What Buyers Look for in a Cannabis Testing Lab

What the buyer is paying for

A buyer is paying for the lab's ability to keep releasing results that growers, manufacturers and dispensaries accept and that the regulator does not challenge. The revenue itself is easy to understand. Samples come in, panels are run, reports go out, and each report is billed. What takes longer to see is whether the sample volume is steady, whether the prices hold up when a competing lab opens nearby, and whether the lab can turn samples around fast enough that clients stop shopping around.

Buyers will ask for sample counts by month and by panel type, because potency, pesticides, residual solvents, heavy metals, microbials and terpenes each carry a different price and a different cost to run. A lab that earns most of its money from potency alone looks different from one that also runs the harder panels, since the harder panels need more expensive instruments and more experienced people. Our post on what seller's discretionary earnings means explains the profit figure most small buyers start from, and a lab that is larger than a one-owner operation is usually looked at on EBITDA instead.

Accreditation and the audit file

The accreditation is the asset a buyer looks at first. Most labs hold a recognized laboratory accreditation against an international testing standard, and the scope of that accreditation lists the methods the lab is approved to run. A buyer wants to see the current certificate, the scope, the last assessment report, and every finding the assessor raised along with how the lab closed it out.

The quality manual, the standard operating procedures and the method validation files sit behind the accreditation. A buyer's technical advisor will read them. Gaps in validation records, undocumented changes to a method, and proficiency testing results that were borderline will all come up. A lab with a clean assessment history and a quality manager who runs the system day to day is worth more than a lab where the owner holds the whole quality system in his head.

State regulators also audit these labs, and the audits can include split samples, unannounced visits and review of the results reported to the state tracking system. Rules vary by state and your attorney confirms what applies to your lab. A buyer will ask for every regulator audit report, every corrective action, and any history of a result that was questioned or retracted. A lab that has had a suspension, even a short one, can still sell, though the buyer will want to understand exactly why it happened.

Instruments and the people who run them

The instrument room is where most of the capital sits. Chromatography systems, mass spectrometers, plasma instruments for metals, plate readers and incubators for microbials, balances and fume hoods all have an age, a service history and a replacement cost. A buyer will walk the room with a list and ask which pieces are owned, which are leased, which are under a service contract and which are one failure away from a long outage.

Instrument downtime costs a lab clients quickly, because a grower with a harvest waiting cannot hold it for weeks. Buyers like to see a second instrument that can cover the first, or a service agreement with a guaranteed response time. They will also check the software that runs the instruments and the lab information system that tracks samples, since a buyer inherits the data and the validation of that software.

The scientists matter as much as the machines. A lab director with deep method knowledge, a few strong analysts, and a sample intake team that handles chain of custody carefully is hard to replace. Cannabis testing talent is thin in most markets, and a buyer will ask who holds the credentials, how long each person has been there, whether anyone is likely to leave when the sale is announced, and whether any of them are under agreements that protect the lab. If the owner is the person who signs every report, that has to change before the sale.

The client roster

Clients in this business are growers, extraction companies, product makers and sometimes dispensaries sending retail samples. Buyers want the roster with revenue by client over a few years. The questions are familiar. How much comes from the top few accounts, and what keeps them loyal? Our post on customer concentration covers why this matters to a lender.

There is a harder question in cannabis testing that buyers ask carefully. Clients want results that pass, and some labs have lost business by being strict. A lab whose clients stay because it is reliable and quick is a better asset than one whose clients stay because it is lenient. Buyers will look at failure rates by client and by panel, and at whether a client who failed a batch kept sending work. They may also ask whether any client has an ownership interest in the lab, since many regulators restrict that, and a buyer wants to see that the lab has kept clear of it.

Records a buyer will ask for

Expect requests for tax returns, monthly financial statements, a sample volume report from the lab information system, a price list with any client discounts, and an accounts receivable aging. Labs often carry receivables from clients who pay slowly, and buyers will look hard at which of those are collectible.

They will also ask for the license file, the accreditation file, instrument service records, calibration records, the employee list with credentials and pay, insurance policies, and the lease. Buyers of regulated businesses go through licensing review, so assemble the application history too, as well as the background and ownership disclosures that the regulator already holds. Our post on getting financials ready for a buyer describes the books side.

What has to transfer

The testing license and the accreditation do not always move with a sale in a simple way. Some regulators treat a change of ownership as a new application or a formal approval process, and an accrediting body usually wants notice of the change and may reassess. This can add weeks or months. Rules vary by state and your attorney confirms what applies. The buyer, the seller and the regulator all need to be talking early, and many deals include a closing that depends on approval.

The lease needs attention because labs build out ventilation, power and plumbing that are expensive to move. A landlord who is comfortable with cannabis tenants today may not be comfortable with a new owner, so consent is worth raising early. The lease and landlord consent post goes through how that tends to go. Instrument leases, software licenses and service contracts may each have their own consent requirement.

What tends to sink a sale

Deals for labs fall apart for a handful of reasons. The regulator's approval takes longer than the buyer's financing allows. An assessment finding that the seller treated as minor turns out to threaten the scope of accreditation. The key scientist leaves. A major client moves its work after hearing about the sale. Receivables turn out to be weaker than the financial statements showed. Confidentiality helps with several of these, and we describe how we handle it in how we market a business confidentially.

Getting the lab ready

Start with the quality system, because that is where a buyer's technical advisor will spend the most time. Close out open findings, update validation files and make sure the quality manager can answer questions without you in the room. Document the methods that only you know. Make sure each instrument has a current service record. Clean up the receivables, and decide how you want the client roster to look, since a buyer will ask about discounts you gave informally.

Talk to your attorney early about the license and ownership change process in your state. If you are thinking about selling a cannabis testing lab, our advisors at Business Advisors of America can value it from your own numbers, prepare the materials a technical buyer will expect, and screen buyers before they see anything that identifies the lab.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.