Snakes in the Grass: Due Diligence and Proper Vetting of Potential Deals
By Heather Burke and Virginia Ryan
Considering the collective/cooperative model did not always allow sellers to vet buyers by anything more than word-of-mouth, today’s operators have a greater ability to vet those with whom they do business. Although business deals can and will still go sideways in the regulated era, licensees undoubtedly have more options in choosing business partners who give the deal a greater chance at success. When vetting a potential deal partner, I usually ask:
(1) Who are the potential deal partners (like, really, who are they?); and
(2) Will the deal benefit our goals?
Determining Who the Potential Deal Partners Are:
When figuring out who you’re about to do business with, I usually look at three areas: (1) regulatory vetting, (2) business vetting, and (3) the old school gut test. Here’s a quick rundown of the first two:
1. Regulatory Vetting
The law is clear that “all commercial cannabis activity shall be conducted between licensees.” 3 C.C.R. § 5032 (a). That means that a potential deal partner must have an active license from the State of California for the type of activity they will be providing to you.
For instance, if a manufacturer is offering to pick up your product, they will need both a manufacturing license and a distribution (Type 11) or transport (Type 13) license. Smart operators will utilize the BCC, DPH, and CDFA license search features to verify the validity of each license that will be involved in the deal and double check the validity of all relevant licenses prior to each transaction.
While each party has a duty to keep their licenses valid, and that representation or warranty should be included in any written agreement, that does NOT absolve the other party of the regulatory violation that would occur if they entered into a transaction with a party that did not have a license. As such, there is no substitute for double checking prior to each transaction.
2. Business Vetting
- Is their entity filed properly on the Secretary of State website? Was the Statement of Information(s) filed timely?
- If they do business under a trade name, do they have a DBA on file in the County where their principal place of business is located?
- Does the person you’re speaking with have “the capacity to bind the entity?”
- Are written agreements acceptable?
- Do they have references of people with whom they’ve done similar transactions?
- Do they have an appropriate level of insurance based on the transaction?
- Are they financially sound based on their financial statements or a due diligence call with the CFO?
- What does an internet search or social media search tell you about the business and their founders or key personnel?
- What do their facilities or operations look like? Do guests go through a security protocol? Is the facility organized with confidential documents appropriately safeguarded or does it look like a dorm room?
For some businesses, gathering this paperwork upon a request may be a struggle. If so, that is a strong indication the more complex negotiations required to engage in business at this level will make success almost impossible. Act accordingly.
Determining Whether the Deal Benefits Your Goals:
Desperation breeds lopsided contracts, meaning that a business desperate for a quick buck is more likely to accept unfavorable terms, which in turn increases the risk of a total loss. Instead, engage in the existential analysis regarding whether the other party shares your values and your vision, or can benefit your long term goals in the marketplace. Here are some examples:
- Aligned Values: For example, if regenerative practices are important to your business model, do you want to do business with a company that does not value regenerative farming or does not employ sustainable practices themselves?
- Longevity: Is this a one-time event only, or are you setting up a longer term agreement? If it’s a one time thing, there is a greater chance of risk that it’s a cash grab by the other party.
- Co-Branding: Is the other party open to having your logo and information on the final product, so that your company benefits from an increased brand identity? (*If building your own brand is your goal.)
It is interesting to note that hyper-successful entrepreneurs invariably trust their intuition when vetting potential deals. Just as in the old world, sometimes you know a dud is a dud, so knowing when to walk away can be just as critical to one’s success as locating a potentially profitable deal. You got yourself to this point, which is historic in-and-of itself, so don’t be afraid to trust your instincts!
**PS, keep a lookout for the final two blogs in this series:
PART 4: Contract Fundamentals: Dude, Where’s My Indemnity Clause and Other Super Fun Terms Every Cannabis Business Should Know
PART 5: Contracts Overview: What Paper to Push? (+ Sample Contracts)
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*This is a communication from a lawyer, but it does not constitute legal advice, nor does it create an attorney-client relationship. This is intended for educational purposes only. Please contact an attorney for specific legal advice.