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Knowledge & Insights

Avoid Public Audit Mistakes with 3 Simple Tests


Now you’ve decided to take your cannabis company public or have your sights set on that goal for the future. Be sure you understand the three simple tests that can help you avoid major mistakes in a cannabis public audit. One of the first steps to complete the process is to fill out a registration statement. This is generally referred to as an S-1. 

The SEC Form S-1 is an SEC Registration requirement for all US companies requesting an initial public offering on a national exchange.

Form S-1 Basics

There are multiple aspects to this document, including the maximum dollar amount a company intends to raise and strategies around growth strategy. 

In addition, companies wanting to be listed on an exchange are responsible for detailing the company’s historical business and financial information. 

Part 1 of this article focused primarily on asset acquisition versus entity acquisition. In this article, we review how to handle business acquisitions that are subject to audit. 

After reading this article, you will be able to understand the following:

  • Which acquisitions need an audit?
  • Why are certain acquisitions exempt from audits?
  • How to determine if your business needs additional audits before filing your S-1

Due Diligence & Good Record-Keeping

When planning on going public, you will need to set a business valuation. You also must demonstrate to the public markets why you are worth the specific value with data to back up your claims so that interested buyers can perform their due diligence.

In addition, you will need a history of past financial performance in case an audit needs to be completed on that acquisition. It’s also a common recommendation to keep open communication with previous operators if possible, if you need to reach out to them. 

For more information on the importance of data and good record-keeping practices, refer to part 1 of this series

Two main questions remain:

  1. What, if any, acquisitions need to have a full audit performed?
  2. How in-depth do those audits need to be?

Asset Sales Becoming Business Acquisitions 

Now, the key with asset acquisition is that sometimes it looks like a legally structured asset acquisition but is still subject to an audit. In addition, avoiding public audit mistakes is extremely important in these types of business acquisitions.

For example, you purchased a cannabis manufacturing facility with employees. The business files as an LLC, and all assets are neatly contained within the entity. But, making a simple update, like the change of ownership on paper from the previous owner to the C-Corp you own, can impact the necessity of an audit. 

While the entity you purchased continues to operate separately on its own, with independent resources, you now have an ownership stake which will drive financial impact to your C-Corp and will most likely trigger the need for an audit of that newly acquired entity. 

Why you ask? Because from an accounting perspective (and that of the SEC), it’s a business acquisition. 

While, yes, you are purchasing assets all neatly bundled into an LLC, it’s important to realize that those assets operate and produce a financial impact on the parent company that’s filing to go public. 

However, the size of the economic impact on the parent company will help you determine if an audit is a requirement.

Significance Tests for Audit Requirements

There are a series of tests to help you determine if your acquisition will be subject to an audit. And you may be in luck! Depending on the outcome of the tests, you could relieve the pressure of the audit requirements for your cannabis business. 

The significance tests include:

  • Investment Test
  • Asset Test
  • Income Test

Each of these tests is applied when determining if a subsidiary meets the regulatory requirements requiring an audit. 

The ratios help operators identify their level of significance on the business overall which then determines the financial reporting requirements.

Calculating Significance Tests

The numerator and denominator components pulled from the SEC are listed below:

For the Asset and Income tests, the SEC recommends using data from the end of the most recently completed fiscal year when calculating the numerator and denominator accordingly.

Analyzing SEC Significance Test Calculations 

The table below summarizes the financial statement reporting requirements based upon the level of significance of the acquisition.

In Plain Terms

After calculating the business ratios from the above tests, you can determine your obligations to produce audited financial statements. 

Depending on the threshold you reach on ANY of the tests here’s what to know:

  • Less than 20% of significance 
    • No financial statement requirements
  • 20-40% significance
    • 1 year (most recent fiscal year) audited plus other unaudited financials
  • 40%+ significance
    • Audited financial statements for the two most recent fiscal years plus other unaudited financials

So, if the financial impact wasn’t above 20% significance, you’re off the hook. 

Otherwise, you have some auditing requirements and want to get those audits going as quickly as possible as they can take time, and doing them under the pressure of a tight timeline can increase costs and delay public listings. To ensure you avoid the common mistakes associated with a public audit, reach out to a professional.

Next Steps

To learn more about audit requirements and to go public, reach out to our team of financial experts at GreenGrowth CPAs. We are here to help your cannabis venture through any level of the accounting, tax filing, or business cycle. 

We employ several financial programs that can assist the company with its fiscal responsibilities including, tax planning and compliance, outsourced CFO support, audit preparation, tax controversy support, and much more.

For recommendations and assistance with tax planning and accounting services, schedule a free consultation or contact us at 1-800-674-9050.

Request a Free Consultation & learn how GreenGrowth CPA’s can help your business grow.

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