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Tuesday, August 9, 2022

Money Doesn’t Grow on Leaves: Investing Cannabis for Dummies (and Non-Dummys)

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When people learn that you are a cannabis advocate, there are a range of reactions. Nervous laughter bordering on doubt may be more common. Another common reaction is the feeling that investing in cannabis is a license to print money. Spoiler alert: This is not the case.

Consider this a public service announcement – an announcement that applies to both cannabis operators looking to raise capital and potential investors for cannabis.

Hemp vs. marijuana

The distinction between hemp and marijuana is very important and not immediately appreciated by many new cannabis investors. While the terms are often used interchangeably in common slang, one of the most common ways to start conversations with potential cannabis customers is to determine if the customer is talking about hemp or marijuana.

This country’s relationship with cannabis is a complex one, and as is often the case with complicated matters, words matter. Marijuana and hemp are different strains of Cannabis Sativa L Factory. So, “cannabis” is a scientific term, not a legal one.

Although the federal Controlled Substances Act has historically made no distinction between marijuana and hemp, in 2018 the federal government defined “hemp” as any part of Cannabis Sativa L The plant, including all derivatives and extracts such as cannabidiol (CBD), Provided the plant contains less than 0.3% THC (THC). Which Cannabis Sativa L A plant or a derivative of such a plant that contains a higher level of THC is considered “marijuana,” which remains a Schedule I substance – the most regulated drug class – under the Controlled Substances Act. Since THC is the psychoactive component in marijuana that produces the feeling of “high,” the essential difference between marijuana and hemp is that cannabis will not produce “high.” Briefly and for the related purposes below, hemp-derived CBD is legal to possess under federal law (and the law of most states), while marijuana is federally illegal.

And to add another wrinkle, the state is now dealing with cannabis derivatives that Congress never thought of when it passed the Farm Bill in 2018 — specifically products like Delta-8 THC, Delta-10 THC and others. A number of these products can result in a “high” but they likely fall within a loophole in the law. This leads to a number of unintended consequences, including, but not limited to, that consumers can now legally access products that will set them high, but also that these products – by virtue of being within a legal loophole – are essentially completely unregulated in federal level. However, these products are largely responsible for the sustainability of the cannabis industry as it exists today.

Raising cannabis money in a nutshell: lack of access to many traditional forms of capital

It can be very difficult to access capital in the cannabis industry. This is essential – if not The Essential – an obstacle to the development of the industry. Capital is the oxygen for any business. In the world of cannabis, capital means research, development and expansion of product lines and treatments for patients. So what is the problem with getting cash?

The legal distinction between marijuana and hemp raises important issues when raising capital. We will address both in turn.

Raising the capital of marijuana

Lending to marijuana operations is almost non-starter than traditional banks. In addition to the reasons outlined above, there is a separate concern regarding warranties (eg.or land, equipment, or marijuana proceeds) are subject to civil asset forfeiture under federal law. This means that the collateral that secures the loan may essentially evaporate and make the loan unsecured. In contrast, banks may not want to foreclose and seize property when possession of the property conflicts with federal law.

There are private lenders that specialize in the cannabis industry. These lenders, who usually make hard cash loans, may be attractive in the absence of other sources of capital, but interest rates often make such loans unattractive or unacceptable to potential cannabis operators.

So who can you get money from? For starters, it is always good to have friends and people who are wealthy and supportive who are willing and able to fund your business. However, it is possible that even your closest friends and family will expect something in return for their generosity. Most companies seeking to raise capital through investors offer one of two things in return: debt or equity. Debt financing, or debt raising, is when a company, usually by way of a bond or promissory note, borrows money from an investor and agrees to repay it at a later date with interest. On the other hand, capital is financed when a company generates capital through the sale of its equity stakes. Aside from interest, the downside of debt financing is the higher amount of risk – principal and interest payments will become due regardless of actual business performance. With equity financing, the main downside is that the company actually sells portions of business ownership, diluting pre-existing ownership.

Private companies seeking to raise capital through the issuance of debt or equity securities also have more traditional options – offering securities to the public or through private placement. An initial public offering, or “public offering,” refers to the process of offering shares of a private company to the public for the first time. Although this option provides companies with an opportunity to offer shares through the primary market to millions of investors, it usually appeals only to larger, more established private companies that are able to meet the requirements of the stock exchanges and the US Securities and Exchange Commission (SEC). At the time of writing, at least, local exchanges are not available for most marijuana operators. Instead, a private placement is the sale of debt or equity to a limited number of qualified investors. These investors may include friends and family, as well as professional investors such as private equity firms and venture capitalists. Compared to IPOs, private placements are subject to less stringent regulations and are more accessible for small businesses and start-ups.

Of course, introducing securities comes with legal obligations at the federal and state levels. The Federal Securities Act of 1933 (the Securities Act) requires that all securities offerings either be registered with the Securities and Exchange Commission or are exempt from such registration. Initial public offerings are not particularly exempt from the registration or ongoing reporting requirements of the company, both of which are known to be costly and arduous. However, founders’ IPOs and some private placements are exempt from registration. In addition to the Securities Act and the SEC regulations under it, each state has its own set of securities laws and regulations. For example, companies doing private placements may be required to file notice deposits and/or pay a small fee in each state in which the securities are issued.

Raising the capital of cannabis

There should be no problem in accessing capital for the cannabis business. After all, cannabis is legal and federally legal (in most formulations) in all states. Provided that you can find a lender that will provide financing for your needs, the law should not act as a barrier to obtaining this money.

However, unfortunately, not all financial institutions have dipped their toes into the cannabis sector. Some cite vague reputational concerns and others haven’t figured out how to price the additional compliance costs. Others may just be prisoners of inertia.

Cannabis Fundraising Considerations

So after all this, you still want to raise money for your cannabis business or invest in a cannabis business? Let’s get into it, with the caveat that space prevents us from hitting every single consideration. Here are some of the most common cannabis fundraising issues:

  1. Fundraising for marijuana

Since all marijuana regulations currently operate at the state level, raising money (or investing in) a marijuana business requires close adherence to the laws of the state(s) in which it operates. Unfortunately, these laws are not uniform across the country. Here are some examples of important types of interstate differences that you should seriously consider when raising capital or investing in your marijuana business.

All states that allow marijuana in one form or another require marijuana operators to be licensed. Most states have specific requirements for who can obtain a license. If you are trying to raise money for a marijuana project, it is imperative that you have all the appropriate licenses. And if you are considering an investment in the marijuana business, your due diligence should include confirmation of the appropriate licenses.

One should also consider whether the state allows the free transfer of stock in the marijuana business or if the transfer requires notice and/or regulatory approval. Also consider whether investors must meet licensing requirements themselves and what kind of care is needed to ensure that the investment is appropriate from this perspective. Finally, remember that most states require disclosure of all investors (or at least those with a significant stake), and consider whether the company and investors are comfortable making this information public.

2. Cannabis fundraising

There are fewer and less complex considerations in cannabis fundraising, but there are still mystery traps. Smart banks and investors will require extensive due diligence to ensure that the cannabis business operates within the broad and evolving cannabis regulations at the federal and state level. In particular, there is concern that cannabis could turn into marijuana if the THC level (regardless of intent) rises above 0.3%. Suddenly, then, it could be argued that an investment or loan that is entirely legal begins to run counter to federal law and could embroil money laundering concerns.

Takeaway

Will you make money investing in cannabis? we do not know. Some people definitely do and some don’t. What we do know is that you are more likely to be successful in fundraising or as an investor if you take the time to understand the ins and outs of the cannabis business and work with professional providers with experience in the industry.

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