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

by Mark Hefner, CEO of MGO Realty Advisors and Dustin Grizzle, MGO Tax Partner

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executives are well-acquainted with detailed financial analyses for other parts of the business, but have a limited or out-of-date idea of their enterprise’s square footage, details of lease agreements, or comparable values in shifting real estate markets.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.

NOTE: This is an excerpt from the MGO Cannabis M&A Field Guide. 

Access The Full Guide Here

Mark Hefner, CEO and Shareholder of MGO Realty Advisors, is a real estate investment professional with over 30 years of experience supporting occupiers and investors as they navigate commercial real estate markets. Mark focuses on providing strategic advisory, transaction advisory, capital markets guidance, and ownership formation support for all types of commercial properties, both nationally and globally.

Dustin Grizzle, CPA, Tax Partner and Office Managing Partner of MGO’s Boca Raton, has over 15 years of experience providing tax planning and compliance services to real estate management and investment companies, manufacturing companies and high-net-

worth individuals. Dustin focuses his practice on tax compliance and real estate structuring, as well as tax consulting for entities with large inventories and manufacturing-related needs. He also manages tax programs involving investment funds, corporate structuring and IRS examination representation.

About MGO

One of the top 100 CPA firms in the country, MGO has a 30-year history of providing trusted accounting and advisory services to many leading public corporations, private companies and government agencies. The MGO team has developed a suite of proven solutions to help operators, regulators and institutional investors navigate the complexities of the cannabis and hemp industries.

About the Cannabis M&A Field Guide

This serialized multi-media project is an educational resource for cannabis and hemp operators and investors. It focuses on the evolving market conditions driving mergers and acquisitions, and provides first-person insight on best practices for strategy, structuring, valuation, and other topics behind successful M&A transactions.

Member Blog: Attracting Investors Requires Compliance And Scalability

by Frank Nisenbaum, Vice President of ERP Sales, c2b teknologies 

More new cannabis entrepreneurs are trying to carve out space in the industry, and as the market continues to expand, so are cannabis investors.

This comes as no surprise. Cannabis investors have more predictable ways to invest in cannabis companies since marijuana can now be found in everything from beverages to beauty creams.

But the needed operating capital coming from these investors isn’t being thrown at new upstarts riding on nothing more than the dream of success in the legal marijuana marketplace. Cannabis investors want to see the people and businesses into which they put capital have a strong commitment to their industry and a dedication to their processes. Of course, this entails strict adherence to local, state and federal regulations for compliance initiatives, but investors also want to see a solid foundation for expansion and scalability in place.

Scalability

Consider your projected growth over the next few years, what are you doing to meet it? Investors want to see more than forward-thinking ideas, they want to see the initiatives you’ve put in motion to meet your projections. Are you upgrading suppliers, creating new products, or even better, adding new locations?

Investors need to believe that organizational leadership has a sound plan for scalability in place. More importantly, as you expand into new markets and grow your product offerings, you have invested in the framework and infrastructure in order to grow their operation in line with your business plan.

Regulation and Compliance

Among the more burdensome compliance issues for cannabis operators is the need to track the entire lifecycle of cannabis products from seed to sale. You need to be able to account for every step in the lifecycle of your cannabis plants and be able to provide this information to regulatory agencies at a moment’s notice.

Adding to the complexity of tracking the plant, you’ll need tracking for each employee who works with the plant. These seemingly minor details can derail the best intentions, so demonstrating success surrounding mandated quality assurance testing at key points in the plants’ development will get the attention of would-be investors.

Multiple Jurisdictions for Added Complexity

Compliance is even harder to achieve due to the multiple bodies which have jurisdiction. Local, state, and federal agencies all jockey for partial control of regulatory measures placed upon your cannabusiness.

Some of the federal agencies involved in the regulation of legal cannabis plants include, but are not limited to:

  • United States Department of Justice
  • Environmental Protection Agency
  • Internal Revenue Service

Each state in the U.S. has its own regulatory body for cannabis operations. Examples include:

  • Department of Public Health
  • Department of Food and Agriculture
  • Department of Fish and Wildlife
  • Department of Pesticide Regulation
  • Alaska Marijuana Control Board
  • California Bureau of Cannabis Control
  • Colorado Department of Revenue Enforcement Division Marijuana Enforcement
  • Illinois Department of Financial and Professional Regulation, Cannabis Regulation
  • Maryland Medical Cannabis Commission
  • Massachusetts Cannabis Control Commission
  • Michigan Department of Licensing and Regulatory Affairs Bureau of Marijuana Regulation
  • Nevada Department of Taxation
  • Oregon Liquor Control Commission
  • Washington State Liquor and Cannabis Board

The full list of regulatory bodies is much longer. Compliance concerns are not exclusive to this industry, but as a cannabis operator, you face a tremendous number of regulatory bodies and each of these agencies has specific requirements to adhere to in order to stay compliant and stay in business.

