In this post, I want to get into what’s arguably the most important part of any cannabis M&A transaction – the purchase price and how it’s paid. There are virtually infinite ways to structure payment in these transactions, but we’ll take a look today at some of the most common structures and issues.
To make the most sense of this, I’ll break the post into two parts: 1) purchase price and 2) payment and escrow. In my next post, I’ll discuss the ways that purchase prices can be adjusted pre-closing and post-closing.
Part 1: Purchase Price
The purchase price for a cannabis business is obviously one of the most heavily negotiated aspects of M&A deals. I don’t intend to get into how business are valued today, but to actually look at how parties settle on a purchase price.
First off, there are many different ways to structure payment to sellers. Typically, payments are made in cash, stock, or some combo of the two. We tend to see straight cash purchases for smaller M&A businesses and cash-stock hybrid deals where larger companies or MSOs are the buyers, or where the purchase price is larger. It’s a lot easier for a company to avoid paying a large sum at closing by issuing stock in many cases.
Cash deals are simpler because they don’t implicate a lot of the same securities law issues that stock deals do. And, in a stock deal involving stock of a public Canadian cannabis business, the parties also need to consider Canadian securities law, which can make the drafting and negotiation process a lot more complicated.
Part 2: Payment and Escrow
There are also tons of ways to structure how the purchase price is paid which can affect the negotiations. Here are some of the ways we see:
- Payment of entire purchase price (whether in cash or stock) at closing. This generally only happens on smaller deals.
- Payment of some part of the purchase price at closing and payment of the remainder in installments.
- “Seller financed” transactions where part of the purchase price is paid at closing and the buyer issues a promissory note or similar instrument promising to pay the remainder over time. This is sort of similar to the concept of installment payments except that they may be treated differently for tax purposes and bear interest where installment payments generally don’t. Notes can be more flexible and have balloon payments, etc.
- Milestone or “earnout” payments. These can be common where the sellers want a high purchase price and the buyer isn’t convinced that the business is worth that price because it’s newer, has limited operating history, etc. The buyer will pay some part of the purchase price at closing, will usually require that at least some of the sellers stick around to help with operations post-closing for a specific period, and pay them more money only if the business hits certain pre-negotiated milestones (usually financial in nature). This is a bigger risk for sellers because they may never get that money, but it can be a big win for buyers given that the sellers will be extremely incentivized to make sure the milestones are hit and the business does well.
Escrow is also something that can affect how the parties decide the purchase price will be paid. If you aren’t familiar with escrow, it is a neutral third party that holds the purchase price (or other things) until the parties close a transaction or confirm that certain post-closing milestones have been met. The incentives for using escrow are obvious – if the purchase price and, say, stock certificates of the business to be purchased, are held in escrow, the parties will be incentivized to work harder towards getting to close.
Escrow is often used to hold initial deposits made on signing of M&A transaction documents through closing. Many M&A deals will include initial deposits of some percentage of the purchase price. Sometimes these are fully or partially non-refundable if the deal doesn’t close or if the buyer walks for certain reasons. This spurs the buyer into action and lets the seller know that the buyer is serious.
Buyers will also often negotiate that some part of the purchase price be held back in escrow after closing for a specific period for various adjustments, which I’ll get into in my next post on this topic. For now, please stay tuned to the Canna Law Blog.