Explosive growth in M&A activity

Consolidation is a natural phase of any industry lifecycle, and cannabis is no different. As legal cannabis continues its rapid growth, the market is beginning a new phase of consolidation. There are many players now eyeing the cannabis market, including highly capitalized companies in traditional industries looking to enter the market via acquisition and established cannabis companies seeking to expand their footprint by absorbing competitors. With the current conditions, this year promises to be an explosive year for cannabis mergers, acquisitions, and expansion.

Recently, the industry saw one of its largest acquisitions to date. In March, Verano Holdings was recently snapped up by Harvest Health for $850 million, which was reported to be the industry’s biggest deal to date. The acquisition will create one of the country’s largest cannabis companies, with hundreds of retail and cultivation facilities.

The cannabis industry is in a land-grab stage, and the opportunity for Harvest Health to add so many retail facilities and cultivation centers was certainly a factor in the high price it paid for Verano. Large multistate players are rushing to stamp out their footprint, capture market share, and position themselves for further expansion.

On the other side of the coin, the need for cash is driving many smaller cannabis companies to offer themselves for sale. There are still many mom-and-pop operators that need capital and don’t have banks they can turn to for business loans. However, The Safe Bank Act introduced in the House is a step in the right direction and should lead to more banks entering the space, though it still has a long way to go before being adopted into law.

Typically, these small-business owners have worked hard over the past two to five years. They’re strapped for cash and worn down. So when an acquirer comes calling, they’re eager to entertain offers. It’s been reported that many businesses in Oregon, for example, are selling at fractions of annual revenue – mainly due to burnout and increased pressure to compete in a low barrier marketplace.

Many of the acquirers are publicly traded cannabis companies, listed on the Canadian Securities Exchange. As their valuations rise, they have access to a war chest of capital to spend. And when they see discounted valuations on small cannabis businesses, they jump. It’s a chance to build their brand, increase their footprint, and raise their public market value.

There are now thousands of cannabis companies that are potential acquisition targets. Here are six steps a company can take to make itself more attractive to acquirers and help to ensure a successful sale.

1. Enter with an exit in mind

The first step when entering the cannabis industry is to develop an exit strategy. It’s critical because this business is hypercompetitive – a multibillion-dollar market created and inundated virtually overnight – and if sellers don’t thoroughly understand their business structure, their cost structure, and where those two stand relative to their competition, they will quickly be out of business. To realize a successful sale, business owners need an exit strategy from the start. They need to identify their stress points so they can address any glaring shortcomings well ahead of a deal, rather than reacting to them at the last minute and being forced to sell quickly at a deep discount.

2. Invest in branding

Big tobacco, liquor, and pharma are now entering the cannabis market. And their entrance is inspiring many of the existing players to build their brand, raise their profile, and attract top dollar in an acquisition. They usually do this by acquiring smaller retailers themselves – strengthening their brand through integration and deploying brands in new states.

3. Sweat the small stuff

It’s essential to focus on even the smallest details. The companies that do well and attract top dollar in an acquisition are those that work hard at every phase of their business. They pound the pavement to make sure their products are in every dispensary. Then they work with budtenders to make sure their products are top of mind and are being recommended to customers.

4. Get your financials in order

To obtain an accurate valuation of their business, a seller must have sound financials. Many cannabis companies lack proper financial statements, forcing a last-minute rush when an acquirer comes calling.

For example, while there is a focus on federal income tax compliance, local sales and use tax compliance can also present complications during the due diligence process. Unknown federal, state, and municipal tax liabilities can negatively impact a company’s valuation. Companies motivated to sell must make it easy for potential acquirers to perform due diligence.

5. Hire a professional management team

As the industry grows and matures, professionals from other fields are joining cannabis companies and bringing mainstream business practices with them. But companies must choose their management team carefully because investors and acquirers often cite management as the single most influential factor in their investment or purchase decision. On the flip side, the management teams of cannabis companies are increasingly thought of as the most important point of exposure and liability in a company’s operations.

6. Build a data room

A data room is an online warehouse of business documents that can help buyers better evaluate a company. A data room enables a seller to provide valuable information in a controlled manner, which can speed the M&A process. It should include key documents, including contracts, intellectual property information, employee information, and financial statements. Due to the nascence of the industry, even the largest of deals isn’t always based entirely on proper metrics, where offerings may not be supported by actual projections. The reality is that sale prices in this industry are still based on somebody’s best guess due a lack of metrics on which to base prices. Full visibility into a company’s data room can help buyers and investors feel confident about their acquisition and positively impact a valuation.

As the “green rush” accelerates, there’s great opportunity for small, independently held companies who are ready to sell. The most attractive acquisition targets will be those that are professionally managed, have clean books, and well-documented operations. By setting a clear strategy from the start, cannabis companies looking to sell will better positioned for a smooth process and maximizing their price.