As cannabis legalization becomes more widespread, each jurisdiction develops its own guidelines surrounding cannabis, from seed to sale. Unfortunately, this often creates confusion and leaves cannabis compliance open to interpretations. Without the systems in place to track and document multiple aspects of the cannabis industry, you’re at risk for considerable fines for non-compliance.

How to Present Your Cannabusiness

If you’re seeking capital from cannabis investors, understand that building a cannabusiness for compliance and scalability is nearly impossible without purpose-built technology. To that end, cannabis operations software is an invaluable platform for your cannabusiness when looking to attract investors.

Beyond your core business functions, investors consider the systems in place which support your cannabusiness. By planning ahead and incorporating a cannabis operations solution before you seek outside funding, you’re able to enjoy the fruits of efficiency, but you’re also able to prove it.

Cannabis operations software features tools for inventory tracking, asset management, and personnel scheduling and management, which means that the regulatory guidelines with which a cannabusiness must remain compliant are areas intrinsically handled by the platform. These systems excel at tracking inventory and allocating resources while maintaining clear audit trails, which is extremely important if a regulatory agency knocks on your door.

Cannabis operations software gives you and potential investors a unified view of your entire operation by bringing all operational data under the same umbrella, standardizing the data reporting and making it available for easy cross-referencing. By collecting all data into a single pipeline, a best-in-class solution gives everyone in the process the tools and insights necessary to make the right decision.

Vice President of ERP Sales, Frank Nisemboum, is a trusted advisor at c2b teknologies who has guided organizations of all sizes enabling them to establish a technology presence and expand their business through technology. His proven ability to analyze the current and future plans of a company and work with team members to subsequently bring technology solutions to the organization result in improved processes and controls that assure continued growth and profitability. 

Frank has worked in the ERP and CRM software selection, sales and consulting industry for almost 25 years. His strong ability to understand, interpret and match the needs of an organization to the right solution make him an asset to all of his clients. 

c2b teknologies integration and engineering experts have partnered with leading cannabis industry experts to develop a software solution that provides a complete cannabis operations system. The best-in-class solution not only handles tracking of seed-to-sale activities but encompasses your entire cannabis operations with compliance needs handles along the way. Our passion for solving problems drives us to deliver innovative solutions for everyone we work with. Visit c2btek.com for more information. 

Member Blog: What To Know About Cannabis Business Valuations

By Melissa Diaz, CFO, Rebel Rock

The rapid growth and ever-evolving nature of the cannabis industry has resulted in wild and hyperinflated business valuations, making it extremely difficult for companies to zero in on a fair valuation as they seek to acquire or be acquired in the up-and-coming field. 

What can cannabis companies do to counter overinflated valuations as they pursue an exit or acquisition strategy? The best approach is to better understand what investors are looking for when they evaluate a company for a potential merger and acquisition deal.

Many Ways to Determine Value

Pinpointing the value of a business is not an exact science. Investors rely on a variety of methods and evaluation techniques to help them land on a fair valuation. Let’s break down some of the most common methods.

  • Discounted Cash Flow: A Discounted Cash Flow (DCF) analysis attempts to determine a company’s value today based on projections of how much money it will generate in the future.

  • Market Transaction: This method estimates a company’s value by comparing the business to similar companies in the marketplace. This approach works really well with publicly traded companies.

  • Adjusted Net Asset Method: A company’s value is determined by analyzing the net value of its assets minus any liabilities.

  • Revenue Multiplier/EBITDA: A company’s value is determined by dividing its revenue multiplier ratio by its earnings before interest, taxes, depreciation, and amortization (EBITDA).

Unique Cannabis Challenges 

Because of the unique nature of the cannabis field, each of the above-mentioned valuation methods come with their own challenges when applied in the industry.

  • Discounted Cash Flow: Because cannabis businesses’ operating costs are so high and their margins are so slim, a DCF analysis will likely produce a more modest valuation than some of the eye-popping ones seen throughout the industry in recent years. But that doesn’t mean it’s unfair or wrong. DCF analyses take into account the current realities of U.S. tax code and the impact it has on costs and earnings.

