Bridging the Gap: The Cannabis Lawyer’s Critical Role in Today’s Mergers and Acquisitions

As the cannabis industry has rapidly accelerated and its businesses have begun to consolidate, one thing has become abundantly clear: large investors and cannabis operators come from two very different worlds. Many of the larger investors that are looking to enter the space do not have any experience operating in the semi-legal cannabis industry. On the other hand, many of the founders of these successful operations, who have been around for years, have never sold a new business before.

This disconnect creates a difference in expectations between the parties as they enter into business combination transactions, and it provides a unique opportunity for the cannabis attorney who advises on these deals.

Big companies bring with them big lawyers from big law firms. Big law firms employ some of the world’s most experienced and sophisticated attorneys and have the ability to staff each deal with a deep bench of partners and associates. However, these law firms have only recently become comfortable taking on clients who operate in the industry. Smaller, boutique firms that have catered to marijuana entrepreneurs since the beginning generally do not have large teams of lawyers with centuries of combined legal experience, but they do tend to be experts of their clients’ trade and the laws that affect them.

In order to help a budding industry continue to grow and thrive, the cannabis attorney needs to be prepared to bridge the gap between the investors (and their advisors), who expect these deals to run “business as usual,” and the entrepreneurs, who expect to be able to cash in on their efforts without having to continue to carry the risks that come naturally with operating in the cannabis industry.

There are at least four key aspects of any purchase and sale transaction in which these differences are likely to present an issue and in which an experienced cannabis attorney can make a huge difference by educating both parties as to each side’s understanding and expectations.

Reps and Warranties

Reps and warranties (more formally, representations and warranties) are an integral part of any business sale, in which the seller makes representations about certain facts pertaining to the company and its operations. If any representation turns out not to be true, the buyer may be able to recover for any damages it suffers as a result.

While reps and warranties are usually the source of great debate between the parties, you would be hard pressed to find any seller who demands their removal from the agreement, entirely. Not so in the cannabis industry. People who are not often a party to such transactions do not immediately understand why they should need to continue to carry the risk of anything that might go wrong in the future, even if the cause predates the sale of the company. Sellers of cannabis companies do have a point, though—to operate in the marijuana industry is to walk through a minefield of unique legal risks. Anyone entering into the space should be prepared to assume some level of risk.

Applicable Laws

A very standard and almost boilerplate rep involves the seller attesting that it has complied will all applicable laws and regulations. Seems obvious enough – no one wants to buy a business that is in violation of the law. So, you can imagine how surprised experienced corporate lawyers might be when seller’s counsel suggests an exclusion from this rep. But almost every cannabis company is in violation of the federal Controlled Substances Act, so it is important that the seller does not represent that it is in compliance with this law.

Code Section 280E

Section 280E of the Internal Revenue Code forbids people from taking business deductions if such business involved trafficking in controlled substances. This has, unfortunately, made it extremely difficult for cannabis operators to turn a profit. Some people take a very aggressive approach in terms of how they apply 280E to their tax calculations, while some take an extremely conservative approach. However, most end up somewhere in the middle.

While a seller’s representation that it has complied with all tax laws in filing its returns tends to be fundamental to the buyer, sellers understand that their approach to 280E could easily be challenged by the IRS at any time. Just recently, the United States Tax Court reaffirmed the strict application of 280E to marijuana businesses.

License Transferability

People who are used to buying businesses are used to a straightforward structure through a purchase of either all of the company’s assets or all of the company’s equity interests. Each state has a unique cannabis licensing regime, however, and each state has different rules as to who can hold a cannabis license, as well as when and how one can be transferred (if at all). Creative cannabis attorneys have devised innovative structures to achieve the economic results desired by the buyers and sellers, while remaining compliant with the various state rules and regulations.

As the industry is new and regulators are still figuring out how to effectively administer their cannabis programs, it is important that all parties to these transactions remain flexible and willing to change course as new regulatory issues present themselves. A well-minded and understanding cannabis attorney can be invaluable in keeping the parties on track and optimistic as they encounter these inevitable differences of opinion and experience.

Ben Leonard

Ben is an attorney at Vicente Sederberg specializing in corporate law. He regularly represents both buyers and sellers of marijuana business across the country and has served as regulatory counsel on some of the industry’s largest transactions Prior to joining VS, Ben worked in the corporate and real estate departments of two mid-sized western regional law firms. While not at work, Ben enjoys traveling, skiing and spending time with his new wife and two adorable schnoodles.