Taming the Unicorn- Brokering Hemp Biomass and CBD Deals
I’ll set the stage. You are about to make a lot of money on a very large deal worth millions of dollars. Despite the large figures and the fact that you do not know most of the involved parties’ last names, it seems legitimate. You are friends with your primary contact and have personally spoken with several people who seem to know a lot about the deal. The buyers need the material and the sellers are ready to provide it. The deal is supposed to close tomorrow, but there are a few calls to be made and “proofing up” to do before it can happen. You’re nervous, excited, and a little confused. Most of the deal has progressed by text messages.
Welcome to the world of hemp biomass and CBD brokering. This is only the very beginning. Most likely, you’ve just encountered a “Unicorn”, by which I mean a big money deal involving CBD or hemp biomass that seems legitimate but never closes for reasons you can’t quite discern. Most of these deals do not close. In this post, I aim to help increase your odds of success.
In order to do so, we’ll need to articulate the key components of the “deal” and address them directly. I’ve found that it’s best to think of a biomass or CBD deal as a “circuit” composed of “nodes”. The circuit itself can be thought of as representing the deal, with each of the nodes representing various players in the deal. At each end of the circuit are the “terminal nodes”, by which I mean the actual buyer and the actual seller. The terminal buyer is the person, entity, or collective that is actually paying money. It is one of the terminal nodes. On the other end of the circuit is the actual seller, which is the terminal node that is the person, entity, or collective that is actually in possession and control of the biomass or CBD that is being sold. In between are any number of non-terminal nodes, which we refer to as “brokers”.
In the hemp and CBD business, brokers have gotten a bad rap. They are often seen as leeches and hangers-on who insert themselves into deals and screw them up. In this view, brokers either kill deals or make too much money relative to their contributions. As with most stereotypes, this view of brokers is partially based in truth. There are a lot of amateur, greedy, and/or disreputable brokers in the hemp/CBD industry. However, the bad acts of a few (or even a lot) should not taint the entire pot. In fact, brokers have been around as long as business itself. They serve a valuable and necessary function.
According to Merriam-Webster, a broker is “one who acts as an intermediary”, “an agent who arranges marriages”, and “an agent who negotiates contracts of purchase and sale (as of real estate, commodities, or securities)”.
Brokers are often necessary to a successful deal. They act as intermediaries between the terminal buyer and seller, arrange a “marriage” between two businesses, and/or negotiate a purchase or sale of a valuable item, such as hemp or CBD. Without brokers, many sellers would be unable to connect with buyers and many buyers would be unable to connect with sellers. Most deals are created by, and rely on, brokers. They are key nodes in the circuit, notwithstanding that they are not terminal. This post is about how to be a successful broker.
PART 1: NON-CIRCUMVENTION AND THE IMPORTANCE OF INFORMATION
First and foremost, you must obtain and transmit reliable information without being circumvented. The fear of circumvention kills many, if not most, deals. A broker for the seller, for instance, has a legitimate fear that if she gives away too much information the buyer will circumvent (ie, go around) her and deal directly with the terminal seller (or even a broker that is one or more nodes closer to the terminal seller). The primary way to resolve this issue is through the use of a well written non-disclosure/ non-circumvention agreement (NDNCA). This agreement should be signed by every person with whom the broker interacts in the deal before any substantive business is discussed.
A NDNCA will provide some protection to the broker that she will not be circumvented. This, in turn, will enable her (and the other broker nodes in the circuit) to seek and reveal sufficient information to keep the circuit open. This is important because information is to a hemp deal’s circuit what electricity is to an electronic circuit. Since no deal can close without sufficient information, the ability to obtain and reveal information increases the likelihood that a deal will close. I strongly recommend that you obtain a well written NDNCA and use it. [Note: Unfortunately, I will not be sharing any of my standard agreements on this post. I told my malpractice insurance carrier that I was writing a blog post on hemp deals and wanted to share my forms, such as the NCNCA and other contracts that I routinely use, on the post. I was strongly discouraged from doing so.]
PART 2: THE PRELIMINARY TERMS OF THE DEAL- LOIs and MOUs
Once the NDNCA is signed by all parties, they should put together a simple but meaningful letter of intention (LOI). An LOI is a document that outlines the basic terms of a deal. Mostly, it will include a list of the parties involved (the nodes), a description of the goods to be sold (ie, hemp biomass or CBD), their price, and the timing. In contrast to a memorandum of understanding (MOU), which serves a similar function, an LOI is non-binding. It is not a contract. An MOU is a binding contract and can be the basis for a lawsuit if its terms are breached. For this reason, be careful about what you propose, and what you sign, in an MOU.
PART 3: PROOFING UP
After the parties sign the LOI, they will begin the “proofing up” dance. This is where the buyer proves to the seller that she has the funds to consummate the deal and the seller proves to the buyer that he has the goods to sell. The buyer provides “proof of funds”, which is a document of some sort evidencing the buyer’s financial position. This can be something as simple (and unreliable) as an American lawyer’s letter stating that she has seen a British barrister’s letter stating that the barrister is holding a certain amount of funds in escrow for the deal. It can be a screenshot of the buyer’s bank account. It can even be an affidavit by the buyer or someone else, such as a CFO or CPA, who has actual knowledge of the buyer’s accounts.