  • Market Transaction: A market method should not be used by cannabis companies in pinning down a valuation because cannabis companies that have gone public — most notably in Canada — have not been able to sustain their sky-high IPO values, which raises concerns that they were overvalued. Also, public cannabis companies north of the border have seen their values plummet in recent months because big promises of heady market growth don’t seem to be coming to fruition.

  • Adjusted Net Asset Method: While this method can be beneficial for certain cannabis businesses with a lot of assets (cultivators, for instance) one potential downside is it assumes the value of the company is simply the value of its assets and does not take into account any potential for future earnings.

  • Revenue Multiplier/EBITDA: This is currently the most widely used valuation method in the cannabis industry and is likely going to be used in tandem with another valuation method. That’s because EBITDA eliminates the impact of tax restrictions under IRS tax code 280E. It allows investors to look at a company’s hypothetical profitability for when those tax issues are eventually resolved. Most professionals in the cannabis industry agree those tax and legal issues will be eliminated in the next five to eight years. The risk or challenge with this method, then, lies in if that timeline ends up being longer than expected.

Other Valuation Considerations

Evaluating a company’s valuation is a multifaceted approach. Investors often rely on a hybrid approach, using more than one of the standard valuation methods. But they also take into consideration other metrics that have little to do with the bottom line. Some of those include:

  • Management Team: Who’s on your board? Who are your top executives? Investors take a look at management before any other metric. Because of the industry’s legal haziness, investors want to see legitimate industry expertise on boards and management teams.

  • Brand Loyalty: Brand loyalty is big in cannabis. If buyers find a strain they really enjoy, they are more likely to try other strains from the same brand when the preferred product is out of stock. Investors will look at how companies measure brand penetration as part of their due diligence.

  • State of Financials: How quickly are you able to produce them? Is your accounting managed through a cloud-based system? Are your company’s financials messy? Unbalanced? Clear and organized financials are important, as is responding to investor requests in a timely manner. Otherwise, an investor will get the impression that you are disorganized and don’t truly understand your business — which can have a huge impact on any potential valuation.

Be Your Own Advocate

Whether a cannabis business operator is pursuing an acquisition or an exit, it’s important to understand the standard approaches investors take when evaluating such opportunities. Also, don’t be afraid to suggest a particular valuation method or approach to potential investors. Ultimately, nobody knows your business better than you — it’s vital to be your own best advocate.

Advocating for your business and having a better understanding of the valuation process will go a long way toward landing on a fair valuation for your business.

Melissa Diaz is a co-founder and CFO of Arizona-based Rebel Rock, which provides cannabis businesses across North America with specialty accounting solutions, income tax services (U.S. only), CFO and controller services, and business system implementation. She guides companies of all sizes through GAAP compliance, financial modeling, financial reporting and general financial accounting inquiries and functions. 

In addition to leading Rebel Rock, Melissa co-founded Rebel HR, which provides cannabis companies with technology-based HR solutions. She is also a partner in High Rock, a likeminded accounting firm focused on cloud technology integration. Melissa has additional experience as a financial statement auditor with a large international accounting firm, providing audit services for domestic and international businesses. Further, Melissa has experience overseeing global revenue and receivables for a Fortune 500 company. 

Melissa earned a bachelor’s degree in Accounting from University of Arizona and a master’s degree in Accounting from Arizona State University.  

Member Blog: Weighing the Options for Cannabis Facility Construction

by Albert Marks, Cannabis Facility Construction

As more investors consider the cannabis industry as a growth market, the need for cannabis cultivation facilities, processing centers and dispensaries is projected to rise to keep pace with demand.

A report from New Frontier Data projects that by 2020 the legal cannabis market will create more than a quarter-of-a-million jobs. These are more than the jobs expected to be created from manufacturing, utilities or even the U.S. government, according to the Bureau of Labor Statistics.

Forbes magazine estimates that medical marijuana sales are projected to grow to $13.3 billion by 2020. With this growth will be the need for quicker, cost effective construction with investors likely to consider the remodeling option.

There is value in remodeling the interior design of existing abandoned or non-productive buildings into state-of-the-art cannabis facilities that can be brought to life quickly and on-budget so that the facility becomes a new source of jobs and tax revenue for the area. This is a popular option for investors looking to tap into the burgeoning cannabis market.  

Cannabis businesses have to keep track of many moving pieces in the name of compliance, growth and sustainability. Industry experts are seeing value in integrating processing and cultivation at the same site, which can open the door for better quality control. A well-designed cannabis process goes far beyond just extraction; it overlaps heavily with cultivation on the front-end and product development on the back-end.

