What to Know About M&A in the Cannabis Industry

M&A transactions, a strategic expansion model, executed by many operators in the cannabis industry, have tripled over the past year. Some of the key factors leading to the significant uptick in M&A activity are lower costs of capital and positioning for future interstate sales.

We expect cannabis companies to rely more on mergers and acquisitions as a long-term growth strategy soon. We see this unfold in operators expanding operations to become vertically integrated. Other examples are MSO’s acquiring hemp-oriented cultivation facilities in states where cannabis is illegal to support future operations. These are a few of the many reasons that M&A transactions will continue to grow in the fragmented cannabis industry.

As mergers and acquisitions transactions increase in the cannabis industry, companies can expect M&A litigation to increase, as well. M&A-related claims are frequently made against the directors and officers of the companies involved in merger activity.

However, there are several key insurance products that both the buyer and seller can use to protect their personal assets and their company’s balance sheets and ensure the transaction does not create gaps in coverage post-acquisition.

Representations and Warranties (R&W)

Also known as “transactional risk” insurance, R&W is a form of coverage designed to guarantee the contractual representation made by sellers associated with mergers and acquisitions activity. A protection plan for buyers and sellers from costly litigation that’s designed to cover legal fees and settlements.

Additionally, this policy serves as an excellent negotiating tool. Consider what would happen if a seller’s representation were inaccurate, causing a buyer’s financial loss? Or if the buyer filed a lawsuit against the seller, alleging a breach in the terms of agreement?

With shareholders challenging 82% of M&A deals involving public companies, and private companies experiencing similar highs, R&W insurance is an imperative insurance product for M&A transactions. Typically, the cost of the policy is anywhere between 1-3% of the transaction price.

Directors and Officers

Mergers and acquisitions activity is spearheaded by the directors and officers of both the buyer and seller. Directors and officers (D&O) insurance protects company leaders from personal liability caused by a professional decision or action.

With “merger objection claims” by shareholders occurring frequently, adequate D&O coverage is not only crucial throughout the transaction but following the transaction as the parent company moves forward. Many acquired companies terminate their D&O policy once the corporate transaction is completed, making it essential for the buyer to understand their D&O exposure to mitigate gaps in coverage.

Employment Practices Liability (EPL)

Post-acquisition companies typically have many more employment practice risks to navigate. Plus, with so many changes, employees could quickly become offended by new leadership actions.

We recommend this labor law coverage as standard coverage for companies with any number of employees in the current legal landscape. This EPLI recommendation is especially true when onboarding new employees to a company they did not initially sign on to work for.

Fiduciary Liability Insurance (FID)

Fiduciary liability is a great insurance vehicle for protecting individuals charged with creating, managing, and administering employee benefit plans within business organizations. Consider benefits of 401k plans, employee stock ownership plans, or healthcare plans; benefit plan administrators are fiduciaries. These responsibilities and action plans are most certainly challenged when onboarding new employees from a merger.

Errors & Omissions (E&O)

E&O insurance covers third-party financial loss arising from the insured’s product or service substandard performance or the insured’s act, error, or omission during the performance of client services. Post-acquisition companies endure many changes concerning leadership, operational practices, benefits, etc. Clients could easily slip through the cracks of all these transactions and lead to legal action.

General Liability

A general liability policy is third-party liability coverage to protect a company from incidents on their property. This coverage is the basis of any robust risk management plan. Aligning insurance plans by reviewing each company’s current insurance programs is essential. This approach works to mitigate exposures from gaps in coverage. M&A transactions often do not happen overnight. Understanding how the buyer’s and seller’s insurance will respond to control change is essential during and post-acquisition.

Workers’ Compensation (WC)

This policy covers injuries that employees sustain during work, and most states require it. Workers’ compensation premiums rely on several factors: industry, years in operation, claim history, employee pool size, state established codes, rates, etc. It’s essential to understand the effects mergers and acquisitions will have on this policy regarding premium increases, especially if you acquire a business with poor safety practices and a high claims history.

Tail Coverage (Extended Reporting Period)

Tail coverage gives your business protection for claims reported after your insurance policy ends. It can be added after canceling insurance or if an insurer doesn’t renew a policy, which is a common action by the company being acquired once the M&A transaction is complete.

Furthermore, post-acquisition is the most popular time for lawsuits. As a result, tail coverage offers insureds an additional three to six years of protection. This extension allows you to report claims post-acquisition for alleged wrongdoings pre-acquisition by the seller that happened before the merger.

Unsurprisingly, many executives understand necessary insurance coverages for a successful merger or acquisition. However, these coverages often drop off once the parent company takes over and creates a significant exposure if a lawsuit arises for actions of the acquired before merging.

Protecting your cannabis company can seem confusing; however, we’re a full-service insurance brokerage working with carriers worldwide to offer you the best coverage possible. We’re here to help! Please reach out to us today by emailing [email protected] or calling 646-854-1093 to learn more about your cannabis insurance options.