Meanwhile, the seller does the “proof of life” dance in which he demonstrates that he has the biomass or CBD to sell. This can be pictures, letters, or even videos. Occasionally, the terminal seller will allow the buyer (or the buyer’s agents and brokers) to visit the laboratory or farm where the product is being manufactured or stored.
The proofing dance is where most deals break down. Primarily, this has to do with the brokers’ lack of information. A broker without direct access to one of the terminal nodes has no real control over the proof to be provided. Too often, a broker is tossed around like a leaf in the wind, without any real control over the deal. In order to assert control a good broker will obtain the information and documentation- proof of life or proof of funds- before the deal gets too far down the road. After the NDNCA, obtaining proof is a broker’s most pressing order of business.
Regardless of whether you are a broker for the buyer or the seller, it is vital that you have reliable and credible evidence to support your position, whether it be that the goods you are brokering exist or that the money to purchase them is available and ready to be deployed. Failure to have accurate and sufficient information will not only decrease the likelihood that the deal will close, but will also reduce your credibility in future deals.
PART 4: THE CONTRACT
Once the parties are all satisfied that the product exists, the funds to purchase it are available, and the basic terms are agreeable, they should enter into a binding agreement. I have always thought it strange that something such as the purchase of a house, or even a car, requires a stack of documents and a formal closing process but people think it’s perfectly acceptable to enter into a multimillion dollar CBD deal through text messages and no formal contract. It’s ludicrous.
A good contract will cover the basic terms (volume and price) and also delve much deeper. A short, non-comprehensive, list of terms that should be negotiated and committed to a signed agreement include: form and timing of payment, delivery, risk of loss in transit, quality assurance, lien rights, dispute resolution, confidentiality, etc. A contract will ensure that the entire transaction is reliable. There is an old saying that “good fences make good neighbors.” In deals, particularly the large ones I’m seeing in the hemp industry, good contracts help everyone relax knowing that their respective rights and responsibilities are delineated and protected.
PART 5: THE BENEFITS OF ESCROW AGREEMENTS AND PAYMASTERS
One of the most important components of a hemp or CBD deal is the escrow agent, sometimes called the “paymaster”. Strictly speaking, an escrow agent is not necessary. If the parties are all comfortable with each other, then the buyer can pay the seller directly.
However, this level of comfort is rare, particularly for an initial transaction between the parties. If the buyer pays prior to receipt of the product then she will worry about her money until the product arrives in the amount and quality for which she bargained. On the other hand, if the seller sends the goods expecting payment upon receipt, he will worry about how to recover his money (or goods) if the buyer takes off without paying. In the meantime, all of the brokers will worry about getting paid at all. An escrow agent can resolve this dilemma and alleviate these concerns.
An escrow agent is a neutral, trustworthy third party who holds the buyer’s funds until the goods arrive as promised. The buyer pays money to the escrow agent to hold. It cannot be refunded except under specific circumstances. This makes the seller feel comfortable sending the goods. And, since the escrow agent will not pay the seller until the goods arrive, the buyer is comfortable that she will not lose her money if the seller fails to deliver in volume or quality. The brokers are comfortable that they will be paid and not circumvented by the terminal nodes.
A key aspect of the escrow agent is that she has little to no discretion on how to disburse funds. A good escrow agreement will read almost like a computer program: if x, then y. If the goods are delivered on x date in y amount at z level of quality, then funds are disbursed to the seller. An escrow agent who holds authority and discretion over how the proceeds are to be disbursed can jeopardize an entire transaction. She can also open herself up to lawsuits based on a party claiming that she improperly disbursed funds. A good escrow agent will not want that sort of responsibility or potential liability. She will want a contract that is as elegant and straightforward as an algorithm, one that tells her exactly how to disburse funds in any given scenario. A typical escrow agent’s fee is a percentage of the total amount of funds that she holds and disburses. Although an escrow agent has some work to do, the fee is primarily earned based on the risks assumed by the agent, including that she may be inadvertently laundering money, that the funds will get stolen or misappropriated, that she will be sued for improper disbursement, etc.
PART 6: CONCLUSION
This is a simple overview of the hemp “circuit” deal. Hopefully, it provides some clarity to a what is often a chaotic process. Unfortunately, most large hemp biomass and CBD deals fail. As the number of broker nodes in the circuit increases, the likelihood of success diminishes. Each node is a potential failure point and the more nodes in the circuit the less reliable the information that travels through it. A good broker will seek to get closer to the terminal nodes by the use of a good NDNCA, skillful questioning, deductive reasoning, leveraging relationships, and luck.
If you find yourself swept up in a hemp biomass or CBD deal about which you know little, with millions of dollars on the line, and most communications through text messages or short conversations with people whose last names you do not know, you’re probably trying to ride a unicorn. Odds are, the deal won’t go through. However, by using your wits and a simple strategy with proper documentation, you will increase your odds significantly.
February 19, 2019
Rod Kight is an attorney who represents lawful cannabis businesses. He speaks at cannabis conferences across the country, drafts and presents cannabis legislation to foreign governments, is regularly quoted on cannabis matters in the media, and maintains the Kight on Cannabis legal blog, where he discusses legal issues affecting the cannabis industry. You can contact him here.