Group Co.
CANNABIS CORNER: The Right Way to Acquire a Cannabis Dispensary or Brand
Traders Magazine Online News, July 22, 2019
“How does Cannabis One find its acquisitions?” is a question I hear every day. Acquiring a cannabis brand or dispensary is a risky—and costly—endeavor. The potential for profits is massive, but so is the potential for loss. By conducting a thorough investigation and looking for certain risk factors, acquirers can mitigate risk and ensure they’re making a worthy addition to their portfolio.
Cannabis One’s criteria for M&A begins with a high-level filter of the financials. With dispensaries, we look for a financial picture that illustrates market stability, depth of penetration, and market share of the neighborhoods. A targeted dispensary’s financials must reflect a smooth, stable cash flow for the prior 12 months with minimum $3.5 million top-line revenue and a flat-to-up trend with at least a 40% gross profit. After financial filters are satisfied, our analysts conduct a “red flag scan.”
The team objectively looks for more than a dozen red flags, such as licensing issues, accounting irregularities, disciplinary actions from regulators, complaints filed against the entity, high turnover, and choppy cash flow. This last factor is particular concerning—and usually an instant dealbreaker, since it more often than not signifies serious systemic problems that cannot be easily resolved.
Gaps in a dispensary’s cash flow are never a positive indicator and will always lower the target’s “deep-dive” (or DD) due diligence score. However, there are rare instances where the gaps in cash flow can actually be cleared, such as a product recall or a temporary closer by regulators to conduct an unwarranted investigation. If this investigation finds the dispensary not in violation, we can restore it to full working status.
If these red flags are cleared, the acquisition target is cued for our proprietary DD due diligence. However, if our analyst doesn’t grant clearance, the file is downgraded, and the acquisition target is moved to our watch list until management can resolve the issues. We have developed our proprietary DD scoring system to speed up the due diligence process; it creates a unitized work flow that breaks up the workload to allow multiple analysts to work on the same file simultaneously. This process has removed the time bottleneck that most due diligence was causing prior to our implementation structure; it has increased our analysts’ productivity by more than 400%. Through this process, our firm has maintained its competitive edge in the cannabis consolidation race.
Upon completion of the DD, our M&A analysts prepare a report and assess a DD score. This score is similar to a personal FICO score: it summarizes the business in an objective nature and in a format that can be easily communicated to the M&A committee for final decision. Dispensary acquisitions tend to be straightforward because the financials tell a fairly complete story: an objective and quantifiable decision-making process is applied to most acquisitions with very little subjectivity.
Cannabis One’s acquisition criteria for cannabis brands, however, is very different from our dispensary acquisitions because the evaluation criteria has to be much more subjective. Market share and rapid growth in market share are the most import metrics we look for in our brand acquisitions. With brand acquisitions, the revenue hurdle for consideration is currently $5 million in trailing 12-month revenue with an overall up-trending growth pattern.
The brand acquisition process commences with a review of the financials similar to the screening conducted on dispensaries. We generally look for the same type of immediate red flags as our dispensaries. Once the revenue and red flag screens have been satisfied, our M&A team starts a subjective evaluation to determine the brand’s penetration into its respective market. Like any brand acquisition, the most important factor in our brand acquisition decision-making is market share.
To determine market share, we have developed a grading process taking into consideration factors like: 1) the number of dispensaries in a geographic area that carry the brand; 2) the brand’s location within dispensaries: whether it’s a highly-trafficked area or tucked into the back of a site; 3) the number of a brand’s products displayed in each store. (Less than 25% is considered an immediate red flag and typically a disqualifier from consideration.)
The final step in Cannabis One’s due diligence process for brands is the onsite visit. Once Cannabis One’s M&A analysts complete this onsite visit, they prepare an extremely comprehensive report on the brand—sometimes more than 100 pages long—for our acquisition committee. The committee evaluates the analysts’ recommendations, prepares deal terms, and rates a target based on a proprietary grading scale developed in-house. And then, finally, an offer will be made. From there, it’s off to the races!
Jeff Mascio is CEO of Cannabis One
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