Security is a growing issue for cannabis dispensaries, cultivation and processing facilities. According to Security Sales & Integration magazine: “Once the products reach the warehouse or dispensary shelves cannabis companies rely on advanced security systems including visual and audio surveillance to protect their valuables and even their license. In order to prevent diversion of product, most state cannabis regulations require growers, storage facilities, processors and dispensaries to have advanced video security systems.”

Cannabis facility building contractors are charged with integrating top level security measures into their renovation. This is not only relevant to cultivation facilities, but also processing facilities and dispensaries. This builds confidence with clients and investors.  

When building a cannabis cultivation facility, it is critical to understand that local codes are constantly changing as local building and fire departments try to keep pace with the rapid rate of changes in the industry. Rather than try to wade through these regulations, it is important to consult with a contractor who is experienced in the industry and is current with the latest changes.

Here are a few examples of buildings remodeled into high end cannabis facilities:

  • CFC renovated a 5,200 square-foot dispensary in Morris, Illinois that evokes old world charm, including a bar that originally was constructed in the Anheuser-Busch pavilion at the 1893 Chicago World’s Fair. The dispensary was originally the Rockwell Inn.

According to Mitch Kahn, CEO and founder of Grassroots, a national leader in medicinal cannabis, “It really is just a neat building with character that we wanted to keep, from the tin ceiling to the bar that’s over 100 years old, and retrofit it to our purposes. We saw the promise of remodeling an old building and turning it into a modern facility.”

  • A remodeled 40,000 square-foot cultivation facility in Illinois that was formerly a roller skate manufacturing facility. The facility was positioned in an Enterprise Zone that saved the dispensary owner more than $300,000.

Investors looking to build cultivation, processing and dispensary facilities, particularly in controlling construction costs, should:

  • Know there is an art and a science to converting raw materials of cannabis and finished products so any construction must meet all state regulations and local fire and safety codes.
  • Find a partner that can manage security infrastructure and planning as well as permitting and compliance support. It is critical to balance safety and customer-engagement.
  • Hire general contractors that will work on a fixed sum in lieu of a percentage of construction. This is especially important when it comes to a partner who will closely watch trade contractors to ensure they provide the best possible solutions, taking into account time and money.   
  • Work with a partner that will watch their back from a relationship standpoint, not just the transaction.

Albert Marks is Client Relations Manager for Cannabis Facility Construction based in Northbrook, Illinois. Albert currently works with clients in three states, including Illinois, Wisconsin, and Massachusetts. Marks draws on his extensive knowledge of social media and digital marketing. He oversees the company’s blog, LinkedIn, Facebook, Instagram, and Twitter profiles. Marks is trained in using the SalesNexus CRM software, which he has used to make connections while working with clients, industry partners and trade partners in the residential, commercial, retail, restaurant, exterior and cannabis verticals.

 

 

Member Blog: Top 3 Reasons Cannabis Angels, VCs, & PEs Use Data To Analyze Deals

by Henry Finkelstein, CEO and Founder of Cannabis Big Data

Key Highlights:

  1. For cannabis investors focused on private companies, larger deal flow means better investments
  2. Vetting cannabis companies is complex, time-consuming, and expensive
  3. Using a data-driven deal analyzer automates top-level due diligence, resulting in more deals processed, better fits, and overall higher returns

The emerging cannabis industry is in a state of rapid growth – over 30% compound annual growth rate (CAGR) for the next 5 years – and investors are starting to really pay attention. Angel investors, venture capitalists, and private equity groups are raising funds dedicated to cannabis and they’re starting to grow their portfolios.

To make smart investments, investors of all shapes and sizes need to review a large volume of deals to find the best picks that fit their investment strategy, often referred to as their investor or portfolio “thesis.” But wading through all those decks and conversations can be very difficult and draining.

Investors (and businesses) lose time, energy, and money qualifying and chasing poor fit deals

Cannabis investors spend tremendous amounts of time and energy talking to and qualifying potential deals, only to realize much too late in the process that this company is not a good fit.  Although every conversation yields an opportunity to learn, some conversations are much more interesting and productive than others. In the worst case scenario, investors don’t realize the deal is a dud until after deploying capital, resulting in direct portfolio losses.

No one, neither investors nor businesses, wants to waste their precious resources on deals and discussions that will go nowhere. More importantly, these wasted resources result in overall market friction that reduces the rate and acceleration of industry growth as well as investor return on investment (ROI). Double whammy!

