The end of the lottery process in Ontario and the opening-up of cannabis retail to the public at the beginning of 2020 has led to many more cannabis retail stores opening with hundreds still being processed and scheduled to open over the coming year. This has contributed to increased mergers and acquisitions ("M&A") activity in the cannabis retail space in Ontario which is expected to be more active over the coming months given the current delays in the issuance of Retail Store Authorizations ("RSAs") by the Alcohol and Gaming Commission of Ontario (the "AGCO"). This uncertainty and delay has caused some would-be operators to reconsider their retail cannabis aspirations and canvass their options to monetize their interests and cut their losses by looking for potential third parties to take-over their leases and if in operation, purchase their businesses.
The M&A activity started earlier this year with certain retailers acquiring stores from past lottery winners, including Superette's acquisition of its Ottawa store, Choom Holdings' acquisition of its Niagara Falls store, Fire & Flower's acquisition of a store in Kingston and in Ottawa, High Tide's acquisition of two stores, one in Sudbury and the other in Hamilton, Tokyo Smoke's acquisition of a store in London and Meta Growth's acquisition of a store in each of Waterloo, Kitchener and Toronto. It is expected that this activity will continue in the months ahead and will expand from lottery winners to M&A involving larger more established industry participants. This is evidenced by Fire & Flower's recent purchase of Meta Growth's Toronto store and the recent merger of Hide Tide and Meta Growth who combined have approximately 63 stores across Canada. With this uptick in M&A activity it is important understand the nuances of selling a cannabis retail store.
In order to legally sell recreational cannabis in Ontario, the entity seeking to operate a cannabis store must first become licensed by the AGCO. Specifically, the proposed operating entity must obtain a Retail Operator's License (an "ROL") from the AGCO, which is a license to sell recreational cannabis. The future store owner must also obtain a RSA from the AGCO for each specific store location that it wishes to operate. The need to obtain an ROL and RSA is foundational to the cannabis industry in Ontario and is what makes M&A in the cannabis retail space unique. As a consequence of the licensing process, when a retail cannabis store is to be purchased and sold, the AGCO and sometimes the Ontario Cannabis Store (the "OCS") will have to be directly involved in the sale process, and the AGCO will have the right to approve, or reject, the proposed buyer.
Share versus Asset Transactions
Assuming that the cannabis store to be sold is owned by a corporation, as opposed to a sole proprietor, there are generally two ways to structure a sale, as a share sale or as an asset sale. Each structure has its advantages and disadvantages, depending on what side of the transaction your interests lay. Given the different tax consequences and liabilities assumed at the conclusion of a sale, sellers typically prefer to proceed with a share sale while buyers sometimes prefer an asset sale.
An asset sale consists of the sale of individual assets used in the operation of the business such as equipment, goodwill, trade names, inventory, leaseholds and contracts. Proceeding with this structure allows the buyer to select those specific assets that it wishes to purchase and the liabilities it wishes to assume or exclude. With regard to taxes on an asset sale, there are two levels of taxation, first at a corporate level and then at a shareholder level when after-tax proceeds of the sale are distributed to the shareholders.
On the other hand, a share sale occurs when the shareholders of a corporation sell all of the shares of the corporation to a buyer and effect a change of control of such corporation. When you purchase all of the shares this includes the underlying assets and liabilities (known and unknown), and is typically a seller-favorable structure. When a seller sells shares in a corporation, the proceeds are paid directly to the shareholder(s) and, as such, only taxed at the shareholder level. In addition, when you sell shares, the proceeds are subject to capital gains treatment, and in certain instances, individual shareholders can take advantage of their lifetime capital gains tax exemption (currently, worth approximately $883,000).
Share Transactions in the Cannabis Space
In a share sale, the ROL and RSA will remain the same and the shareholders (i.e. owners) of the corporation will change. Accordingly, while there is no requirement on a share sale that a new ROL or RSA be issued to the buyer, the buyer, as the future owner/shareholder of the license holder, will be subject to the eligibility requirements set out in the Cannabis Licence Act, 2018 (the "CLA") as well as rules and standards set by the AGCO.
No share sale can be concluded without the prior approval of the AGCO which will not be granted prior to the AGCO conducting and completing its diligence on the new ownership group. This diligence process can be lengthy and the timing of its completion is often unpredictable. However, buyers should note that the level of complexity of the buyer group will impact how long the AGCO's review process will take. If the buyer is a single individual or a wholly-owned corporation by one individual, the AGCO will only need to conduct its diligence on that one person, and the process can be concluded relatively quickly. However, if the buyer is a corporation with a complex structure, with many directors, shareholders and officers (and perhaps holding corporations that also have directors, shareholders, and officers), the process can be quite lengthy as the AGCO will conduct diligence on each entity and individual at every level of the buyer's structure.
Asset Transactions in the Cannabis Space
In an asset sale, the buyer will have to apply for, and be issued both an ROL and RSA prior to the sale being completed, with the associated filing fees for these applications, which run $6,000 and $4,000, respectively. In its application review, the AGCO will conduct the same due diligence review described in a share transaction above to ensure that the new ROL and RSA holder meets all applicable eligibility requirements.
In addition to ROL and RSA issuance process, there is a further consideration in an asset sale related specifically to cannabis inventory. To transfer the seller's cannabis inventory to the buyer involves working with the OCS.
While the OCS has permitted the transfer of cannabis from one licensed holder to another, it is not a straight forward process, and it involves three steps:
- The seller and buyer agree as to what inventory is going to be purchased/sold and advise the OCS accordingly.
- The OCS will then invoice the buyer for the amount of the cannabis to be sold, based on current wholesale prices.
- The buyer pays the OCS the amount of the invoice and once funds are received by the OCS, the OCS will refund such amount to the seller.
This process requires coordination of the buyer, the seller, the AGCO and the OCS and can take some time prior to being finalized. However, the AGCO and OCS have established guidelines to help one navigate through the steps and are cooperative in the process.
We are seeing and expect to continue to see increased M&A activity in the cannabis retail space in the months ahead, as competition increases and the challenges and time to open new stores forces certain hopeful cannabis operators to cut their losses and monetize their assets. For the well-financed players in the industry this will present an opportunity to further expand their footprint as the smaller players struggle to survive.
This article was originally published in The Business of Cannabis.
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