Due diligence plays an important role in many types of cannabis industry transactions. Due diligence involves a third-party conducting a thorough review of certain documents and records related to a business. As a best practice, cannabis companies should remain aware of the various times when third parties may conduct due diligence with respect to their business. Often investors participating in a financing will want to see certain corporate and other paperwork prior to investing in a business. Acquirers of the stock or assets of a company will conduct similar but often more thorough diligence processes for target companies and to mitigate liability or investment loss risk.
This piece will touch on a few key housekeeping matters that businesses should consider thoughtfully and paperwork that should be maintained throughout the corporate lifecycle in anticipation of participating in a due diligence process. Taking steps to maintain business records in real time will position a company for a more successful process should an investment or acquisition opportunity present itself. The failure to be prepared with respect to the matters mentioned below can result in costly and messy cleanup processes or complex securities laws issues.
On a high level, future acquirers or investors will consider or look at (among other things) the following items to ensure that the business and business value is protected:
that the appropriate backup documentation accurately and correctly reflects the company’s equity, both outstanding and reserved for future issuance.
Examples of documentation for cannabis businesses:
- Organizational and formation documents and authorization of shares or other equity;
- Founder restricted stock purchase agreements paperwork (including copies of checks or proof of payment of purchase price for the shares; copies of board approvals for issuing such equity; 83(b) elections, each as applicable);
- Option award agreements (including copies of board resolutions approving grants, exercise price and fair market value analysis);
- Copies of 409(a) report that may speak to the setting of the price for option awards;
- Copies of equity plans, if any;
- Copies of promissory notes that are convertible into equity;
- Copies of simple agreements for future equity, if applicable; and
- Copies of warrants or any other instruments giving right to or future right to any equity interest.
(2) Intellectual Property:
that the intellectual property of the company is adequately protected and that the company has secured the intellectual property it needs for the business.
Examples of intellectual property items for cannabis companies:
- Confidential information and invention assignment agreements of employees and consultants;
- Technology assignment agreements for technology pre-existing employment being assigned to the company;
- Trademark filings;
- Patent applications, to the extent applicable;
- Copies of documents where a company may have acquired intellectual property assets from a third party; and
- Inbound and outbound licenses of intellectual property, as applicable.
(3) Litigation, Debt and Financials:
that there are not litigation matters or other major fiscal risks or obligations outstanding.
Examples of items pertaining to litigation, debt and financials:
- Settlement or release agreements (of employees, consultants or third parties, as applicable);
- Demand letters or other threats of litigation; and
- Company financial statements.
(4) Material Agreements:
that the material contracts entered into by the company don’t materially limit the company, the business or provide for problematic terms or provisions in event of an acquisition or other triggering event and that the material agreements needed for the business with third parties are in place.
Examples of material agreement items:
- Agreements reflecting obligations of, or to, the company in excess of certain dollar thresholds;
- Exclusivity agreements;
- Agreements with most favored nations provisions;
- Agreements with restrictions, penalties or which are difficult or problematic to terminate; and
- Agreements that are violated on a change of control or ownership of the company.
that the company has obtained all necessary regulatory approvals and local and state government authorizations to conduct its business, as applicable.
Examples of cannabis compliance documents:
- Business licenses;
- Cannabis licenses;
- Other authorizations, if applicable; and
- Communications from regulatory agencies.
If a company works to keep up with these corporate records and related corporate minutes and approvals of the board and shareholders or applicable members of an organization in connection with company actions, a company will be better positioned to respond to diligence requests in connection with financing and other corporate opportunities. We at Rogoway Law Group regularly regularly assist cannabis companies with responding to due diligence requests. Our experienced cannabis attorneys are standing by to assist with any due diligence needs.