So any investor that can review more deals faster, and quickly isolate the most relevant opportunities to pursue further, has a considerable advantage in snapping up the best investments before others get a chance.

Maximizing cannabis investment ROI requires a data-driven deal flow

From our first-hand experience raising capital, as well as second-hand experience talking to investors, one of the biggest challenges is quickly and efficiently identifying a good match on industry vertical, business focus, traction, and values. Beyond these foundational considerations, the next round of challenges revolves around product-market fit, growth potential, and deal terms.

Simply put, there is a standard list of 15-20 questions that every investor should ask a prospective investment (and every company should ask a prospective investor). But these questions can drag on for multiple discovery conversations or documents, ultimately wasting time and energy on both sides.

Some investor platforms, such as Leafwire or Arcview, ask a small set of these questions to help grease the wheels. Cannabis Big Data uses a deal analyzer that algorithmically matches investors & potential deals based on self-reported preferences. Think of the tool like Match.com for investor deal flow with a compatibility score based on profile overlap.

Regardless of the platform or format, investors that have an automated, dynamic way to speed up their deal flow will be able to review more deals faster and find the best companies that fit their thesis. It also means investors have more time for due diligence on the highest value deals, ultimately resulting in higher portfolio returns from investing in stronger, more aligned companies.  

For entrepreneurs, a standardized set of investor questions means more time and mental space to focus on developing their product or service and growing their customer base. For the industry, accelerating investment due diligence means less friction in the capital markets and happier humans doing more meaningful work with more time to care for themselves, their customers and their families.

Bonus concept: data-driven investors empower long-term success with historical machine learning & predictive modeling

Beyond the immediate and impactful value of a data-driven investor thesis to save time, energy, and money for both investors and businesses, there is also a longer term impact and benefit to cannabis capital bearers.

Over time, cannabis investors can run historical correlative analyses identifying the core considerations that are most likely to impact success and, most importantly, returns on investment. Said in the lexicon of a data nerd, this is a machine learning protocol and predictive model with historical data-driven deal assessments as a training dataset. In plain English, this is a computer algorithm that looks back in time, figures out what worked and what didn’t work, and applies those lessons learned to the matching score for future potential deals.  

Overall, what’s true for companies is true for their investors: those most adept at activating their data will quickly dominate the market. So investors need to consider an automated deal analyzer to save time, energy, and money in the short-term while also get smarter picking the best bets that yield the highest returns in the long-term.

Henry Finkelstein, CEO & Founder of Cannabis Big Data, empowers colleagues and clients by spinning data into gold with intuitive, actionable insights. After working in e-commerce, consulting, healthcare and government contracting, Henry saw the opportunity to create a modern-day data toolkit for cannabis businesses that connects the data dots with one-click reports & dashboards that help companies earn more and stress less.

Henry’s person-centric approach to the power of data is summed up as “Let’s count what counts & celebrate our successes because the only relevant data is actionable data.”

Member Spotlight: Tidal Royalty Corporation

In this month’s member spotlight, we hear from Paul Rosen, CEO of Tidal Royalty Corporation, a Toronto-based company providing financing for U.S. licensed cannabis operators looking to expand their operations.

Cannabis Industry Sector:
Finance and Investments, Expansion Capital Provider

NCIA Member Since:
2018

 

Tell me a bit about your background and why you launched your company?

I am a lifelong entrepreneur, having started my career as an attorney with my own firm before founding a number of companies in different industries. Within the cannabis industry, I was the co-founder of The Cronos Group (NASDAQ:CRON, CRON.V), a company that I led as CEO and President for 3 years. I am also a very active investor with over 100 investments in cannabis companies globally, I serve on the Boards of iAnthus Capital Holdings (IAN.C) and Hill Street Beverages (BEER.V), and I am an advisor to numerous companies in the industry.

I see a lot of similarities between U.S. cannabis today and the Canadian markets from 5 years ago, especially around the massive capital investments required to build out an industry of this magnitude. Unlike Canada, however, the lack of access to traditional capital markets makes it much more difficult for licensed U.S. operators to build the scale they will need in order to compete globally. I founded Tidal Royalty Corp. (CSE: RLTY.U) (OTC: TDRYF) to fill this market need and to provide growth-minded entrepreneurs with the resources they need to build sustainable businesses that positively contribute to society.

What unique value does your company offer to the cannabis industry?

