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  • Kresimir Peharda | Cannabis: Advice for First-Time M&A Buyers in the Market
    POSTED 11.16.21 M&A Masters Podcast

    On this week’s episode of M&A Masters, we speak with Kresimir Peharda, corporate and M&A attorney with YK Law. Kresimir is the Chair of the firm’s Cannabis Practice.

    As federal legalization inches ever closer, we invited him on the show to discuss the ins and outs and the rise of M&A in the world of cannabis. 

    Listen as he walks us through:

    • Improvements are happening and usage is up, but what challenges lie ahead for M&A in the cannabis industry
    • How cannabis regulations affect deals and why buyer/seller trust is everything
    • What trends he sees coming in the cannabis M&A market for 2022 and beyond and his advice to first-time buyers in the market 
    • And much more

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there. I’m Patrick Stroth, trusted authority in executive and transactional liability and president of Rubicon M&A Insurance Services. Now a proud member of the Liberty Company Insurance Brokers Network. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today I’m joined by Kresimir Peharda, partner and chair of the cannabis practice at YK Law. With offices in New York, Texas and California, YK Law describes itself as the gravity and prestige of big law with the flexibility and efficiency of a solo.

    And I asked Kresimir to come on today because in the news, we’ve got legalization on a federal level with cannabis that’s imminent, it always seems to take a little bit longer. But I thought now’s the time before that federal federal stuff gets passed, that maybe we start looking at the ins and outs of mergers and acquisitions in the world of cannabis. So Kresimir, great to have you. Thanks for joining me today.

    Kresimir Peharda: Well, thanks, Patrick. Glad to be here. It’s definitely an interesting and ever changing topic.

    Patrick: Yeah. And you know, in certain places, it’s, you know, top of mind with a lot of folks. So I’m glad you were able to come and join me. Now before we get into cannabis and specifically M&A and cannabis, let’s set the table for our audience. You know, why don’t you talk about you real quick, what led you to this point in your career?

    Kresimir: Yeah, it was actually really organic. Just clients or potential clients coming to me in the first case was a landlord years and years ago, probably more than 10 years ago, way before legalization in California, or I think anywhere, for that matter. Who wanted to rent space to a dispensary. Yeah, in the in the real estate that they held. And so they came to me asking for advice. And at that time, really, I had no good advice to give them which was super frustrating. You know, I had explained that I understood real estate leases, and I could help them with that. But I had no idea what would happen if the police heard about it. Or if the neighbors complained, or somebody came in. I really that was uncharted territory.

    So I had to unfortunately tell them to go to talk to a criminal defense attorney. And and that experience kind of snowballed from there. We had other folks, we had people looking to invest in cannabis business. And same thing I can tell him look, I understand securities, and and investments. But because this is illegal, it’s really uncharted territory. But you know, the whole subject matter of the investment is illegal, technically. So how do you how do you manage risk there, there, there was no playbook. And then, of course, companies looking to grow, cannabis companies started coming to me. So I thought it’s time to really, really get into it, and learn about it understanding that it is ever changing, complicated and multi subject matter.

    Patrick: We had talked about the the real challenge that you just talked about it here, where you’re taking an industry, which is pretty large, that’d been up until now in the shadows, and now it’s coming into legitimate business. And that’s a real awkward transition, because, as you know, you have a lot of the first legal advice they got was on the criminal side exclusively. And there was no other business, you know, availability or resources there to bring it. So talk about, you know, that challenge on going from shadows into now your operating?

    Kresimir: Yeah, well, it couldn’t be more of a contrast, right? Because, you know, 10 to 15 years ago, the only people advising cannabis companies were criminal defense attorneys. And of course, their job is to keep their clients out of jail, you know, limit the prosecution, minimize the evidence that the state can use against their clients. And so their their mandate to clients was always to not have any documentation, make everything oral, everything verbal, handshake deals and all that. Well, now in 2021, we’ve we’ve come really full circle to the opposite situation. The the regulators in California and other states require license holders to provide documentation of almost every major deal.

    Not only ownership and financial interest holders of people financing, but any significant really deal that involves any measure of control or significant share of revenues, is going to have to be disclosed and regulators. So the world is flipped on its side. But yet many of the people running these businesses have come from the gray world, the world where they were told for years and years not to have any documentation. So it is a little bit of a battle, to to get folks to understand that the times have changed. And now you really do need to have everything on paper, because it will only help you and it’s expected.

