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Acquiring a cannabis brand or dispensary is a risky — and, many times, costly — endeavor. The potential for profits is massive, but, so too, is the potential for loss. By conducting a thorough investigation and looking for certain risk factors, acquirers can mitigate risk and ensure they’re making a worthy addition to their portfolio. But how do you even know where to start?

Like most business acquisitions, the first place to look is at the financials; because numbers never lie. With dispensaries, it’s crucial to look for a financial picture that illustrates stability, depth of penetration and market share. A targeted dispensary’s financials must reflect a smooth, stable cash flow for the prior 12 months with minimum $3.5 million top-line revenue and a flat-to-up trend with at least a 40 percent gross profit.

After financial filters are satisfied, analysts must conduct a “red flag scan.” This scan should objectively look for more than a dozen red flags, such as licensing issues, accounting irregularities, disciplinary actions from regulators, any complaints filed against the entity, high turnover and choppy cash flow. That last factor is particular concerning — and usually an instant dealbreaker — since, more often than not, it signifies serious systemic problems that can’t be easily resolved.

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If these red flags are cleared, the next step for the acquisition target is proprietary DD; due diligence. However, if clearance isn’t granted, the file should be downgraded, and the acquisition target should be moved to your watch list until management can resolve the issues. This proprietary DD scoring system speeds up the due diligence process, creating a unitized work flow that breaks up the workload to allow multiple analysts to work on the same file simultaneously.

Upon completion of the DD, M&A analysts should prepare a report and assess a DD score. This score is similar to a personal FICO score: it summarizes the business in an objective nature and in a format that can be easily communicated to the M&A committee for a final decision. Dispensary acquisitions tend to be straightforward because the financials tell a fairly complete story, leaving little room for subjectivity during the quantifiable decision-making process.

Acquisition criteria for cannabis brands, however, is very different from dispensary acquisitions because the evaluation criteria has to be much more subjective. Market share and rapid growth in market share are the most import metrics to look for during brand acquisitions. With brand acquisitions, the revenue hurdle for consideration is currently $5 million in trailing 12-month revenue, with an overall up-trending growth pattern.

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The brand acquisition process commences with a review of the financials, similar to the screening conducted on dispensaries acquisitions. The review should look for the same type of immediate red flags as dispensaries. Once the revenue and red flag screens have been satisfied, your M&A team should start a subjective evaluation to determine the brand’s penetration into its respective market. The most important factor in the decision-making process should be market share.

To determine market share, develop a grading process that takes in a number of factors.

1. The number of dispensaries in a geographic area that carry the brand
2. The brand’s location within dispensaries. Whether it’s a highly-trafficked area or tucked into the back of a site
3. The number of a brand’s products displayed in each store. (Less than 25% is considered an immediate red flag and typically disqualifies it from consideration)

The final step in the due diligence process for brands is the onsite visit. Once M&A analysts complete an onsite visit, they prepare an extremely comprehensive report on the brand — sometimes more than 100 pages long — for the acquisition committee. The committee evaluates the analysts’ recommendations, prepares deal terms and rates a target based on a proprietary grading scale developed in-house.

Finally, an offer will be made and, from there, it’s off to the races.

Jeff Mascio is CEO and Co-founder of Cannabis One in Denver, CO