Tidal Royalty is a publicly-traded company that provides licensed U.S. cannabis operators with the expansion capital that they need to scale their business. We write institutional-level cheques in the $5MM – $25MM range and have a world-class executive team that can assess and close deals quickly. But what makes us most unique is that we provide financing in exchange for a royalty on future revenue. This is most attractive to entrepreneurs in high-growth industries – like U.S. regulated cannabis – in that they get the benefit of a large capital infusion without dilution, and without the risk associated with debt. We are looking to align ourselves with best-in-class operators that will form the future of this transformative industry: when they do well, Tidal Royalty does well.

Cannabis companies have a unique responsibility to shape this growing industry to be socially responsible and advocate for it to be treated fairly. How does your company help work toward that goal for the greater good of the cannabis industry?

As institutional-level capital providers, Tidal Royalty has a level of responsibility that goes beyond our duty to be prudent stewards of capital for our shareholders. That is, we look to back licensed operators that we feel will positively impact the industry as a whole, in the U.S. and globally. We don’t see these as being mutually-exclusive; the operators that understand their social responsibilities and are willing to accept them are the ones that have the opportunity to make out-sized returns in the long-term. As part of our investment diligence, we not only assess the business case, but also look at how operators interact with their communities and the impact they can have on the segment of the population that they interact with. We think this is important in and of itself, but it’s also simply good business practice.

What kind of challenges do you face in the industry and what solutions would you like to see?

One of the most significant hurdles for many operators is the restrictive banking landscape. The legacy banking environment that discourages many institutions from participating in the regulated cannabis industry poses massive logistical challenges and business risks.

The industry as a whole is working hard to show the level of sophistication and societal benefit that a regulated cannabis market can offer, but the lack of banking infrastructure really creates an environment for criminal activity and black-market operators to flourish. Licensed operators can’t get access to the most basic banking services available to other industries and have to deal with the risks associated with a cash-only economy. I would like to see the states – either on their own or in partnership with private enterprise – really push an agenda to resolve some of these issues. There are a lot of good initiatives proposed that need to get pushed forward to make a difference.

Why did you join NCIA? What’s the best part about being a member?

We joined the NCIA to be part of a like-minded community working to advance the interests of this industry. The level of engagement, innovation, and enthusiasm we’ve experienced from the NCIA organizers and members has been incredible. We’re looking forward to helping contribute in any way that we can.

Member Blog: How to Build a Financial Backbone for Your Cannabis Company

By Maureen Ryan and Chris Vane, RoseRyan

As cannabis laws liberalize across the nation, entrepreneurs and emerging companies are racing to make their mark and stake their claim in the market. The road to legitimacy goes beyond votes, however—it requires companies wanting to play a significant role in this market to grow, attract investors, and constantly prove their credibility and worth.

A focus on the finance and accounting side of the business will make a difference in setting apart companies as the competition continues to heat up. Here are five key ways to elevate as a qualified, proficient operation.

View financial discipline as a necessity. Financial statements are the language of business. Accurate and timely financial reports don’t tell you how to run the business but show you how well it’s doing. Which product lines are turning a profit? What do the trends tell you? How does cash flow look over the next couple of months—and year? Are you properly accounting for all costs to accurately track margins?

The questions are many, and only with a solid accounting foundation to provide management with the answers you need—and reliable financial statements to tell the story—can you confidently move forward with decision-making.

Bolster your internal controls. Here’s a scary thought: 75% of companies experience fraud, and in most cases, the biggest fraud threat comes from within. In this industry, the threats are even higher as long as issues at the federal level keep companies mostly cash-based operations.

To ensure checks and balances exist, a working set of internal controls is critical. For instance, do you have adequate segregation of duties, or does one person have a hand in everything? Do you perform regular cycle counts in inventory? Your internal controls can ensure that you’re keeping tabs on critical items—a must for meeting the evolving tracking and tracing requirements set by the cities, counties, and states where you do business. The controls can be simple, designed for the size of your company, but be sure they can scale as you grow.

Be ready for investors. Even if you’re nowhere near a funding round or an exit seems a lifetime away, it’s always smart thinking to factor in what investors want. They’ll want to know your history and to see whether the business is well run. Reliable financial statements are one way to get their attention. You’ll also need to show them key performance metrics, specific to your business, that you’ve tracked over time.

They’ll be most interested in signs of financial discipline that you’ve ideally ingrained in the business. This discipline reflects favorably on management in any industry and drives home management’s capabilities to investors.

Be nimble. Successful companies look to today (day-to-day operations), tomorrow (what’s needed in the next 12-18 months) and the future (3-5 years). Their strategic planning efforts make room for pivoting for the unexpected. By making sure their financial plans are in sync with other operational plans, companies can pull off fast moves smoothly with full awareness of how one change impacts another part of the business and the company as a whole. Being nimble allows you to pivot, as necessary, when market forces out of your control (new regulation or a sudden surge in orders) require you to consider alternative moves.