    Patrick: Well, I think also the issue is that you’ve got this overwhelming moral view one way or the other with cannabis as a product, you know, virtue or not. And, you know, as we look at it, a lot of us have come around to the belief that look, if if cannabis is no different than, let’s say, a pharmacy, and, you know, pharmacies have, you know, controlled substances, and they and they are regularly putting those out to the public, you know, with prescriptions and everything, but there are controls there. So, if cannabis can go ahead and have guidance, policies, procedures, like a pharmacy, then they should be looked at no differently than Walgreens. And that’s the process I think, you know, people like you are bringing, bringing along there. So, tell us, what does your practice, what are you bringing to the table for cannabis now. And talk about, you know, investors, growers, however, however, you’re structured.

    Kresimir: You know, so personally, I come into this industry, having been in three startups, two in real estate one and healthcare. So I understand regulated industry, but, you know, regulations here are kind of at another level. And what I would say my personal view is that, really, cannabis is going to be really kind of like alcohol and should be treated like alcohol in the future. So I think that’s the direction we’re headed in. As a brief aside, having the one of the challenges we’re gonna have, you talk about legalization, one of the challenges we’re gonna have in the future is, what happens if the federal government if Congress decides to, you know, tomorrow? And I’m not saying they will, but tomorrow legalize it, what happens to all the state regulatory regimes? Right, because my clients and clients out there throughout the states have spent a lot of time and money preparing for and complying with the state specific rules.

    So if the federal government tomorrow were to say, okay, it’s now federally legal, I think nobody knows exactly what what that would do to all the state by state licensing systems. So that is, that is one thing I would say. In terms of what we do, you know, so our approach really, or I should say, my approach is one coming from also representing a lot of public companies. NASDAQ and NYSE companies. And understanding that they have, you know, tremendous burdens, which actually, there’s some parallels to what cannabis companies have to go through, of course, they’re doing it on budgets that are a fraction of the size. But it’s, it’s really, you know, they’re forced to do regular reporting one way or another.

    And the way we look at, you know, the business is it has to be multi specialty. It has to go through a corporate lens and a regulatory lens, at a minimum, but then you you layer in employment, because there are very specific labor laws that apply to cannabis. You you layer in IP, where cannabis companies basically cannot get trademarks on their key property. So they have to do workarounds. You layer in taxes 280E and some of the complexities and structure. And so the point is, we have a kind of a multi specialty approach to the industry, because there’s so many different areas that impact even a relatively small player in the business.

    Patrick: Well, and and I can only imagine that with with the confusion from state to state, I, these companies aren’t multistate, are they?

    Kresimir: Well, so you know, some are, and you know, that that means that, that we’re working with either people who are licensed in that state or within our firm, or we’re partnering with folks who have local licenses throughout various states, because we certainly don’t have don’t claim to have a person in you know, every single state out there. But, you know, once once you have, I think, a very in depth knowledge of a state that is, let’s say, a little more challenging like California, I think it’s a lot easier to then work with a local partner in other states to help clients reach their goals.

    Patrick: Well, when when we talk about regulations, there are a lot of people that if they’re not in a regulated industry, it’s a full time job, stay on top of that. And it’s really unique because regulations do have a lot of impact, particularly with people who are investors or don’t realize their investors? And so why don’t you talk about just some of the impacts that regulations have on cannabis companies.

    Kresimir: Sure. Yeah, they’re massive, really. They’re massive. So in California, as an example, and this will vary, Colorado is different. But in California, the regulations will control the type of structure you use on your M&A transactions. You’re basically limited to stock purchases, and mergers. Asset purchases are not allowed. You know, the visibility. So you know, if you’ve ever tried to do timetable for a deal in M&A, you understand this, this this issue, it’s extremely difficult to come up with, with any kind of reliable timetable, or calendar and you know, list list of items to do. Because everything is so new for the regulators. 

    Now, now, this is getting a little better. But you know, drilling down a little bit, you have to keep in mind that even with with a single target, so let’s say you are the buyer buying a single target, they may have locations in multiple cities, and they may have multiple licenses. So each city is a stakeholder in your M&A transaction. And each administrative agency at the state level is also a stakeholder in your transaction. So you can imagine if you have multiple targets, multiple licenses, multiple cities, the level of complexity that you need to manage, that’s just on the regulatory side, not not even having to do with the M&A transaction itself.

    Patrick: Well, and on top of that, if the regulator’s this is all new to them, if they haven’t made determinations, is this something akin to tax, where, you know, they’ll they’ll decide it later. So you may be on the hook for some violation after the fact?

    Kresimir: Well, haven’t seen that. But But the challenge is that, you know, a client will will understandably say to me, well, how long do you think it’ll take to get through the approval process at the city? And so in some cases, we can say, well, based on our past experience, you know, it’s been, it’s been this long. But sometimes, you know, it’s a new city, or sometimes it’s a novel transaction, or, or, you know, there’s additional complexity. And so, past experience is not going to be a guarantee of future results. Now, having said that, the development in California that, hopefully is going to be positive is three state agencies have merged into one, which in theory is going to reduce the variability in the process. 

