Lessons of a Failed CBD Acquisition

Last Tuesday, February 18, 2020, Australis Capital Inc. announced the termination of its proposed acquisition (via merger) of Folium Equity Holding LLC, a fully integrated hemp/CBD operating company based in Colorado.  The transaction, announced in the middle of December 2019, was highly anticipated as a major step in the industry’s ongoing consolidation in the current down market.  Australis, a spin-off of well-known major cannabis player Aurora Cannabis Inc., was publicly listed on the Canadian Securities Exchange and over-the-counter in the U.S., as an investment company aimed at being the “beachhead” for Aurora’s U.S. cannabis investments.

Original discussions with Folium began about a year and a half ago when CBD was the “talk of the town” and hot industry.  Following a minority investment by Australis, it was contemplated that Aurora would ultimately acquire Folium.  However, as Aurora and Australis sought to demonstrate their independence (now being wholly-separate companies) and given the existing Australis minority investment, the strategy shifted to having Australis be the proposed acquirer, with a final merger agreement being reached in December of last year.  Yet, in the course of its diligence efforts over the intervening period following the signing of the merger agreement, Australis’ uncovered data and other information that is viewed as materially adverse enough to forego proceeding with the proposed all-in investment.  Despite this decision, the management team at Australis, on its investor conference call today, noted that they continue to maintain a bullish outlook for Folium (and, by extension, the current Australis minority investment therein).  On the call, Australis’ management team indicated that they still view Folium as a well-positioned company with the ability to capture the potential upsides of the growing CBD market, despite the overall depressed prices of the underlying products and raw material commodities.

Notwithstanding the rosy outlook that Australis’ management painted for its minority investment in Folium, rumors have recently circulated that the ultimate decision to terminate the acquisition was largely a result of several concerning factors other than the CBD industry’s recent retreat.  Over the past few weeks, information has come forth regarding Folium’s management, indicative of a certain degree of internal turmoil.  The bulk of these issues have come to light in connection with a number of ongoing lawsuits between Folium and a few of its former employees.  While a good portion of these cases are largely centered on claims by the former employees for owed equity in the company, some contain troubling narratives, including a “murder for hire” scheme involving members of Folium’s current management, a former general counsel, and a former officer.  In addition to the eye-catching headlines regarding possible criminal activity, the claims of equity ownership by these former employees reference certain employment agreements and associated key corporate documents (one of which may have been partially forged), which highlight significant potential deficiencies in Folium’s documentation and record-keeping efforts relating to its corporate housekeeping.

While the Australis management team indicated their enthusiasm and overall general optimism regarding Folium’s future outlook (resulting, inter alia, from its business model, technology, and professional expertise), such sentiments must be taken with a grain of salt, given that Australis still has invested in Folium and, thereby, a vested interest in the public perception of one of its portfolio companies.  It is also telling that Australis abruptly terminated the acquisition of Folium while having admittedly been in conversations with the target for over a year and well immersed in the CBD industry, which hasn’t seen much notable change since the merger agreement was announced.  The reversal of their stance regarding the planned acquisition is probably, at least in part, a derivative of the potentially toxic internal issues prevalent at Folium.  Whereas its minority investment is likely insulated, at least partially, from any adverse effects resulting from such deficiencies, an acquisition of the entire business would see Australis assuming all of Folium’s liabilities, with limited recourse or purchase prices adjustments available to fully mitigate the potential damages of such or, at a minimum, present significant difficulty in doing so.  As a result, Australis’ decision to not move forward with the transaction is quite a prudent one, especially in light of the fact that (as noted on its investor call today) in the days following the announcement of the termination, Australis has been approached by a number of other comparable businesses seeking similar transactions.  Another key takeaway from these series of events is the importance of an operating company’s attention to internal procedures, record keeping, and corporate governance (including the documentation thereof).  Had Folium diligently maintained appropriate processes and taken necessary measures to ensure the proper evidencing of its equity structure and related ownership and employee agreements, Australis may have been much more willing to consummate the acquisition, despite the current state of the market.