2020 has been a shock to all of us personally and commercially, but 2021 looks a lot better, especially for cannabis companies in Washington. Over the past three months I have had serious conversations with many clients and prospects about M&A activity. The pace of inquiries has accelerated considerably since the beginning of January.
Recently I wrote about M&A activity in Washington (see here):
MSOs (multi-state operators) and international cannabis companies (especially Canadian public companies) are trying to buy and sell shares in WSLCB licensees. We can expect more of this in 2021, and more resistance from the WSLCB to MSOs and overseas funds investing in the Washington cannabis market.
Based on the term sheets we received and prepared, it is clear that retail licenses, which have always been in demand, continue to be the most desirable acquisition targets and produce the best value. We’ve seen retail-only license offerings run up to $ 1 million each, while groups of retail licenses with a consistent, solid retail brand cost many times that amount.
Interest in manufacturer and processor licenses is also growing, with pure licenses for a tier 3 license generally in the mid-range of $ 400,000. When it comes to additional assets, and especially when the seller has created a viable business ecosystem (and not just a license), many other valuation factors play a role in the negotiation process.
Call options are always in demand when it comes to non-Washington and non-US funds because the mere sale of an option to buy with no money going to the licensed company does not need to be reported to the WSLCB. This allows MSOs and international operators to buy and sell the majority of a licensee’s marijuana-related assets in Washington without oversight from the WSLCB.
This limitation also means that companies willing to hold cannabis escrow funds and act as closing agents are always in high demand. As lawyers, we cannot represent our clients and act as trustees or closing agents for our business. So if you know any good cannabis transaction trust companies please send them my way. I am always looking for more industry contacts.
As the industry consolidates, the sophistication of potential buyers generally increases, and that also means there are more tire kickers and window shoppers. If you are a potential buyer, don’t try to save money by avoiding a lawyer and letting your agent prepare your term sheet or letter of intent (LOI). You will most likely come across as an unmotivated buyer and be ignored.
I know brokers provide valuable contributions and services, and many of them are worth their salt. But I can always spot a term sheet, LOI, or contract drawn up by a broker – or sometimes worse – brokers on both sides before consulting an attorney. Save yourself time by letting your broker put your bullet points in an email to your transaction attorney. Your lawyer will thank you, and your business will go much smoother from the gate.
And one more tip: don’t confuse a real estate agent with a business agent. I get scared every time I get an LOI that comes from a real estate agent’s office because it’s always less helpful than one from a business agent playing a lawyer. I have no problem with brokers moving outside their core area when they get it right, but it’s often not right. (Once I was involved in a deal where the contract required six changes because the parties insisted we stick to the original, sub-par contract the brokers had prepared. From then on, it wasn’t for all parties involved cheap or easy.)
On the upside, I recently had a great conversation with a Silicon Valley-based M&A advisory firm that reports that the real world is growing cannabis company valuations. It’s better for buyers than sellers, but it’s really good for everyone because it means the market is maturing and we can count on more solid data. This company used to be exclusively in the technology sector and has been working exclusively in the cannabis sector since 2017. It helps potential sellers and buyers justify company valuations while the purchase price negotiations are taking place. Here’s what I learned:
- Private companies are currently valued at ~ 8-10x profit
- The market is shifting from earnings to an EBITDA model to reward better companies
- A current EBITDA of 5-6x is appropriate for sales in 2021
- A company with $ 20 million to $ 30 million in revenue could be defending 8 to 10 times EBITDA
- For retail businesses
- Ratings fell to 0.75 times sales in 2020 but rose to 1.25 times sales as early as 2021
- EBITDA margins are at least 15% and there is still room for growth
- Brands still have the greatest potential. A good brand can generate 2-2.5x sales
So as we head off to the races in 2021, it will help sellers keep these points in mind in order to get good value for their businesses, and buyers will set good metrics to use in their bidding. I’ll see you out there.