of recreational cannabis in the US. The lack of straight forward access to fundamental banking services for the cannabis industry creates a multitude of challenges, most notably the operational and financial difficulties of a multi-billion-dollar industry operating almost entirely in cash. This has obvious implications for public safety and potential diversion to the black market, among other concerns.

The inability to access banking services is often identified as a major hindrance to market entry for large and well-resourced corporations and removal of this barrier could herald a seismic shift in investment into the cannabis industry. At time of writing the House Bill had 152 cosponsors, including 12 Republicans, whereas the Senate bill has 20 co-sponsors.

Adding further momentum to the SAFE bill, last week Last week,  Secretary Steve Mnuchin offered his support for a legislative fix for the banking issues facing the cannabis industry. “There is not a Treasury solution to this. There is not a regulator solution to this,” he said. “If this is something that Congress wants to look at on a bipartisan basis, I’d encourage you to do this.”

Another potentially substantial piece of legislation is the Strengthening the Tenth Amendment Through Entrusting States Act (STATES Act), which aims to reduce conflict between federal and state laws as they relate to cannabis. The STATES Act is a potential gamechanger for the cannabis industry, allowing legal certainty for companies seeking to operate in dozens of jurisdictions across the US.

Although this legislation stalled in December, it was reintroduced on April 4th, alongside other measures, which include:

  • the Ending Federal Marijuana Prohibition Act that would effectively legalize marijuana at the federal level by removing it from the Controlled Substances Act.
  • The Marijuana Justice Act of 2019

The extent to which these bills have bipartisan support may be crucial if they are move beyond the House.

Four steps forward and two steps back in state legalization efforts

It has been a mixed month in terms of advancing cannabis legalization measures at the state level. On the one hand, there has been progress in multiple states, such as Connecticut, Illinois, and New Hampshire. While on the other hand there was a couple of snags holding up the implementation of recreational markets in New Jersey and New York.

Recent adult-use cannabis legalization headlines include:

  • The New Jersey cannabis legalization bill was pulled due to lack of support although Gov. Murphey (D) reportedly stated he remained committed to getting the bill passed.
  • New York dropped cannabis legalization from its budget bill where it was viewed as more likely to pass, however, regulators remain optimistic of progress later in the year. The New York City Council also voted to ban cannabis testing for job applicants.
  • A General Law Committee in the Connecticut Legislature approved a bill that would legalize an adult-use cannabis market in the state.
  • In New Hampshire, the House Ways and Means Committee approved a vote on the floor on legislation that would legalize an adult-use cannabis market.
  • A bill to legalize retail cannabis in Illinois was introduced and passed to a subcommittee for further consideration.
  • Governor of Guam signed a bill legalizing cannabis, becoming the first US territory to do so.

Despite the hiccups outlined above, there is a clear trend towards legal cannabis across the US. Moreover, several states took steps towards expansion or liberalization of their medical cannabis markets. Certainly in the long term, the outlook is optimistic for the cannabis industry on a number of fronts.

Back to the future as Colorado looks to position itself as an investment hub for cannabis

When Colorado became the first state to implement an adult-us cannabis framework in 2014, out of state investment was restricted. This allowed the state to build upon its existing medical cannabis market.

The understandable caution has since been questioned, however, and a Bill offering more flexibility in investment passed both the Colorado House and Senate in 2018, only for then Gov. Hickenlooper to veto it. In 2019, a replacement Bill was introduced and has recently passed its third reading in the House unamended.

As an established market with mature regulations and market stability, Colorado has low-risk potential when compared to emerging markets in other states – although competition is likely to be strong, with ever-thinning margins as prices continue to drop in the state.

Out-of-state investors exploring options in Colorado may be interested in acquiring social consumption licenses in Denver, or seek opportunities for market expansion in the delivery segment of the market. If passed, HB19-1234 would allow licensed dispensaries to offer these services for the first time.