The Undeniable Need for Cannabis Due Diligence

Cannabis has long been touted as a valuable crop both industrially and as a medicinal aid. Despite spending nearly the greater part of a century under strict prohibition across the world, Hemp is finally making a come-back. However, the legislation surrounding Cannabis and cannabis-related businesses leaves us with more questions than answers. As a result of this, due diligence is not only undeniable but a necessary evil to avoid heavy penalties. What is due diligence and how does it apply to the Cannabis industry? Let’s find out.

For the greater part of a century, the sale and cultivation of cannabis have been prohibited in most countries. Recently, however, there has been a surge in the legalization of cannabis, especially so for Hemp and its subsidiary products. Nonetheless, current political restrictions create a murky world for those in the cannabis business (1).

Taking the United States, for example, legislation differences between federal and state bodies mean that any business that deals with cannabis-related businesses, be it financial institutions to lawyers are at risk of strict penalties if the business is deemed to be breaking the law.

This high risk carries with it a sense of extreme caution. This is clearly epitomized by the grey area of cannabis banking in the United States. Because of this, due diligence is necessary for any business or financial partner looking to join or service cannabis-related businesses (2).

Due diligence is defined as having a “measure of prudent” or to “perform a rigorous and prudent review” in order to avoid committing an offense under the law.  For those who are looking to finance or acquire cannabis-related businesses, this includes the due diligence of the law, such as the review of legal requirements and key documents relevant to the business, such as certifications and licenses. In addition, this also includes financial due diligence, aiming to verify the financial claims made by the seller (3).

You may be thinking why this is so important. To answer that we must look at 1) The undeniable need for due diligence in the cannabis industry; 2) What does due diligence look like in the cannabis world; and 3) What is the available guidance of due diligence for those wanting to enter into cannabis-related businesses.

The Undeniable Need for Due Diligence

Due diligence is critical for three reasons, firstly, it provides significant value to the business or individual entering into cannabis-related businesses, including both the value of time and money. Secondly, the quality of financial information can vary for different businesses significantly, having a good grasp of what the records for each business you are planning on dealing with will enable you to make an informed decision, especially related to the validity of that business to meet legal requirements. Lastly, it provides the individual or business with the valid information to go forward, or not, with a cannabis-related business knowing that the risk the business is minimized under the law (4). This will help businesses and/or individuals immensely in the sale and purchase phase of the business transaction (5).

It must be noted that due diligence is not simply an audit, nor is it simply a valuation of the target company. It is a thorough investigation that focuses on key information asserted by the seller and often relies on legal documents to verify their legality to function in the state or country and impinges greatly on the sellers’ financial statements (6).

In a nutshell, this allows the buyer/business to determine what the benefits, liabilities, risks and opportunities are for entering into a transaction with a cannabis-related business. This also provides confidence that the value is fair and legal (7).

The cannabis world, unfortunately, sits in a particularly grey area where the law is concerned, and as such, it is undeniable that carrying out due diligence investigations is crucial for any and all businesses wanting a piece of this green pie.

Due Diligence in the Cannabis Industry

The wave of cannabis legislation has washed across the world in recent years. This has sparked an increasing number of business mergers, acquisitions, and potential services by a considerable number of businesses, including financial institutions. Despite the surge in dealings with cannabis-related businesses, the cannabis world remains an emerging industry that presents a very unique set of challenges, even for those who are well versed in a wide range of industries (8).

Subject to the grey area of law, a number of businesses are affected. This includes companies engaged in the cultivation, processing, sale and distribution of cannabis and cannabis-related products. This also includes ancillary businesses such as financial institutions. Because of the complexity of the law, and the fact that any of these businesses are subject to federal charges in the United States, it is important that all of these businesses undertake adequate due diligence investigations before they start business history with them (9).

As the cannabis world is disguised in a large amount of smoke, especially so regarding the complex laws surrounding transactions with cannabis-related businesses, there are some guidelines that are designed to make due diligence investigations somewhat more at ease.

Guidelines of Due Diligence

Navigating the due diligence required when dealing with a cannabis-related business can be a complex but necessary evil. However, investigations have shown a number of categories of risks and due diligence that a prospective individual or business should consider when dealing with a cannabis-related business (10):

1. Financial information (Valuations, audited financial statements, electronic accounting files, budgets etc.).
2. Legal information (Lawsuits (pending or otherwise), adequate licensing and certification, state law reviews and federal law reviews).
3. Product Information (Know the supplier, strains, cultivation information, adequate supply chains, pricing etc.).
4. Product testing (Assure accurate and non-inflated calculations of the constituents of the product, state certification and its process, laboratory certifications and quality controls).
5. Product safety and product liability (potency testing, extraction methods, any complaints from the product, maintaining federal and state laws).
6. The disclosure of risks for the investors (you need to become an expert on the state and local cannabis legislation and politics).
7. Banking, insurance and security.
8. Intellectual property and publicity.
9. Marketing and sales, including competitors, and finally,
10. Systems and processes.

The Bottom Line

Due diligence is not just an undeniable need for businesses involved in the cannabis industry, it is essential to avoid potential heavy penalties. By carrying out a rigorous due diligence process, businesses wanting to enter into the rapidly growing cannabis world can rest assured knowing they have filled their obligations under national and local law.