Over the years, our corporate attorneys have developed a niche in a host of regulated and soon-to-be-regulated industries across the globe — everything from healthcare, to cannabis, to banking and finance, to securities regulation for Web3 and other companies. And a huge part of that practice has been in mergers and acquisitions (M&A), or the buying and selling of businesses. M&A is a complicated area of the law. But when it comes to buying regulated businesses, M&A is a completely different monster.
While no two regulated industries are the same, today I want to look at the top five concerns a buyer must consider when looking to buy a regulated business.
1. Are asset sales on the table?
Businesses that get to the point where a buyout is on the table are almost without fail legal entities (corporations, LLCs, etc.). So when people talk about M&A, they often think of buying the entity (a “business sale”). However, it’s usually better practice to simply buy the assets of a business with a brand new entity (an “asset sale”). In an asset sale, the buyer will generally get all the assets, and not just the physical ones – IP, name, leases, etc. The advantage to doing it this way is that the buyer gets to continue operating the business but doesn’t inherit liabilities associated with the actual entity that sold the assets.
When it comes to regulated businesses, asset sales may not be an option. Regulated businesses may have licenses, permits, or other assets that cannot be sold to an unregulated entity. For example, in California’s cannabis industry, licenses are “personal” to the licensed business and can’t be sold. And the products that business owns can’t be transferred to an unlicensed buyer. In these kinds of regulated industries, asset sales are off the table.
It’s best to figure out up front whether an asset sale is an option for at least two reasons. First, buyers do not want to waste time and money negotiating an asset sale if it’s not a possibility. But second, and even more importantly, business buyers have a greater risk of undisclosed liabilities and will therefore act much differently in the due diligence and drafting and negotiation processes. This is why, in any regulated business acquisition, it’s critical to work with professionals who understand the applicable market and how it could affect them.
2. Who can own the regulated business?
Regulated businesses may have severe restrictions on ownership that could tank a deal before it heats up. For example, many states have corporate practice of medicine (CPOM) laws that prohibit lay people from owning medical practices. In those states, a lay person buyer would have no legal ability to own the regulated business and could be subject to serious penalties for buying such a business. Here too, a buyer should be aware of whether it can even take a stake in a business from the very outset.
3. What are the change of control issues?
Somewhat related to the prior point, regulators want to know who owns a regulated business. In many cases, before an ownership change can take place, the buyer (or if the buyer is an entity, the buyer’s owners) must be vetted and approved by the regulator. For some regulated businesses, there may be multiple regulators in various government agencies or divisions, each of which will have different rules. Change of ownership processes can be cumbersome and timely, so it’s best for buyers to be aware at the outset.
4. What kinds of special diligence needs to be done?
One of the more complex aspects of an M&A deal is due diligence, especially in a business sale. The buyer will take time diving into the target company’s assets, finances, employment practices, tax issues, material contracts, intellectual property, litigation history, and so on.
Regulated businesses make the due diligence process more complicated – sometimes exponentially so. The buyer will need to look at the target’s licensing status, license applications and renewals, compliance history, history of regulatory violations, and so on. In some fields – like healthcare – the buyer may also need to evaluate credentials or licenses of individuals like physicians who work for or own the target business.
All of this takes time and is in addition to routine due diligence a buyer would seek in any normal deal. What makes this even more complicated is that the buyer may need to work with regulatory counsel who is qualified and competent enough to both know what to ask for, and then to review it.
5. What are the operational concerns?
Following the closing, the buyer owns and is responsible for operating it. Even the most experienced buyer may not be the right person to run a business in a regulated field. Buyers need to consider the complexity of each regulated industry, the regulatory impact and burden, and the learning curve for getting up to speed. These buyers often try to require sellers or officers of the target to remain on for some time after the closing to mitigate these potential problems. Failure to have a practical strategy here is likely to lead to not only poor business, but also to regulators knocking on the door.
Buying any business is tough. Our corporate team has closed countless business and asset sales in regulated spaces and knows just how much more complicated it can be than your run-of-the-mill M&A transaction, even for seasoned business people. Working with the right legal team and advisors from day one will save massive costs, headaches, and penalties that are par for the course in regulated industries.
