By Claire Brown and Jessica A. Morgan
Funding a business with startup or growth capital is a universal challenge, but cannabis businesses face at least one unique hurdle in the continuing federal illegality of the industry. Aside from the difficulty in accessing banking resources, cannabis companies may also have a difficult time identifying and courting investors. As a result, it may be particularly tempting for a new or growing cannabis company to take whatever funding it can get.
LLC interests, shares of stock, and convertible notes are securities, and the offer and sale of securities is regulated in the U.S. and in each of its 50 states. Failing to comply with securities laws can give investors the right to get their money back with interest, can attract enforcement action from a federal or state securities regulator, and can complicate follow-on investment rounds or the eventual sale of a company.
All companies looking to raise money from investors should pay attention to securities laws. Ideally, legal counsel would ensure a company’s compliance with all applicable securities laws before any fundraising activities took place. However, in the practice, lawyers often see companies after they have already taken on investment. As a result, we are often looking back at past offerings and hoping they were accomplished without violations, or that any violations can be addressed.
To oversimplify a complex set of rules and risk-mitigation strategies, it’s better for any company looking to fundraise to focus on attracting a small number of investors, all of whom are wealthy and sophisticated, and to use an existing network of personal connections to locate investors rather than advertising to the public.
Also, paying someone an incentive fee in connection with fundraising activity (for example, by allowing a finder to earn a percentage of amounts raised) introduces far more complexity into any raise. Finally, in general, people who have committed fraud or other securities law violations in the past – so-called “bad actors” – are prohibited from being involved as an officer, director, finder, or major shareholder with companies offering or selling securities.
Any company looking to offer and sell securities should seek the advice of experienced counsel. In particular, however, those who are hoping to advertise, allow a large and diverse group of investors to participate, pay an incentive fee, or include a “bad actor” in the company are unlikely to stumble upon an offering that complies with all applicable rules, meaning that an expensive and time-consuming fix will be necessary at a later date, if it can be fixed at all.
Finally, many companies consider the bank their first choice for financing – for good reason, they will typically try to secure a bank loan to address funding needs before turning to private debt or equity investors. Banks are, of course, still largely unavailable to cannabis businesses, but several pieces of pending legislation might soon change this.
At the very least, the fact that bills seeking to provide cover to banks, credit unions, and similar institutions that work with the cannabis industry continue to attract bipartisan support at the federal level is a positive development for cannabis businesses. While allowing cannabis companies to access the banking system would have obvious benefits related to running a business, such as payroll, it would also give cannabis businesses the ability to access the vast lending apparatus currently available to other types of businesses.
Tonkon Torp has significant experience assisting cannabis-based businesses throughout the fundraising process. Contact Claire Brown, Jessica A. Morgan or an attorney in our Corporate Finance & Transactions Practice Group or your regualr contact in our Cannabis Industry Group to learn more about how we can help.
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