Recent legislative changes and proposals are likely to generate a bit of a seller’s market for licensed cannabis businesses in Washington.
The state Legislature recently increased the number of marijuana retail licenses an individual can own from three to five, and the Washington State Liquor and Cannabis Board is working through the rulemaking process that could potentially allow licensed producers to hold an interest in more than one license (the public comment period closed in May).
While there are potential opportunities, the reality is that in a highly regulated industry like cannabis, buying or selling a licensed business is a complex undertaking that requires patience, diligence and attention to detail. So let’s review some of the basics of buying or selling a cannabis business in Washington.
Finding a qualified buyer or seller is the first, and often the trickiest, part of the buy/sell process. The word “qualified” is the key, and this may mean different things depending on whether you are the seller or the buyer.
For the seller, a qualified buyer is one who: a) is serious about the acquisition of your business and not just casually exploring the possibility or “kicking the tires” as they say; b) actually has the financial resources available to enter into and complete the transaction on terms acceptable to the seller; and c) is able (and willing) to go through the somewhat lengthy Liquor and Cannabis Board approval process, which includes a review of the buyer’s residency, source of funds and criminal history.
For the buyer, a qualified seller is one who: a) holds the licenses in good standing with the state regulatory agency; b) actually owns and has the right to sell the business; and c) isn’t trying to dump a business that is saddled with debts or other obligations that would accrue to the purchaser because the transaction cannot be an asset purchase that would be free of any of the liabilities of the business. Ownership is not always as clear-cut as it may seem and requires the buyer to conduct a review of the seller’s ownership structure, particularly when the business being sold has a complex or contentious ownership history.
Letter of Intent or Option Agreement
Assuming a qualified seller and a qualified buyer are ready, willing and able to enter into an agreement for the sale/purchase of the business, the next step is hammering out the terms of the deal and getting these down on paper so the deal can move forward.
This is usually accomplished by the seller and buyer entering into a preliminary and conditional agreement — either a non-binding Letter of Intent (LOI) or an Option Agreement that can be either binding or non-binding depending on how it is structured.
At this stage of the process, both the seller and the buyer are looking for some degree of certainty that this transaction is going to move forward. The seller wants to nail down the buyer as best they can so that the buyer doesn’t dump them and run off to pursue another deal; the buyer wants to tie up the seller and the business so they don’t continue to shop around for more money or better terms.
The agreements are still preliminary and conditional at this stage because Liquor and Cannabis Board rules prohibit the actual sale of the licensed business, the exchange of money to purchase the licensed business and the buyer exercising control of the business being purchased unless and until the buyer is approved by the agency. Getting ahead of the Liquor and Cannabis Board at this stage of the transaction can have disastrous consequences for the licensee selling the business.
Contingent Sales Contract
An alternative to entering into an LOI or an option agreement is for the buyer and seller to negotiate and sign a Contingent Purchase Agreement. This agreement is the actual contract document that will finalize and complete the purchase and sale of the licensed business, but it is contingent upon Liquor and Cannabis Board approval of the transaction and the change in governing people.
Final Purchase Agreement
If the parties are using an LOI or option agreement, they will also need a final Purchase Agreement that will memorialize and contain all terms of the purchase and sale of the licensed business. It is generally a good idea to negotiate this agreement at the time you enter into the LOI or option, so that the Purchase Agreement can be attached to and incorporated into either of these documents.
Having a negotiated Purchase Agreement serves to provide greater assurance to both the seller and the buyer. It also nails down the terms and conditions of the transaction, and provides the representations and warranties of both the seller and the buyer. Of course, you can wait and do the final Purchase Agreement later in the process, but I recommend that if you are going to have a disagreement about any of the terms and conditions in the Purchase Agreement, it is better to settle that disagreement before everyone spends a lot of time, energy and money.
If any portion of the payment price is going to be paid over time, then that will require a promissory note from the buyer to the seller that outlines the necessary terms for payment. The parties will want to negotiate and clearly state the period of time for payment of the balance of the purchase price, the frequency of payments to the seller, the interest rate and how any default in the payment will be handled.
Sellers often require some form of security to ensure payment of the outstanding purchase price. The seller can take a security interest in the non-marijuana assets of the business, that when properly perfected, will make the seller a secured debtor. It is also possible to take a security interest in the stock or membership interest of the business, so that the seller can (in effect) take back the business if the buyer defaults. This is considerably more complex, but a skilled attorney can and should assist you in drafting the necessary documents.
Neither buying nor selling a licensed marijuana business is simple or easy. It is certainly trickier than buying the coffee stand on the street corner. I have done a number of these transactions and I can tell you, no two of them are the same and no two of them unfold in the same way. There are always challenges and stumbling blocks along the way. Get someone in your corner who has been down this path a number of times before and work with them. Their experience and expertise can help and guide you.
Attorney David Kerr serves business clients throughout Washington, including an emphasis on the emerging legal, regulatory and compliance issues facing new cannabis businesses. He can be reached at firstname.lastname@example.org.