Our Seattle office often receives calls from entrepreneurs who want to operate in Washington’s thriving recreational cannabis market. Washington is not currently accepting applications for new cannabis licenses which means there are a finite number of licenses available. This leaves one option for entrepreneurs who want to operate their own Washington’s cannabis business: buy an existing licensed business. These transactions are common but can be risky if the buyer is not careful. This post outlines some of the key issues buyers need to watch out for when purchasing a cannabis business in Washington state.
1. Prepare to buy the business, not the license.
Generally, a prospective buyer has two options in buying a business: (1) purchase the entity itself by buying all outstanding shares or membership interests, or (2) purchase the business’ assets, such as the equipment, fixtures, property, and goodwill. When buying a Washington cannabis business, purchasing only the assets is not much of an option.
The Washington State Liquor and Cannabis Board (LCB) does not treat a license to produce, process, or sell cannabis as a transferable asset. This means that a buyer must purchase the business that holds a license, rather than purchase the license itself (it is possible to buy a partial share in a business but this post focuses on scenarios where the buyer takes full control over a licensed entity). There are some exceptions to this rule. For example, when a buyer targets a sole proprietor it is possible to assume the license. However, in most cases, the buyer must purchase the entity rather than the assets.
By buying an entity, the buyer takes on all contracts, debts, and anything else registered under the business’ name. This requirement means that a buyer faces increased liability and therefore must carefully evaluate the target business.
2. Do your homework and know what you’re buying.
As with the purchase of any business entity, a potential buyer should perform thorough due diligence before closing. (See our articles on that here and here.) Washington’s Uniform Commercial Code database is available online and can be used search what creditors have filed against a debtor in the state providing useful information about the target entity’s debts. Buyers can also perform federal, state, and county lien searches to determine whether there are encumbrances taken out against the target company. A buyer may also search a licensee’s violation history on the LCB’s website, though this information may be limited. If time permits, a buyer can make a public record’s request for the license to uncover a full history of investigations, violations, and other pertinent information. Such requests take a few weeks or months to process so they may not be available if time is a factor.
The buyer should request all relevant seller company documents and require the seller to list all other debts that could impact the business, including wages owed to employees or debts owed on unfulfilled contracts. Once these debts are outlined, a buyer’s attorney can draft a warranty or indemnity stating that the seller will pay for any outstanding debts that arose before the sale.
3. Know what you’re paying and when you’re paying it.
After due diligence, the parties must agree to terms of the sale, including the purchase price. For background on how to value a cannabis business take a look at the following posts:
Once the parties are settled on the purchase price, it’s time for an attorney to draft the purchase and sale agreement.
In drafting a purchase and sale agreement, timing is everything. This is because the LCB must approve of anyone who is a true party of interest in a cannabis business. The definition of a true party of interest is broad and includes the following individuals in a given entity:
- Sole Proprietorship: The sole proprietor and his or her spouse;
- Partnership: All partners and their spouses. This includes general and limited partners in LPs, LLPs, and LLLPs;
- LLC: All members and managers and their spouses;
- Corporations: All stockholders and corporate officers and their spouses. This includes both publicly and privately held corporations; and
- Multilevel ownership structures: All persons and entities that make up the ownership structure and their spouses.
The definition also includes any person or entity that expects a percentage of gross or net profits (excluding financial institutions) or who exercise control of the licensed business in exchange for money or expertise. Additionally, the LCB requires disclosure of financiers, which includes anyone lending or gifting money to a licensed entity.
Ownership of a cannabis business must not transfer until the LCB approves of the new owner. An undisclosed true party of interest or financier is a major penalty that results in a cancellation of license. This means that the buyer will not “get the keys to the company” until the LCB signs off. To deal with this, we often recommend using a conditioned contract where payment is made in increments over time based on certain events. Buyers may elect to put money in escrow with instructions to distribute funds upon LCB approval. However, buyers should prepare to pay the seller a fee in exchange for the option to purchase the business after LCB approval.
4. Prepare for Licensing.
After the purchase and sale agreement is executed, the LCB will investigate the buyer to determine whether he or she is qualified to own a cannabis business. The LCB investigates the buyer’s finances, requires the buyer show proof that he or she is a Washington resident, and requires the buyer submit fingerprints for a criminal background check. In addition, the buyer must provide detailed information on the source of funds used to purchase the business. This process starts with a phone call where the buyer outlines the details of the transaction. Then the LCB sends out a document request so that the buyer can provide documents to show the details of the transaction. These document requests often require that the buyer submit the purchase and sale agreement, proof of the source of funds which can include bank statements, a list of the buyer’s previous jobs and places of residence, and other personal information.
Conclusion. The process of purchasing a cannabis business can seem difficult, but a buyer with adequate preparation and counsel can get through the process without too much of a headache. Washington’s cannabis market is booming and the limited number of licenses makes a marijuana business a potentially valuable asset. If you have questions about how the process works, contact one of the cannabis business lawyers in our Seattle office.