    But I was just on a webinar last week, put on by the LA County Bar Association, and they put out the question to the panelists, and, you know, basically everybody, you know, are they are they still seeing variability between different clients and different analysts at at the state level, specifically? And the answer was, absolutely. It’s, there’s still a lot of variability. And that is challenging, right? Because your clients will want to know, when, how long, how much? And those are difficult questions to answer just for that reason. And that’s not really obvious from the outside. It’s difficult to appreciate that an analyst within a state agency is going to differ from another analyst. So that makes it difficult on everybody on the deal.

    Patrick: Also, just another challenge here, because banking is not possible. You had mentioned this earlier with without a structure. These have to be stock purchases, or mergers. What other elements of an M&A transaction is unique to cannabis? I’m just thinking one where they’re not getting, you know, any bank loans for this. 

    Kresimir: Right, right. So, no bank loans until relatively recently, normal, insurance was difficult to get, that’s changed, I think, and is changing. I mean, there are a lot of things, one thing that comes to mind is, you know, the and we talked about this, one of the challenges you have is that with so many stakeholders in your deal, oftentimes these stakeholders will literally control your deal. They will tell you what to do, when to do it, and how to do it. So you know, the the case that really comes to mind is when you have a condition of precedent, for the for the buyer to sign off on a deal, the obtaining of governmental approval. 

    Well, we’ve had the regular tell us that our client has to waive that otherwise they will not even proceed and in approving the deal, and they will not even tell us how long it will take to potentially approved the deal. So you have a regulator who’s not just a you know, kind of signing off on the deal. They’re literally controlling how you structure the deal. The timing of it, and the risk that the buyer has to take, in this case.

    Patrick: In your in your experience, how large the transaction value size, are these deals that you’re seeing?

    Kresimir: Oh, I mean, you know, we’re seeing anything from the low seven figures to to, you know, up to about 50, 60 million on the higher end. So, you know, I think the way I look at everything in cannabis is probably about a 10th, the size of what you would see in CPG. And that’s just the nature of the industry by by its, you know, relative youth and being relatively early in the process and relative lack of access.

    Patrick: With, you had mentioned also with insurance, which is an industry and you know, the property and casualty insurance market is coming around, and there are resources there to ensure product inventory, crime, trip, just your basic business trip and fall, work comp, all that’s out there. I would caveat that until now, rep and warranty, which is the backbone insurance for mergers and acquisitions. They haven’t signed on yet. I think there there’s still a lot of unknowns out there that they’re waiting for, which is why, you know, we can’t draw on any experience that way. 

    And it’ll be it’ll be a US company, largely that steps into that. I anticipate Lloyds of London, they still have a very traditional view and look at this as a vice, and they don’t want to promote a vice. And that’s just a cultural thing. That that we will see what happens. But aside from insurance coming around, what other improvements business wise, you know, for operating a cannabis company are happening? I’m sorry, this is off script. But I’m just curious if you’ve seen other evolutions, because the law is obviously evolving.

    Kresimir: Yeah, well, so. So one thing would be banking. There definitely is more banking available. Certainly I know of banks locally and regionally that are providing banking. So that is definitely a positive. And then for the MSOs, the multi state operators and and the larger private companies, you know, that they actually can get institutional debt. It’s very new, kind of brand new, but it does exist at the top end of the spectrum. So that is an interesting development, we’ll have to see if that trickles down to kind of more of a mid mid market and lower market in the cannabis industry. But but that is a hopeful sign of, you know, interest rates below 10% on institutional debt, which is, you know, surprising because that, you know, a year ago, that would be unheard of.

    Patrick: Wow. Okay. And I can just see that we’ve got I mean, by any metrics, usage is up. And so it’s it’s a growing industry, it seems like now is going to be a little bit easier to conduct business as as things go on. There are more business services and resources being brought to bear. You know, Kresimir, what kind of advice would you give a first time cannabis M&A, you know, buyer? I mean, that’s targeting something, what advice would you give?

    Kresimir: Well, so a couple of things. Don’t underestimate the regulatory complexity. You know that that’s going to drive that’s going to drive a first time buyer crazy, because the level of uncertainty that you’re going to have is much greater, I think, than any other space. Really think about the tax liabilities that you are taking on. Assuming you’re, you’re you’re actually buying the business via stock or merger, because we found that most of these targets have tax liabilities of some sort. And then you have to remember that if you’re taking on this business, you take on all that liability. So that means the principal, the interest plus penalties, so those liabilities very quickly become seven figure, even in smaller deals. So that’s that’s a huge, huge issue. And that’s a tough one for the buyer to suss out because really it requires them to really do some forensic accounting, to try to get at that, try to at least scope it. So that’s, that’s another one. 

