Whether players in the cannabis and psychedelics industries like it or not, the era of acquisitions of troubled or struggling companies is here. Access to capital, the mother’s milk of these industries, has been severely restricted for over a year. As losses continue, debt matures and defaults grow, businesses seek strategic alternatives including M&A. What should acquirors be wary of as they consider purchasing a troubled or distressed business in cannabis or psychedelics? Here are five tips:
- Focus on regulatory challenges. Regulatory uncertainty is a major challenge in this space, as the legal and regulatory environment for cannabis and psychedelic substances varies widely from one jurisdiction to another. In some states or countries, these substances are legal for medical or recreational use, while in others they are strictly prohibited. Government approval is often required for a change in control, and these approvals can often be delayed inexplicably, potentially risking the survival of the target if it is struggling. Companies looking to acquire distressed assets in this space must carefully research the regulatory environment in the target company’s operating jurisdiction and assess the potential legal risks associated with the acquisition.
- Assess long term viability. Financial viability is another important issue to consider when dealing with distressed M&A in these industries. Many of these target companies, already struggling, do not have a proven track record of profitability. It is important, therefore, to thoroughly assess the target company’s financial position, including their balance sheet, income statement, and cash flow projections, to determine whether they have a viable path to profitability in the long term and what financial support may be needed to get there. This may require additional due diligence, such as analyzing the company’s supply chain, product development pipeline and marketing strategy, as well as ensuring that the target informs its potential acquiror of all of its troubles and challenges to minimize post-acquisition surprises.
- Industry challenges and exit strategy. These industries remain controversial, and many mainstream and institutional investors have not been ready to invest. In addition, once acquired, these companies may continue to face barriers to some otherwise customary business activity, such as obtaining traditional bank loans or federal trademarks or renting space. A buyer also should take this into consideration when planning its own exit strategy for the business being acquired. This is because the range of potential buyers, along with the path to going public, continue to face some limitations because of the legal status of cannabis and psychedelics.
- Focus on the people. Talent retention is also a critical issue to consider when dealing with distressed M&A in these industries. Many cannabis and psychedelics companies rely heavily on a small group of key employees, such as scientists, researchers, master growers and product development specialists. Acquiring distressed companies, even more so than in traditional M&A, comes with the risk of losing critical talent, which could have a negative impact on the long-term success of the company being acquired. It is important to develop a talent retention strategy as part of the overall M&A plan, and to take steps to incentivize key employees to stay on board, such as offering “stay bonuses,” equity incentives, and career development opportunities.
- Ensure the right fit. Finally, the strategic fit of the target company is an important consideration. As with any M&A transaction, it is important to carefully consider whether the target company is a strategic fit for the acquiring company. This includes assessing the target company’s product portfolio, customer base, distribution channels, and other key factors, and determining how well these align with the acquiring company’s overall strategy and goals. As in any acquisition, it is also important to carefully design an integration plan to ensure the maximization of synergies from the transaction.
Careful due diligence, thoughtful planning, and a clear-eyed assessment of these risks and opportunities can help companies navigate these challenges and make informed decisions about potential acquisitions of distressed companies. With the right approach and mindset, M&A transactions in these spaces have the greatest chance to be successful and lucrative.
We are very grateful to Natalie Zhong, a student at Baruch College of the City University of New York in Manhattan, for her assistance in preparing and researching this article.