Calibrate for rapid growth. Plot out the critical resources you’ll need as you progress through the phases of your business. This means striking the right balance with the people you hire and outsource, the processes you adopt, and systems you put in place.

It’s especially important to master this skill when the company is in rapid growth mode and looking to ramp up. It may be time for a big upgrade, for instance, if your current systems can’t track inventory. Dealing with an overstretched team? Expanding too quickly could alleviate the issue, but if revenue doesn’t pan out as expected, you could end up in a bind.

Get Ahead of the 8 Ball

As finance and accounting consultants who help businesses navigate the ever-changing environment in California, we know that both landmines and opportunities await businesses in the legal cannabis market. Cannabis companies are preparing for the real possibility of hyper-growth and increased competition but need to tread carefully to avoid burning out before that day comes.

What’s going to set your company apart from every new competitor that muscles its way in? Financial discipline—companies need to step up their game to put themselves on the same playing field where others already are and to stay competitive as newcomers enter the market. If done correctly, your financial infrastructure will help to guide your decisions, tell your story to those who evaluate your growth capital needs, and scale with you. Prioritize it if you want a prominent spot on the playing field. 

Maureen Ryan, vice president, heads up business development at finance and accounting consulting firm RoseRyan. From the early startup to the large enterprise, she has seen the emotional rollercoaster of finance challenges at cannabis businesses, tech companies and other fast-paced organizations. She can be reached at mryan@roseryan.com.

Chris Vane is a director at RoseRyan, where he leads the development of the firm’s cleantech and high tech practices. He helps fast-moving companies calm the chaos with precision finance at any stage. He can be reached at cvane@roseryan.com.

Raising Money 101: Accredited Investors and Fundraising in the Cannabis Industry

By Charles Alovisetti and Michael Heyward, Vicente Sederberg LLC

*Updated to reflect new Rule 147A and Amendments to Rule 147

When raising capital from outside investors, companies are faced with several choices regarding terms, structure, filings to make or not make, and type of investor, among other decisions. One choice – whether or not to include unaccredited investors – should be easy to make. For the reasons outlined below, it is strongly advised that only accredited investors be allowed to participate in a fundraising process.

What is an accredited investor? An accredited investor can be an individual or an entity. An individual can be considered accredited if he or she meets one of the following criteria:

  • net worth of at least $1,000,000 dollars (excluding the value of his or her primary residence); or
  • income at least $200,000 each year for the last two years (or $300,000 combined income if married) and have the expectation to make the same amount this year.

For entities, different criteria can apply depending on the form of the entity, but generally speaking, an entity will be considered accredited if all of its equity holders are accredited or it has greater than $5,000,000 in assets. Persons or entities that do not meet the above standards are referred to as unaccredited or non-accredited investors. While this is not an insignificant amount of money, the threshold is not very high. Especially if the person in question is considering investing a substantial amount of money in an uncertain venture that, even in the best of circumstances, may not make any money for years to come.

To understand why this definition is important, you must understand how sales of securities are regulated in the United States. At a high level, federal securities law requires that any sale of securities must either be registered with the Securities Enforcement Commission (SEC) or issued pursuant to an exemption. A full description of each exemption available to companies is beyond the scope of this article. But most private offerings of securities make use of the safe harbor exemption from registration known as Regulation D (in the parlance of our times, Reg D). There are three exemptions under Reg D (note the descriptions below only address the accreditation and disclosure issues discussed in this article and ignore issues related to general solicitation and restricted securities):

Rule 504: Allows for an exemption for the offer and sale of up to $5,000,000 of securities in a single twelve-month period.* Unlike some other exemptions, this exemption allows for a private sale without any specific disclosure requirements (note that the anti-fraud provisions of the federal securities laws still apply). Sales can generally be made to an unlimited number of accredited or unaccredited investors.

*Prior to adoption of new rules on October 26, 2016, the aggregate amount of securities that could be sold pursuant to Rule 504 was $1,000,000. The new rules also eliminated Rule 505.

Rule 506(b) and (c): Has the same criteria and guidelines as Rule 505, with one additional requirement – in the case of a 506(b) offering, all non-accredited investors must be sophisticated (i.e., “must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment”). This is an amorphous standard and creates yet another potential issue for the company offering securities. While beyond the scope of this article, it is worth mentioning that a Rule 506(c) offering, which permits general solicitation and advertising (normally not allowed under a 506(b) offering), cannot include any non-accredited investors.