    And something that they probably didn’t think about is, I think it’s critical in all deals, but but in the cannabis industry, it’s actually more important that you have a reasonable relationship with the buyer. And the reason for this is until such time as that there was an actual transfer of the license, the state, specifically the state and oftentimes the city will will not even interact with buyer or buyer’s representatives. So the buyer is completely dependent on the seller or the seller’s representatives to make progress in the transition process. So if you have a seller that’s unmotivated, or becomes ill, or the key person, you know, flies out to Hawaii for six months, you’ve got real, real logistical problems in your deal. And that’s not something you see in other industries to this degree. 

    That last point, to to the advice to buyers is understand that in many states, you have to work very, very carefully with the buyer to structure the transition so that the business does not close down. Historically, in California, the regulators would would say, if there is no person from the seller side that’s staying on in any capacity, then the business would have to actually shut down and and the buyer would have to start anew essentially. File a new application and begin the process. And obviously, that is devastating for a buyer who’s thinking that they can just continue the business to have to shut down even two or three months, makes a material impact in the financial projections and the whole deal. So I would say that’s, that’s another key point.

    Patrick: I mean, the question out there, I asked all my guests is what, you know, what trends do you see going forward? Pull out your crystal ball. And you know, if you’re right, you’re going to be a genius. But where do you see legalization going on a federal basis?

    Kresimir: I think what I see is very likely is on the banking side, that we get some movement, that’s probably the safest. I would say within the next year, I, I believe that we’ll see some movement on the banking side, because that’s a lot easier to swallow, then an entire deregulation decriminalization of the whole industry. And partly because the banking industry is behind, and law enforcement tends to support it. And it just makes sense from a crime and practicality standpoint. Nobody these days wants to be dealing in cash, not even the tax authorities. So that is one thing. 

    I think we’re gonna see some changes, probably on rep and warranty insurance coming, you know, whether it’s next year or the year after that. I think we’re gonna see more and more banks provide, you know, accounts. It’ll get easier to bank and, and my hope is that, you know, within a year or two, we’ll start to see more debt be available at more reasonable terms, so that these companies can can do it in a way that makes more sense. And they’re not paying, you know, hard money lenders exclusively. They’re not paying, you know, 15%, 20% to try to grow and expand these businesses. 

    Patrick: Wow. Why would you think that also, maybe there’d be a little more efficiency on the regulatory front too. Usually, you get regulators that really like to cling on to their rules, and and their standards, but you you reference, you know, three, three organizations, consolidating in California. Do you think the state regulators might ease up on some of this stuff?

    Kresimir: Well, I’m hoping that the experience level will will improve. That there’ll be more standardization. I mean, the thing that makes it tricky is this variability, every analyst having a different understanding of what the regs are, and that makes it difficult. You know, a lot of times when they’re pushed on that, they they just regurgitate the regs so they don’t take kind of any responsibility, kind of for the enforcement side of it, or the interpretation side of it. So I think that will improve. Hopefully, the cities will have more experience. Just working through transactions, transfers of ownership, transfers of locations, so it will get easier, but it’s going to take time.

    Patrick: Okay. This has been fascinating. There’s gonna be I mean, there’s more to come down. Kresimir, would you, would you, because I got you on tape right now. Would you agree to come back as as things change? You could update us?

    Kresimir: Sure. Absolutely. Just throwing another thing out there. Another thing that kind of hit the industry is the US Postal Service now formalised the ban, basically on on mailing vapes through the mail, and that’s going to have an impact, I think a negative impact on the industry. And it’s not clear to me that that was really the intent Congress had, but that’s where we are so basically THC, CBD is is no longer going to be able to be mailed through the mails with very few exceptions.

    Patrick: We’ve got, things are changing constantly. So the story has not been, it’s been written but it’s still in progress. 

    Kresimir: Oh, very much very much. 

    Patrick: Great. Well Kresimir Peharda of YK Law, how can our audience members find you so that if they have a deal coming up they can they can, you know, avoid some of these pitfalls?

    Kresimir: Sure, pretty easy. Our website is yklaw.us. So it’s dot US as the ending. And my email is kpeharda,  k p e h a r d a @yklaw.us.

    Patrick: Great. Kresimir, thanks so much for joining us today and just a lot, a lot of great insights. Appreciate you being here. 

    Kresimir: My pleasure, Patrick.