Hashish M&A (brief for mergers and acquisitions) in California is rather more sophisticated and problematic than in different states. The largest motive for that is that licenses aren’t transferrable, which all however eliminates the potential for asset gross sales. In flip, which means offers are rather more sophisticated for each purchaser and vendor, and doubtless kills a whole lot of potential offers earlier than they begin. That may change quickly, because the state is contemplating a invoice that might enable license transfers.
Why are asset gross sales so necessary in hashish M&A?
I just lately wrote a put up for one in all our agency’s sister blogs on the highest 5 points patrons face when shopping for companies in regulated industries. Here’s what I wrote concerning the distinction between “asset gross sales” and “enterprise gross sales” within the M&A context:
[W]hen individuals discuss M&A, they typically consider shopping for the entity (a “enterprise sale”). Nonetheless, it’s normally higher apply to easily purchase the belongings of a enterprise with a model new entity (an “asset sale”). In an asset sale, the customer will usually get all of the belongings, and never simply the bodily ones – IP, title, leases, and so forth. The benefit to doing it this manner is that the customer will get to proceed working the enterprise however doesn’t inherit liabilities related to the precise entity that offered the belongings.
Let me flesh this out a bit bit extra. A enterprise – say a company or LLC – has liabilities. These liabilities might embrace taxes, debt, litigation, accounts payable, and so forth. These liabilities are “private” to the enterprise, that means they’re obligations of the enterprise. If the enterprise itself is bought, the prior proprietor (vendor) doesn’t magically retain these liabilities and hand over the enterprise free and clear. Even when the vendor would conform to that, the customer must get the collectors of the enterprise to agree. And good luck with that.
There are some instruments that enterprise sale patrons have, reminiscent of making the sellers symbolize that there are not any liabilities, requiring the vendor to indemnify the customer towards disclosed or undisclosed liabilities, and even holding again a few of the buy value for a time frame after closing to take care of potential liabilities. To be clear although, these aren’t excellent options and we’ve seen instances the place six- and even seven-figure liabilities come to gentle after the closing, with the vendor nowhere to be discovered.
In asset gross sales, alternatively, the customer will purchase some or all the belongings of the unique enterprise, together with the license (extra on that beneath). Because of this the liabilities which can be “private” to the unique enterprise received’t observe it and the vendor should take care of these on their very own. That is vastly advantageous for patrons for apparent causes.
Okay, asset gross sales are necessary…why not use them as a default?
The reply is fairly easy – regulation. Right here’s what I wrote in that put up linked above:
With regards to regulated companies, asset gross sales might not be an choice. Regulated companies might have licenses, permits, or different belongings that can not be offered to an unregulated entity. For instance, in California’s hashish business, licenses are “private” to the licensed enterprise and may’t be offered. And the merchandise that enterprise owns can’t be transferred to an unlicensed purchaser. In these sorts of regulated industries, asset gross sales are off the desk.
In states like Oregon, the place our company staff has closed numerous M&A offers, gross sales are typically structured as asset gross sales. That’s as a result of these states have processes in place to permit licenses to primarily transfer to completely different companies and even probably completely different places.
California, alternatively, doesn’t try this. For no matter motive, drafters of the state’s hashish legal guidelines selected to not create processes for the switch of licenses. And neither did state regulators on the Division of Hashish Management (DCC). The truth is, DCC rules don’t even create a simple pathway for enterprise gross sales – regulations relating to modifications of possession mandate that an authentic proprietor stick with the enterprise for a time post-closing.
This similar regulation makes clear that “Licenses aren’t transferrable or assignable to a different particular person or proprietor” and, besides in a single very particular occasion, “licensees might not be transferred from one premises to a different.” Because of this belongings gross sales are off the desk.
I must also point out right here that California is a dual-licensing jurisdiction, which implies that licensees should even have native licenses. Some (not many) localities have provisions in place to permit for license or location transfers, however doing so is troublesome if not inconceivable given the DCC’s guidelines.
Will license transfers be allowed?
Earlier this week, California Meeting Member Phillip Chen proposed AB 2540. The proposed invoice may be very brief, and the substantive change is so as to add the blue and italicized phrase to the next current regulation:
“It being a matter of statewide concern, besides as in any other case licensed on this division, the division shall have the only real authority to create, subject, deny, renew, self-discipline, situation, droop, switch, assign, reassign, or revoke licenses for business hashish exercise.”
That is actually all of the invoice in its present kind states, and if the invoice progresses by means of the legislature it’s nearly sure to be supplemented. Whereas we don’t have a ton of knowledge on AB 2540 simply but, we do have some details about what the aim is from a 2023 effort by Chen to suggest a considerably similar invoice, AB 351, which died in committee. A committee evaluation of the considerably similar invoice from April 18, 2023 states:
Below current regulation, DCC doesn’t have express authorization to switch, assign, or reassign a state-issued license. At present, with a purpose to purchase a license, one must purchase all the firm that holds the license (e.g., an LLC) and assume all of its legal responsibility. Subsequently, the proprietor of the corporate being purchased must add the purchaser to the license. As soon as permitted and added to the license, the purchaser might then offload the vendor from the license. The creator and sponsor contend that this course of is overly burdensome and being able to switch a license would enhance continuity of operations.
I’ll simply assume that this is identical logic behind AB 2540. In that case, it hits the nail on the pinnacle. Enterprise gross sales are problematic each as a result of (1) they require the belief of liabilities (a lot of which can be undisclosed by the vendor and even unknown to the vendor), and (2) the DCC has an irrational and unnecessarily sophisticated possession change course of, which requires at the very least one authentic proprietor to stay related to a enterprise for a size of time after it’s offered.
What the long run might maintain
Provided that Chen’s try to move an analogous invoice failed final 12 months, I believe AB 2450 has a comparatively tough journey going ahead. That mentioned, if the invoice passes, it might open the state up for a bunch of hashish M&A transactions that might fully change the business. Hashish M&A transactions will most likely improve considerably if asset gross sales are permitted. This is able to be an enormous aid for smaller enterprise homeowners seeking to offload licenses, retire, or simply exit the business.
As talked about, the invoice is in its infancy and has a protracted highway forward of it, throughout which period it could possibly be modified or supplemented to the purpose the place it’s practically a unique invoice. Whether or not or not that occurs, if the invoice passes, there may be nonetheless the difficulty of native regulation, which the invoice presently doesn’t tackle. Except cities or counties determined to observe swimsuit, the state’s modifications could be of minimal utility.
It doesn’t matter what occurs with AB 2450, it’s clear that the legislature is starting to get up to the truth that the business is clearly damaged and in want of main regulatory overhauls. For only one instance, a number of days in the past, I Up to date a put up on an effort to permit integration of the hemp and hashish industries, which might be an immense change to the established order. Keep tuned to the Canna Law Blog for extra updates on modifications to California’s hashish business.