Mistakes in Oregon Cannabis Business Sales: Part 2

We have been helping people buy and sell Oregon cannabis businesses since the early days of the adult use market. Most of these sales are relatively simple asset purchase agreements—including many for naked licenses—but some have been stock sales. Others have taken place amid administrative enforcement action by the Oregon Liquor and Cannabis Commission (OLCC).

This is the second of two posts on mistakes we commonly see in Oregon cannabis business sales. Last week, I covered lazy diligence, sleeping on inventory, services agreements and unclear deadlines. Today I have five more hazards for you: sale structure, landlord issues, local issues, earnest money and escrow issues.

Sale structure (asset or stock sale agreement)

Story time. We represented a minority shareholder in a sale recently where the company agreed to an asset sale (total liquidation) of an OLCC licensed vertical out of a C-corp. When alerted to the potential tax impact, the selling attorneys reasoned the C-corp “wasn’t well managed and there were outstanding liabilities.” It seems that no consideration was given to what could be accomplished in a standard, pre-close window, as well as standard options for closing conditions, indemnity escrows, promissory note offset rights for the buyer, and other types of holdbacks. A seller can also negotiate responsibility with a buyer for various liabilities during diligence, at which point the parties may negotiate related representations and warranties, indemnities, etc.

The point here is that not all Oregon cannabis businesses are LLCs taxed as partnerships, and not all sales should be asset sales. Still, I’ll be surprised if I don’t come across a few more instances in the next 12 months similar to the story above, where a selling C-corp agrees to an asset purchase proposal (as in, total business liquidation) simply because the buyer suggests it. “That’s just how these businesses are sold,” people sometimes say. “That was the best offer.” Etc. Unfortunately, sellers – and even their advisers – often fail to understand the tax implications associated with selling off everything but a company’s stock. A likely consequence: too much tax.

So why do C-corp businesses generally prefer stock sales? First, the proceeds will be taxed at capital gains rates rather than ordinary income tax rates. In the sale of a C-corporation, taxes at the company level are bypassed with a stock sale. Selling shareholders may also realize the incredibly valuable qualified small business exclusion if the stock has been held five years and other criteria are met. Finally, the selling company and its shareholders may get liability protection in a stock sale by shedding both known and unknown liabilities— at least, the ones that they do not agree to keep.

Blindly capitulating to an asset sale in every cannabis business deal is not the way to go. Talk to a cannabis CPA prior to agreeing to a sale structure, including purchase price allocation where relevant– especially if you are a seller. I hate seeing people pay too much tax.

Landlord issues

Landlords are an interesting lot. By that I mean owners of small commercial buildings—especially marginal buildings, and especially landlords willing to lease to cannabis operators—can be challenging to deal with. Griffen Thorne in our L.A. office has written a fair bit about this dynamic. See here, here and here.

When someone buys a cannabis business, they often need to take a lease assignment from the seller, or negotiate a replacement lease with the seller’s landlord. The landlord’s consent is usually required in the former scenario, and always in the latter.

Some landlords have little interest in working with a buyer— especially if things have been going well with the current tenant. Many landlords also insist on using ill-fitting leases, often cobbled together without counsel from ill-fitting forms. The landlord used that form with the seller, after all, and nothing terrible happened. In my view this is like riding a bicycle with a cracked helmet, because you’ve always used that helmet, and a new one is expensive, and you’ll probably never crash.

In any case, it’s very important that Oregon cannabis business sellers ensure their landlord will work with them, to the extent required, prior to signing a term sheet. And it’s important for buyers to diligence the lease and ownership aspects of a property sooner rather than later. This is one of the issues where transparency and cooperation between the parties is vital, in order to close a deal.

Local issues

Local issues can be cumbersome in Oregon cannabis sales. I’m not just talking about Land Use Compatibility Statements or pointless local licensing programs. When the sale of a business involves real property (real estate), any number of things can pop up, especially in a place like the City of Portland. I’ve seen state and local bodies require all manner of improvements and concessions associated with changes in use or real estate ownership, e.g.: six figure curb cuts, easement grant requirements, or mandates to add points of vehicular access to a given parcel.

Some of these requirements may be due to the nature of the use of a piece of property (cannabis; cannabis retail; cannabis processing; etc.), while others may ensue from regulations or policies adopted after a parcel last changed hands. It’s unfortunate, though, when a surprise like this surfaces well into a deal—especially after some portion of the purchase price has gone firm, or a buyer has made other binding commitments. This leads me to the next topic.

Earnest money issues

I like earnest money in deals, even if it’s wholly or partially refundable, and even if it’s just in the form of a promissory note or something similar. People should have skin in the game. The issue with many Oregon cannabis sale agreements, though, is that they lack basic parameters around earnest money. Most purchase agreements are not standard forms, after all, and earnest money is often something that is stuffed in along the way.

Another story. Last month, someone returned to us a redlined draft of a purchase agreement where no earnest money had been required to start (the LOI didn’t contemplate it in this case). The seller’s lawyer added a line that read “Buyer shall provide to Seller $20,000 earnest money upon execution of this Agreement, which shall serve as a credit against the Purchase Price at Closing.” There were no instructions for deposit, let alone anything about how or whether the earnest money would be refundable, or when it would “go hard.” What if the seller breached the agreement? What if buyer breached? What if the landlord refused a lease assignment? What if OLCC refused to grant a license because of this breach or that? Etc. Anytime money is going over the transom, whether and when it can come back, if at all, must be very clear.

Escrow issues

There are a few issues around escrow that make Oregon cannabis deals interesting. First, in the real property context, it’s still impossible to find a title company that will serve as escrow on a deal. (It’s hard enough to find one that will extend a title policy.) I think I first wrote about that six years ago and not much has changed. This means that cannabis business buyers and sellers need to find a different type of agent. And that escrow agent should not be one of the party’s lawyers absent special circumstances– which is another mistake we often see.

Over the years, we have always worked with third-party escrows who aren’t title companies in cannabis asset purchase, stock purchase and real property transactions. Those agents tend to schedule their fees off of title company calculators for real property deals, and may agree to flat fee a business sale agreement. Escrow is affordable in either case, and most deals should run through escrow, at least in part, under a standard escrow agreement.

_______

Let us know in the comments if you are seeing these or other common mistakes in Oregon cannabis business sales. Or feel free to email me with any thoughts. Until then, may all your deals close quickly and without stressors.

Source: https://harrisbricken.com/cannalawblog/mistakes-in-oregon-cannabis-business-sales-part-2/