The Pot Thickens

William Mark Levinson provides his Insight on cannabis as an emerging business for entrepreneurs and business owners

November 6, 2018, brought the cannabis industry further into the mainstream of acceptance as a recreational and pharmaceutical alternative. The exact value of cannabis sales remains unknown, but an Internet search shows value in the three following categories:

From Michigan to Malibu, Calif., states and cities continue to accept medicinal or recreational marijuana within their jurisdictions, despite the federal government’s decades-long prohibition of the cultivation, distribution, and possession of marijuana, which characterized it as a Schedule 1 drug under the Controlled Substances Act of 1970. The Cole Memorandum promulgated during the Obama White House years relaxed the Justice Department’s enforcement of the act and provided some comfort to banks, investors, and service providers, like lawyers and accountants, who had been considering the cannabis industry as a business in which they could participate. Then, on January 4, 2018, the Justice Department issued a memo returning federal marijuana-enforcement policy to the rule of law under the act.

In the memorandum, then-Attorney General Jeff Sessions directed all U.S. attorneys to enforce the laws enacted by Congress and to follow well-established principles when pursuing prosecutions related to marijuana activities. This enabled local federal prosecutors to determine when, where, and how to enforce the act. Following the revocation of the perceived protections of the Cole Memorandum, potential participants in the cannabis industry paused. Where will this process end up?

[To read more of William Mark Levinson’s thought leadership click here]

A couple of years later, is it fair to say the country is changing?

Over the last year and most recently with the midterm elections, we see that, whether from a red or blue state, conservative or liberal, whether in Missouri or California, cannabis use and sales restrictions appear to be again relaxing. About 70% of the voters in the City of Malibu approved recreational marijuana use inside their city. In the State of Michigan, about 56% of voters in this Midwest, conservative bastion made it the 10th state to legalize recreational cannabis when they passed the Michigan Regulation and Taxation of Marijuana Act. Finally, on the East Coast, voters in Washington, D.C., approved recreational cannabis. At last count, Alaska, California, Colorado, Maine, Massachusetts, Nevada, Oregon, Vermont, and Washington state permit recreational cannabis use. Former Speaker of the House John Boehner, said, “I’m all in on pot.” Marijuana became legal in Canada on October 17, 2018.
CNN reports that a recent survey of 1,000 U.S. consumers conducted by A. T. Kearney, a global strategy and management consulting firm, reflected that half of respondents in their survey would likely try recreational cannabis if or when it becomes legal. Some predict that the California cannabis industry will rival, if not exceed, revenues derived by the California wine industry.

Participants and many governing bodies see green and they want their share. Marijuana Business Daily published the following table last May to compare annual cannabis sales in the U.S. to some other industries:

Taboos that involvement in the cannabis industry might bruise a company’s brand are receding in light of popular acceptance of legalization of cannabis. Is the momentum of change inexorable? Many recognized names in the consumer space are actively exploring how they might grow, manufacture, distribute, invest in, and otherwise participate in the legal cannabis business, regardless of the status of the Cole Memorandum or whether complexities exist in developing traditional banking relationships.

CNN further reports that beverage companies are positioning themselves for cannabis market growth. These companies may use cannabidiol (CBD), a nonpsychoactive component in marijuana, as an ingredient. For example, Constellation Brands, the owner of Corona beer, has a more than $4B stake in Canopy Growth (CGC). Constellation’s CEO, Robert Sands, says Constellation originally got involved with Canopy because “the whole market, all channels, all forms, is going to be explosive.” Molson Coors (TAP) entered into a joint venture in Canada to develop nonalcoholic, cannabis-infused beverages. Coca-Cola (KO) is “closely watching” the cannabis sector. Not to be outdone by Coke, Pepsi’s (PEP) CFO recently commented during an earnings conference call with analysts that Pepsi too is looking into the cannabis industry, even though it has no current plans to get into the business while marijuana is still illegal in the U.S.

Over the last year and most recently with the midterm elections, we see that whether from a red or blue state, conservative or liberal, whether in Missouri or California, cannabis use and sales restrictions appear to be again relaxing.

The beverage industry isn’t the only potential beneficiary. At every stage in the process, this agricultural revolution finds investors considering investment opportunities ranging from industrial real estate (buildings are required to house agricultural activities in a secure space) to products designed to maintain precise humidity levels while flower and other product ships to manufacturing facilities where they are packaged for retail consumption, to the financial aspects of facilitating all of these transactions.

Whether growing, manufacturing, distributing, or selling, qualified accountants and lawyers are supporting these transactions to create value and enhance investment returns of clients. Lawyers guide clients through the complexity of patented flower DNA and unique packaging and other attributes, raise capital in the capital markets, best structures for transactions that include acquiring or selling cannabis companies, or otherwise through the maze of the licensing, compliance, and financial aspects of this budding industry.

Lawyers refine the deal terms, consider legal risks arising out of a transaction, and document the transaction and work to minimize the legal and financial exposure for their client. An experienced lawyer will share knowledge of market deal terms and identify reasonable and market-driven solutions to hurdles that arise in the transaction, thereby avoiding unnecessary controversy and delays. Lawyers are also critical to the fact-finding or due diligence process, where attorneys make a detailed evaluation of all facts and company documents to, among other things, develop an understanding of the company, its competitive position in its industry, and the potential synergies of combining the businesses. An attorney will test assumptions and otherwise determine whether the parties should proceed with a transaction and whether the price makes sense. Discovering issues in the due diligence process allows for solutions to be implemented and a smooth transaction.

Accountants and investment bankers are providing accounting and quality of earnings guidance. Prior to any sale, it is critical to ensure that all revenues and expenses are in order. Flawed accounting data affect price which, in turn, impact the company’s value. It is fair to say that hurdles regularly arise but are rarely terminal, so long as they are identified and addressed in due course. It is up to the participants, the lawyers, and the accountants to craft solutions, sometimes creative solutions, that enable the transaction to proceed.

Many successful investment and merger and acquisition transactions have already occurred. It has become commonplace to read and hear about corporate cannabis combinations and sales as companies seek more professional management. For example, MedMen (Canadian Stock Exchange: MMEN) (OTCQX: MMNFF) announced on November 8, 2018, that it entered into a letter of engagement with Canaccord Genuity Corp. for Canaccord to purchase, as lead underwriter and sole bookrunner, on behalf of a syndicate of underwriters 17,648,000 units of MedMen, subject to all required regulatory approvals, for gross proceeds of $120,006,400. MedMen said it will use offering net proceeds for working capital and general corporate purposes.

Plan and Have Your Corporate Act Together

While this world of cannabis expansion may sound glamorous, we must not forget the hard truth—this is an industry in its infancy. Growth may be stymied if regulatory challenges reemerge or if regulations do not continue to ease on the federal level. The good news is that many of these obstacles are foreseeable and, with proper planning and guidance, are being addressed in a way that is nurturing the industry. Critical thinking, solid planning, and guidance from trusted and experienced investment bankers, accountants, and lawyers will increase the likelihood of an industry that will be run successfully and professionally.

[For more on Carlton Field’s approach to Corporate Law click here]