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What to Know About Cannabis Joint Venture Deals

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July 23, 2019

In the past, we’ve discussed the pros and cons of franchising as a strategy for expanding your cannabis business. Today, we’ll present another option: embarking on a cannabis joint venture. Not that joint! ;)

A joint venture is when two or more business entities enter an enterprise agreement for the purpose of advancing a specific project or business activity.

Put simply, joint ventures are:

  1. Separate companies that have a shared business interest;
  2. That have some ownership stake in this shared interest;
  3. And agree to share income and expenses.

As you well know, it’s incredibly difficult to establish yourself and grow in the extremely competitive cannabis market. A joint venture might be the best way to gain a foothold in a new municipality, reach a new customer base, or add a new product line to your existing inventory.

Here’s why you should consider finding a partner to align yourself with in a joint venture.

Benefits of a Joint Venture

There are some great reasons to develop a joint venture with another cannabis operator.

First and foremost, a joint venture can grant you access to new markets and distribution networks.

Leverage existing relationships to get ahead in this relatively new industry, where building a network takes time and lots of effort. By gaining access to new opportunities in the market, you’re giving your company the ability to grow faster and generate bigger profits.

A second benefit to entering a joint venture is the opportunity to share risks and liabilities with a partner.

Working together allows you to align your incentives and get your team working toward a common goal. When a joint venture works best, both partners are tied together with financial and product quality objectives. The incentive to succeed is higher and the risk is much lower.

Next, joint ventures offer access to greater resources you may not be able to reach working solo.

By sharing resources, your companies are able to complement each other in new ways. Find a partner with the specialized staff, technology, and finances that would otherwise take years for you to attain. Joint ventures offer the security of not having to build everything on your own. Turbo-boost your productivity and get to the market faster by sharing expertise, knowledge, and resources with a business that has reciprocal qualities to yours.

A final key benefit to joint ventures are that these agreements tend to be less formal than other contracts.

A joint venture can be a temporary agreement, meaning you aren’t married to your cannabis partner for life. The deal is flexible, and if it goes well, you can opt to make it more official. A joint venture is defined by the fact that both partners retain their individual identities and intellectual property. If the venture doesn’t work, you still walk away with little exposure to risk.

Example: Cannabis Grower + Processor Joint Venture

How does a joint venture work in practice?

Here’s a scenario where a cannabis grower with wholesale biomass and a cannabis processor enter a mutually-beneficial joint venture together.

In this example a grower has excess trim after they harvest their flower.

Normally, they would sell this wholesale directly to a processor at $100/lb. While that’s a great deal, further research shows the grower that down the supply chain, processors are getting great yields on the grower’s wholesale product. The margins that the processors have motivate the grower to get a piece of the financial action.

As a result, the grower enters a joint venture with the processor to “give” the processor the trim. The processor agrees to process it and split the profits. Essentially, the grower is financing the working capital of the processor.

Does this result in a mutually beneficial arrangement for the grower and the processor? Let’s look at the numbers.

In the first scenario, where business continues as usual, the grower continues to sell trim wholesale. At $100/lb, 250 lbs of trim yields $25,000 in revenue.

In the second scenario, where a grower and processor enters a joint venture, the grower gives the processor the same 250 lbs of trim.

The processor yields 13% per lb. For every pound of trim, they get 58.9 grams of extract.

That means 14,725 grams for 250lbs of trim.

Each gram of extract sells for $4 wholesale. With a 50% split on the revenue of the extract between the processor and grower, that leads to $117.80/lb or $29,450 in revenue.

Clearly, the second scenario is preferable as the grower increased their revenue by 17.8%. It’s an easy call, as this increase comes simply by entering an agreement with a processor they know and trust already.

The benefit to the processor, again, is that they have their working capital financed by the grower and don’t have to risk any further financial exposure than absolutely necessary.

Two other considerations for this deal if you're the grower:

  1. Make the processor agree to a fixed yield percentage,
  2. Have the processor enter into a contract with the customer to fix the price of the the extract.

These two items will completely remove the risk from the processor:

  1. Messing up the extraction and giving lower yields, and
  2. Changing or giving wholesale discounts of oil on per gram pricing.

Considerations Before Jumping into a Joint Venture

What do you need to know before entering a joint venture?

First and foremost, make sure the profit split is fair for both parties.

Factor in costs such as transportation – in the above example, who is footing the cost of transporting the product to the processing facility?

There may be added costs to entering into a joint venture. This is why more often than not, no joint venture will ever be a 50/50 equal split in profit. It is extremely unlikely for all the companies working together to share the same involvement and responsibilities.

The second thing to consider is whether or not your joint venture will violate any existing agreements you may have with other vendors/partners. Make sure you protect any exclusive IP and don’t destroy pre-existing relationships. This is one industry where reputation matters!

When you enter a joint venture, clearly delineate who will be paying taxes. Make sure to reach out to a CPA who has brokered one of these deals before so that each party pays their fair share.

Lastly, agree on a proper timeline for revisiting your terms or discussing whether or not to continue your joint venture.

Get help from a transactional lawyer who is familiar with the cannabis space when drafting your joint venture. Don’t just do a gentleman’s handshake agreement because you will have little to no recourse if things go sideways.

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Post Tags: Finance

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