In the past six months or so, we have begun to see an increase in consolidation throughout the Oregon marijuana industry. Large companies from other states are moving in, and Oregon companies are buying each other’s assets or stock and integrating to form verticals. In business parlance, we have entered the scaling portion of the inevitable consolidation curve. This development should make for a lively second half of 2017.
Generally speaking, there are three primary structures that acquisitions follow: (1) stock purchase; (2) asset purchase; and (3) merger. Each comes with a raft of legal and tax implications, and each is discussed very briefly below:
- Stock purchase. Stock purchases tend to be favored by sellers. In these transactions, the buyer purchases some or all of the seller’s shares (or, in the case of an LLC, its units or membership interests). Sometimes, a buyer will purchase only a majority of the shares, and later force a sale of the remaining shares by statutory short-form merger, or simply as permitted under internal company documents. Unlike a buyer in an asset sale, a buyer of stock is purchasing the target company’s assets and liabilities.
- Asset purchase. Asset purchase agreements tend to be favored by buyers. Under an asset purchase agreement, the buyer purchases the seller’s assets and assumes no liabilities, unless the parties agree otherwise. Assets can be both tangible (e.g., inventory and equipment) and intangible (e.g., intellectual property and goodwill), but generally do not include cash. Unlike with a stock purchase, an asset purchase allows the buyer to “step up” the company’s depreciable basis in its assets, within IRS guidelines. From a taxation perspective, that can be crucial.
- Merger. In a merger, two entities combine to form one upon the issuance of a “certificate of merger” by the State of Oregon. The surviving company (purchaser) assumes all liabilities and receives all assets of the disappearing company (seller). We have seen fewer mergers in the cannabis space than stock purchases or asset purchases; the exception would be “downstream” mergers where the holding company absorbs its wholly owned subsidiary.
Before a transaction can be consummated, but after discussions have commenced, the purchasing entity will typically discuss its plans with counsel. The attorney will then draft a term sheet or a letter of intent, to present to the target company. Once the parties have negotiated and executed that foundational document, the purchaser will be ready to undertake the time and expense of performing due diligence on the seller and any related parties.
If the due diligence checks out, the purchaser may form a wholly owned subsidiary to purchase the target business, and to further insulate itself from liabilities of the purchased entity. In Oregon cannabis, there are also critical state licensing strictures related to consolidation. Those conversations are important to facilitate early on: in this way, the purchaser will not find itself sitting on unproductive assets after putting a bow on the transaction.
Acquisitions can be an intense process, and the blizzard of documents and disclosures can feel dizzying at times. Ultimately, though, these transactions tend to be memorable experiences for clients and attorneys alike. And in certain instances, an acquisition is crucial for a company to achieve its ultimate goals.
Stay tuned for Part II of this series, where we will discuss the cannabis acquisition term sheet, a critical document in these transactions.