While the cannabis trade has been around for thousands of years, accounting professionals in the U.S. have only begun to recently focus on this industry as more states legalize the use of marijuana for both medical and adult-use or recreational purposes. Given that business licenses and other agreements are not freely transferrable, deals are being structured as investments in an existing operator or company, and therefore structured as acquisitions of stock rather than purchases of only business assets. As such, additional time and money will be spent reviewing the historical financial, legal and tax history of the business to ensure the business can continue as a going concern.
Here are seven due diligence tips for cannabis operators as they consider a potential sale of their business:
- Start the dialogue with regulators and elected officials sooner than later.
- The due diligence process may take longer than expected, particularly if a timeline isn’t established and/or the business doesn’t have the administrative bandwidth/capacity to meet the required demands and additional responsibilities (e.g. meetings, calls, information requests, etc.).
- Although a review or audit is a compliance-driven exercise, primarily for banks and investors, don’t wait until you need one. Approach this reality with the perspective that the findings can and should be used to improve your business processes, which will better prepare you to raise capital or sell.
- Prepare financial reconciliations and compare estimates to actuals at least quarterly. A common pain-point for dispensaries is the integration of their seed-to-sale software and their accounting and financial reporting software. Reducing this complexity can only serve to improve the diligence process.
- Know your weaknesses and be prepared to explain them, understanding that your investor/acquirer’s goal is realizing the future expected performance of the company to meet their expected rate of return.
- Implement a system to corroborate cash receipts with product sales along with controls to limit manipulation. Depending on what state(s) you operate in, limited access to commercial banking will result in sales heavily transacted in cash and/or vendor payments transacted through personnel credit cards.
- Don’t overlook critical tax areas because investors/acquirers will ask for a price adjustment for the unpaid taxes and they typically are not going to alert you to any overpaid taxes that might generate substantial tax refunds after the sale. Most immediately think of income taxes and federal IRC section 280E. However, many aren’t thinking about the risks and opportunities related to other taxes, such as: sales and use, property, and payroll taxes.
Without adult-use legalization in New Jersey, it is estimated that by 2025, New Jersey would account for less than 0.5% of all legal cannabis sales in the U.S. However, with the recent state leadership change in early 2018, a legal cannabis market may be on the horizon. With state of almost 9 million residents, this could become a very significant cannabis market in the U.S.