CA Cannabis Mergers – A Guide to Survive and Thrive

With the capital markets dried up and M&A activity at a standstill many CA companies are considering mergers to achieve profitability and scale. KO Acquisitions has put together mergers for over two decades and one thing is for certain – mergers of private companies is as much art as it is science. Unfortunately, mergers do not always achieve the desired results even when the founders conclude the thesis is a “no-brainer”. A deep dive into the details, both qualitative and quantitative, is necessary to determine if “1+1=3”. Here are a few areas to focus on:

Vision & Culture: Alignment on vision and culture needs to encompass your company’s values and leadership philosophies. Can you define and agree on the core principles that will drive how your company will respond to organizational challenges? It may sound like “fluff” but it’s not.

People: Cannabis entrepreneurs are required to wear many hats that often results in someone being outside of their core competency and ill-equipped to handle a role. Getting the right people to do what they do best is critical to building a scalable human infrastructure. Be transparent regarding where your skills lack and put your people in position to succeed.

The Process: Acquisitions are truly process driven, designed to look into every nook and cranny during exhaustive Due Diligence. Private mergers, however, do not go through the same degree of scrutiny, often because the founders do not have the experience or discipline to perform (mutual) diligence on their partner. It’s the biggest strategic move of your life – be thorough and don’t cut corners.

Control: Just because someone holds 51% doesn’t mean they have control of “NewCo”. Developing the proper corporate decision-making is about far more than your equity stake and is critical to resolving future disagreements. This includes Board make-up, voting rights, shareholder management and approval processes for critical corporate initiatives. Clean and clear corporate hygiene can be more important than your equity percentage.

Financial Analysis: Your partners balance sheet is a very good place to start since many companies have significant liabilities that cannot be cleaned up in a private merger. Be clear up front on 280e, convertible notes, and other long-term liabilities that will create challenges at the closing table. Remember, investors on your cap table will look out for their own best interests so if you want their buy-in, get it early.

Valuation: As noted, private mergers are more art than science given a lack of capital market data and today’s somewhat meaningless comps. Revenue growth, margins and the balance sheet are table stakes for determining valuation but many qualitative metrics may be of equal if not greater importance. Critical analysis and alignment of what goes into the valuation matrix will help avoid disputes later.

Synergies: Deep financial analysis must be given to the potential for synergies in a merger. While synergies typically translate to EBITDA it is important to know exactly what assets (human and physical) will be leveraged and what will be shuttered.

Product Alignment: Is the thesis for coming together to be 100% vertically integrated? Is the plan to dominate a brand category? We have often seen companies believe their own bullshit when making these assumptions. This exercise needs to be performed with both rigor and skepticism and competitors need to be considered. Be your own worst critic and have a session with your prospective partner regarding “why won’t this work?”.

Disputes: How you handle disagreements during the dating phase will be a great indicator of what will happen when things go wrong post-merger. One of the biggest problems is transparency as nobody likes surprises so air you dirty laundry early and often. Seeing how your “partner” responds will go a long way to determining if the marriage will survive.

Of course these categories are just the tip of the iceberg but the key is to focus on things that matter and tackle the hard issues early. Mergers are challenging but with the proper framework and candor you can create magic, but the roadmap should be comprehensive from the onset rather than left for post-closing.

When we all get through this “Cannabis meets Covid” chaos there will be a lot of buyers looking to get back into California. But let’s be clear, the future M&A market will be driven by EBITDA and scale so best to start getting everybody on board with that thinking today. Mergers can be a great way to achieve that goal.