So you’re finally ready to close on the marijuana startup that your company is acquiring and the basic terms and conditions of the sale have been worked out. Well, you are almost done but there are still a few more things that need to be ironed out.
Towards the end of the sale of a cannabis startup, parties begin developing and negotiating what is called a definitive agreement. While occasionally referred to by different names (“stock purchase agreement, “definitive merger agreement”), a definitive agreement effectively deals with some of the nuanced and remaining stock or asset purchase issues that may be negotiated for in addition to the actual acquisition of the company. For example, what kind of stock will the buyer be getting? When does the stock vest? Do certain markers of success need to be met before the stock transfers? What if those markers are not met?
It’s All In The Details
Clearly, the purchasing of a company can be far more complex than simply handing over a fixed sum and assuming “ownership” of the company. Indeed, perhaps the most challenging aspect of a deal is the mechanics of structuring the financing of the sale. One of the central purposes of the definitive agreement is to describe in detail the final financial terms of the transaction. Of course, these terms were likely outlined in the letter of intent or term sheet at the beginning of the acquisition or sale but very likely not in final form. The definitive agreement establishes the exact and final terms of the purchase, either for the company’s stock or hard assets. The agreement also delineates the total consideration (generally a cash transfer) that the buyer will pay, how the buyer will pay (i.e. cash, stock, promissory notes, etc.), what liabilities will transfer to the buyer, the terms of closing, and the various documents to be exchanged.
Definitive Agreements and Seller Assurances
Of critical importance to the buyer, the definitive agreement contains final statements made by the seller regarding the company’s assets, intellectual property, contracts, customers, and vendors. These representations and warranties are a product of the due diligence process effectuated by the attorney representing the acquirer. Fundamentally, the purpose of conducting a due diligence analysis is to gauge whether or not the target company is truly worth the amount claimed by the seller and what, if any, are the associated risks with the purchase. The seller makes binding statements guaranteeing the veracity of the information presented to the seller and if the due diligence process reveals a fact which contradicts the seller’s guarantees, the buyer may walk away from the sale.
Because (unfortunately) the very real possibility of breaches of representations and warranties exist, indemnification provisions are included in definitive agreements to mitigate the risk and responsibility of the acquirer when a risk is discovered. If a breach of representations is discovered before closing, the acquirer is likely able to walk away from the sale without closing or request that the seller lowers the purchase price. If a breach is uncovered after closing to the buyer’s detriment, the seller is responsible for compensating the buyer for that harm.
Conversely, sellers may reduce their own risk through provisions which limit the time that an acquirer can make a claim, providing a deductible, or prohibiting the acquirer from suing the seller over information that was disclosed in due diligence.
Final Thoughts on Definitive Agreements
Purchasing a marijuana startup is uniquely interesting and challenging because of its federal illegality and the lack of a centralized federal regulatory structure to dictate financial constraints, otherwise available to traditional startups. It is the responsibility of both the seller and buyer to of the prospective company to protect themselves at all times. Let the fun begin.
Click here to read Abe Cohn’s previous article on legal startup basics.
Abe Cohn manages THC Legal Group, a Marijuana Law Firm specializing in the cannabis industry. Their attorneys assist startups, entrepreneurs and established businesses protect their most prized assets. Connect with them to learn more.