Investing in Hashish: 5 Due Diligence Pink Flags

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Our hashish workforce has carried out due diligence on numerous enterprise purchases, investments, loans, and nearly each different type of transaction you possibly can think about. As you possibly can think about, we’ve seen some fairly dangerous and even sketchy issues over time. With rescheduling on the horizon (see right here and right here), we count on to see a rise in loans, investments, and different transactions. And so we thought it may be time to have a look at 5 of the largest due diligence purple flags.

#1 No cooperation in due diligence

Palms down, the largest purple flag in due diligence is when the vendor, borrower, and so forth. refuses to take part within the course of. I don’t imply getting fatigue when the customer or investor’s lawyers ask too many questions – I imply refusing to take part within the fundamental course of. We’ve seen individuals refuse to offer fundamental data. Or stroll away from a deal when fundamental questions have been requested. Or say that different individuals did comparable offers with out data, so you must too.

That is all extremely suspect conduct. Somebody who’s promoting a enterprise or searching for a mortgage or funding must be utterly open. Clearly, diligence durations can get off the rails and change into too lengthy, however failure to offer fundamental data is a purple flag that one thing dangerous lurks beneath the floor.

#2 When the pitch doesn’t match actuality

One of many subsequent massive purple flags is when due diligence reveals info that grossly contradict pitches or early disclosures. The due diligence course of normally begins as soon as a client decides a deal is value pursuing sufficient to pay lawyers or monetary advisors. That signifies that the client will count on that what was disclosed to them initially is true. However typically, as soon as lawyers begin to look underneath the hood, issues can change shortly. Think about an organization saying it has X quantity of licenses, when actually it has half of that and has merely utilized for extra – stuff like that.

I can’t let you know how upset clients can get once they determine this out. A deal can simply die on the spot. If a purchaser or investor fails to do correct diligence, it could not study the reality till after the deal closes. Whereas the customer or investor might sue for fraud, that cash might simply disappear. It’s a lot better to know this up entrance, earlier than losing money and time.

#3 Unhealthy or loopy enterprise constructions

One other massive factor to search for in due diligence is the goal’s enterprise construction, plans, and organizational chart. In our expertise, the extra sophisticated an org chart or enterprise construction is, the larger the prospect that issues gained’t work out (my colleague, Vince Sliwoski, wrote a reasonably good put up explaining a few of the wackier enterprise constructions we’ve seen over time). In some circumstances, over-complexity is utilized in a misguided try to cut back tax burdens or keep away from different issues. Nevertheless it will also be used to straight up confuse and defraud potential traders. Once more, due diligence is crucial.

It’s not simply dangerous or loopy enterprise constructions {that a} purchaser or investor ought to look out for. In addition they want to grasp basically what the goal’s marketing strategy is. We’ve seen various circumstances the place a goal claimed to have discovered some hidden loophole within the legislation that meant its enterprise would have the ability to nook the market. Generally, a goal will even get a legislation or accounting agency to offer an opinion letter in assist. However these sorts of pie-in-the-sky guarantees hardly ever come to fruition.

#4 Byzantine governing paperwork

Investing in a hashish firm means getting inventory (of a company) or membership pursuits (of an LLC) and turning into an proprietor of the corporate. An excellent reasonably well-governed firm will ask its traders to signal on to present governing agreements. In circumstances with smaller firms, an investor could have the prospect to barter new governing agreements, however that’s in no way a assure. So one of the crucial essential factor an investor can do with respect to due diligence is to have a look at the goal’s governing agreements.

That is one thing that may journey up a number of lawyers and virtually any lay particular person. I’ve seen funding transactions with 80 or 90 or much more than 100 pages of company paperwork slipped into the deal. In case you are not intimately acquainted with company legislation, it’s possible you’ll miss key provisions that dramatically have an effect on you.

For instance, I’ve seen transactions the place an investor thought they have been going to have the identical rights as different house owners, however the governing agreements gave them non-voting inventory with no administration rights and a decrease place within the distribution waterfall. This type of factor could be buried deep inside an working settlement and couched in language that’s extremely dense and difficult to grasp. This is only one space the place working with good company counsel pays dividends (no pun supposed).

#5 Possession disputes

One of the essential issues to search for is ongoing or threatened litigation. It’s comparatively straightforward to seek out out if a enterprise is concerned in lively litigation (court information are public in spite of everything, despite the fact that they is probably not simply searchable). However discovering information of issues like non-public arbitration, mediation, or demand letters could also be unattainable until the sellers or goal firm discloses that data to the customer’s representatives. A step past that, generally there could even be a possible for a dispute, for which no demand letter has been served. Once more right here, a purchaser might want to depend on a vendor to reveal these info.

This can be a little bit of a digression, however the level is that it’s crucial to carry out due diligence on a goal’s litigation profile. One space the place litigation can result in disasters includes possession disputes in an M&A (enterprise buy) transaction. Think about an individual is attempting to promote you their enterprise whereas they’re presently embroiled in a lawsuit with an ex-partner who says they have been illegally compelled out and personal half the enterprise (we’ve seen this!).

If a purchaser fails to determine that an possession dispute has or is more likely to come up, or does study and proceeds with the deal anyway, it’s nearly begging to be named in that lawsuit. If cash was handed over to the vendor, that cash could also be pretty much as good as gone.

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Above are 5 of a few of the greatest purple flags we now have seen in hashish transactions when performing due diligence. This record is in no way exhaustive, and there are numerous different issues that might tank a deal or result in litigation. We’ll proceed to weblog about every kind of company legislation mishaps for the hashish business, so keep tuned.

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