Mergers and acquisitions (M&A) activity continues to ramp up in the cannabis space. For many founders and entrepreneurs, being handed a check to move onto the next project sounds like a dream. However, the reality of M&A activity is much more complicated. There’s a lot of pressure on smaller operators into thinking that their only way “out” is through consolidation with a much larger competitor. Thankfully, though, there are way more options.
If you’re wondering how to sell your company, here are some “founder-friendly” tips to help a startup or small business think clearly and navigate the pressure that may come with negotiating with a much larger company.
Don’t get distracted by shiny objects
A founder-friendly deal is strictly term-specific and has nothing to do with gifts, travel, parties or even a high valuation. Be sure to partner with a company that is transparent, honest, responsive and seeks to maximize shareholder value for the long haul.
Secure offer positions
Before the deal closes, insist upon officer positions with written employment agreements. These agreements should be for a defined period of time, with mechanisms for termination only “for cause.” If the employment relationship is “at will,” as opposed to a term of years with clearly defined termination mechanisms, a founder could be terminated for any or no reason as soon as the ink on the deal is dry. This is particularly important to note if the buyer seeks to employ its own, in-house talent.
Stay on the board of directors or managers
Propose that at least one director or manager be “independent,” meaning somebody who does not have an ownership stake in the company. The board is supposed to represent shareholder interests, establish policies for corporate governance and oversight and make most major decisions (except those which, by law or corporate agreement, are reserved for shareholders). The board will have its finger on the pulse of matters that affect the company’s valuation, liquidity, growth strategies, hiring and firing of officers, and other priorities. By preserving a seat at the table for yourself, you can assure your participation in deliberations, have a vote on crucial matters, and know there will be an objective voice in the room.
Insist on a supermajority
Insist that major decisions be made by a supermajority of the decision-makers, whether it be the board or the shareholders, and not by a simple majority. This ensures that those in control of the company are on the same page with the minority shareholders with respect to big-ticket items, such as:
- Deciding whether to liquidate
- Selling the company or its assets
- Mergers
- Incurring substantial debt or investing in another entity
- Hiring or firing key employees
- Amending the organizational documents in any material respect
- Materially deviating from the company’s budget
It is not uncommon to insist upon a veto right over matters of importance that may have attracted the buyer or their financier(s) to your company in the first instance. For example, if the company was acquired for genetics developed by the founders, the founders may want to insist that any matter related to the commercialization or exploitation of the company’s intellectual property pass through them for the final say.
Insist upon a variety of minority shareholder protections
Minority shareholder protections include, at a minimum:
- Protection against dilution, particularly disproportionate dilution
- Rights of first refusal in the event a shareholder wants to transfer or sell its shares
- Rights of participation in future fundraising sufficient to retain your pro rata interest in the company. This is generally called “pre-emptive rights.”
- “Tag-along rights,” which enable minority shareholders to join a sale involving the majority shareholders, and to their shares on the same terms and conditions as selling majority shareholders.
Have important conversations about distribution preferences
When it comes to a distribution preference (or dividends), while those who made significant capital contributions will want to — and should — get their money back at a priority to those shareholders who did not, don’t allow 100% of available distributable cash to be distributed directly to them. Insist upon a lower threshold, such as 70% or 80%, so that those who contributed sweat equity or other assets are not cut out completely while waiting for the financiers to be repaid. For license holders, sweat equity includes acquisition of the license itself.
Who’s buying cannabis companies?
Undeniably, multi-state operators (or, in States like New York, multi-borough operators) have the capacity to provide relief to a startup or small business. This can be in the form of funds for cash poor businesses, and it can also be in the form of accessing experts and advisers to guide it through various phases of growth. These resources include licensing valuable intellectual property, raising capital, operations, team building, real estate transactions, build-out, and marketing.
Startups and small businesses rarely have the same bargaining power as multi-state operators. Absent cleverly negotiated financing or an acquisition, smaller operators can risk losing their identity, sacrificing management and control or being completely disenfranchised.
At the same time, multi-state operators are not a founder’s only option when it comes to finding the right merger or acquisition partner. Interest in M&A activity comes from:
- Ancillary companies interested in buying a cannabis operation
- A cannabis operation interested in buying an ancillary company
- Acquisitions by companies who wish to enter the cannabis industry
- Two similar single-state operations who wish to enter new regions
Sell your company with the right legal team in your corner
It remains to be seen whether partnering with a multi-state operator is the only key to an exit, particularly in markets that prohibit vertical integration (as in Washington, or in New York) or where there may be caps on the number of operations a company may be permitted to support (as in Massachusetts or New Jersey) or on the number of licenses an operator is entitled to own (as in California,New York, and New Jersey). At the very least, craft and small business operators should avoid “rolling over,” where possible, to increase competition and to preserve diversity and character in the cannabis industry.
Consult with experienced legal help before exploring any opportunity. At Rudick Law Group, our award-winning attorneys have years of hands-on experience in deal structuring and negotiating M&A terms in the cannabis industry. Schedule a consultation to see how we can help you.
A version of this article originally appeared in Marijuana Venture: https://www.marijuanaventure.com/founder-friendly-deals-keep-your-place-in-your-company/
.webp)