The most important takeaway from the descriptions of the exemptions above: if you wish to undergo an offering without limitations on the number of investors, size of amount raised, or without specific disclosure requirements, you must sell only to accredited investors. Any offering which includes unaccredited investors, whether done under 504 or 506, will impose at least one of these restrictions on the offering.

Beyond the above-mentioned restrictions, there are other reasons not to include unaccredited investors in an offering. For one, it is not unusual to give investors the right to invest in future financing rounds – often referred to as a preemptive right. This is fine, provided no investors are unaccredited, but would be an issue for a company that has existing unaccredited investors with the right to invest in future rounds. Suddenly, a future financing round may inadvertently involve unaccredited investors and this may require a company to spend time and money developing fulsome disclosure documents or risk violating securities law. Another concern, while not immediate, is that if the company wants to go public, the SEC may evaluate all prior issuances of stock by the company and require that it take remedial actions to cure any past violations of securities laws, which might delay or imperil the IPO.

While any emerging company would be wise to restrict its offering to accredited investors, cannabis companies should be especially vigilant. Securities regulators, both on a federal and on a state level, made it clear that they consider the cannabis industry to be an area of special concern. Not because of the ongoing federal illegality of cannabis, but because of the increased risk of fraud in such a new and dynamic industry. The last thing any cannabis company should want to do is take any action that could expose them to the ire of regulators.

What if your investors are Canadian? After all, almost $500,000,000 Canadian dollars were raised last year in the Canadian public markets, and many Canadian investors are eagerly eyeing U.S.-based assets. Setting aside any Canadian securities laws issues, which are beyond the scope of this article, a Canadian or Canadian entity can certainly qualify as an accredited investor and allow an issuer to rely on Reg D. But be sure to have any Canadian investors carefully review their accredited investor questionnaire (a document issuers should require investors to fill out certifying what criteria marks them as accredited) they provide in connection with the offering – while Canadians are familiar with their version of accreditation, the qualifications differ just enough from US qualifications to be a potential issue. Note that there can be additional complications involved with accepting foreign investment, both for the investors and the company raising capital beyond those related to securities law.

It is also worth mentioning that the underlying policy arguments for restricting offerings (in the absence of fulsome disclosures) to accredited investors become even stronger in the cannabis industry. The risk of failure, and the total loss of investment, is undoubtedly present in an industry and remains federally illegal and operates based on federal guidance that could be changed at any moment. And investing in a cannabis company requires an even higher level of sophistication than a typical deal because of the challenges involved. A company should not accept money from investors who cannot handle the risk of losing their entire investment – not only is this unfair to the prospective investor, but any burned investors who end up in a financially precarious situation increase the risk of damaging litigation. While it may be tempting to accept funds from non-accredited investors, all the above issues can be readily avoided if non-accredited investors are not permitted to participate in a company’s offering.

This information is educational only and shall not be construed as legal advice. Please consult your attorney prior to relying on any information in this article.

Vicente-Sederberg-TransparentCharles Alovisetti is a senior associate and co-chair of the corporate department at Vicente Sederberg LLC. Prior to joining Vicente Sederberg, Mr. Alovisetti worked as an associate in the New York offices of Latham & Watkins and Goodwin where his practice focused on representing private equity sponsors and their portfolio companies, as well as public companies, in a range of corporate transactions, including mergers, stock and asset acquisitions and divestitures, growth equity investments, venture capital investments, and debt financings. In addition, Mr. Alovisetti has experience counseling portfolio and emerging growth companies with respect to general corporate and commercial matters and all aspects of compensation arrangements, including executive employment and consulting agreements, stock option plans, restricted stock plans, bonus plans, and other management incentive arrangements. Mr. Alovisetti has experience in both U.S. and cross-border transactions, and advised clients across a range of industries prior to focusing on the cannabis space. He holds a Bachelor of Arts, with honors, from McGill University and a law degree from Columbia Law School, where he was a Harlan Fiske Stone Scholar. Mr. Alovisetti is admitted to practice in both Colorado and New York and is a Level One Interpener. He can be reached at charlie@vicentesederberg.com. Follow him on Twitter @CAlovisetti.

Michael Heyward is a law student at the University of Denver Sturm College of Law and a law clerk at Vicente Sederberg LLC. He holds a Bachelor of Arts in History and Political Science, and a Master’s Degree in History from Florida Agricultural and Mechanical University.

 

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