The purpose of due diligence is to reduce risk when entering into an agreement or contract with another party. While it may seem like a pain, the due diligence process is a normal and necessary part of any investment or M&A transaction.

However, there are a few prominent challenges cannabis businesses and their prospective investors or partners encounter when going through the process — mostly due to the unique nature of the cannabis industry.

To illuminate some of the specific challenges cannabis operators face, here are five questions that a potential investor or partner could ask as part of the due diligence process: 

1. Does your cannabis business have a public banking relationship? 

If yes, that is a positive signal to potential investors, and it means they can move on to examine other areas. If not, you will want to explain why. Lacking a public banking relationship can be a telltale sign the business may have compliance gaps or other serious risk factors. 

2. How are board members legally protected? 

In this case, a potential partner will want to know if the business offers directors and officers liability insurance (D&O), regulatory event coverage, or other types of indemnification. They will need to be clear on what their personal liability will look like in the case of a material issue or regulatory challenge involving the cannabis business. 

3. How is the facility regulated? 

Naturally, the next thing an interested party might investigate is how your facility is regulated. If they are considering investing in or partnering with a cannabis business with a licensed facility, they will likely review the two most recent regulatory inspection reports. These reports can provide them with insights as to how the regulatory body that governs their potential investment views the quality of the business. 

4. Who is your bookkeeper? 

An interested partner or investor will want to get to know the person who manages the company’s financials, especially if it is an LLC. First, they will want to find out if this person is knowledgeable about some of the tax intricacies in the cannabis world – such as Internal Revenue Code 280E. Second, they might look at the tools they use for bookkeeping. If they are not actively seeking the latest technology to support their accounting, this could be a red flag. 

5. What other information could influence the decision to commit? 

Interested parties can ask a whole range of questions pertaining to the cannabis business’ operations, employees, protocols, and more. The bottom line is: A wise potential partner or investor is not going to enter into an agreement without feeling completely comfortable and clear on the cannabis operation’s financial and legal standing. 

Because of the persistent legal and financial gray areas in which cannabis businesses operate, they continue to be held to particularly high standards when it comes to due diligence. Business leaders can look into various cannabis-specific tools to help make the due diligence process simpler. For example, Xero is an excellent cloud-based accounting platform that may be integrated with inventory management and payroll software. 

So, before your company begins seeking partnerships or investing, ensure you can provide satisfactory answers to the questions above. Consulting a cannabis accounting expert can help you approach due diligence measures with confidence.