Third-Party Due Diligence for Cannabis Companies

February 01, 2022

By David Sumner

As the cannabis industry expands and matures, cannabis growers, sellers and distributors are transforming from an emerging industry to a seasoned established one. As cannabis companies progress along this transformation, they are faced with many of the same challenges and risks as those organizations operating in more established industries. One important area is the assessment and mitigation of risks with third parties with whom they may be doing business. High-risk third parties for cannabis companies can be many, including, but not limited to:

  • Packaging material suppliers,
  • Solvent suppliers,
  • Celebrity endorsers, and/or
  • Other cannabis manufacturers or dispensary operations.

Each of these risk areas can present significant supply chain and/or reputational risk to the entity. While all risks cannot be eliminated altogether, companies can identify and mitigate those risks through a proactive three-step process:

  1. Identify the unique risks facing your specific business.
  2. Evaluate the risks and identify what is being done or could be done to mitigate the risk.
  3. Monitor and update your risks periodically.

If a cannabis company has one supplier for their packaging materials, the following steps may represent how they would assess and mitigate their risk:

  • Does the company understand the contract with the supplier, with particular attention to order lead time, order cancellation provisions and quality requirements?
  • Has the company identified a short-list of “pre-qualified” suppliers to pivot to if the primary supplier is unable to deliver?
  • Does the company have a process in place to monitor the supplier for adverse events on a periodic basis?

Similarly, if the cannabis company is considering entering into an agreement with a celebrity, have the following steps been considered:

  • Has a thorough business intelligence report been requested and reviewed on that celebrity prior to the agreement’s execution?
  • Does the company have a process in place to monitor for adverse events regarding the celebrity on a periodic basis?
  • Does the contract have a release clause if the celebrity is in the news for any negative statements or actions that the company would like to immediately distance themselves from?

These proactive steps can be performed using in-house personnel or by acquiring business intelligence reports from a cost-effective provider to identify adverse events related to these third parties. Equally as important as the evaluation of third parties when they are originally contracted, is to establish a process to periodically evaluate and monitor contractors, refreshing any business intelligence reports as needed.

The business intelligence reports can be custom-tailored and cost little in relation to the potential risk to the company, and provide the company with a fact-based view into the supplier’s, celebrity’s or others’ past history including legal troubles, bankruptcy, adverse media articles or social media posts, in addition to finding out if they are affiliated with a potential competitor (if that is a concern). With this information in hand, the company can make an informed decision as to whether partnering with this supplier or individual makes the most sense for their brand.

In summary, cannabis companies should treat their high-risk third parties just like seasoned companies do and evaluate critical business partners through risk assessments and due diligence reports before entering into agreements with them. After the ink is dry on the agreement, acquiring updated reports on a periodic basis will ensure that the cannabis company has current information on their critical business partners allowing them to make an informed decision.

About David Sumner

David Sumner is a director in the Financial Advisory Services Group with years of auditing, forensic accounting, financial reporting and internal control design and implementation experience serving clients in a variety of industries.