Money Doesn’t Grow On Leaves: Cannabis Investing For Dummies (And Non-Dummies) | Bradley Arant Boult Cummings LLP

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When people learn that you are a cannabis advocate, there are a range of reactions. Nervous laughter bordering on disbelief can be the most 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 – one that applies to both cannabis operators looking to raise capital and potential cannabis investors.

Hemp vs Marijuana

The distinction between hemp and marijuana is hugely consequential, and one that many new cannabis investors don’t immediately appreciate. While the terms are often used interchangeably in everyday language, one of the most common ways I start conversations with potential cannabis customers is by determining whether the customer is talking about hemp or marijuana.

This country’s relationship with cannabis is complicated, and as is often the case in complicated matters, words count. Marijuana and hemp are different strains of the Cannabis Sativa L Plant. 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 ingredient in the drug Cannabis Sativa L plant, including all derivatives and extracts such as cannabidiol (CBD), provided the plant contains less than 0.3% tetrahydrocannabinol (THC). Any Cannabis Sativa L Any plant or derivative of such a plant with a higher THC content is considered “marijuana,” which remains a Schedule I substance under the Controlled Substances Act – the most strictly regulated category of narcotics. Because THC is the psychoactive ingredient in marijuana that causes a “high,” a key difference between marijuana and hemp is that hemp does not induce a “high.” In short, and for the following relevant purposes, possession of hemp-derived CBD is legal under federal (and most state) law, while marijuana is illegal at the federal level.

And to add another wrinkle, the country is now dealing with cannabis derivatives that Congress almost certainly never considered when it passed the Farm Bill in 2018 — specifically products like Delta-8 THC, Delta-10 THC, and others . Some of these products can produce a “high,” but likely fall into a loophole. This leads to a number of unintended consequences, including, to name a few, consumers can now legally access products that get them high, but even those products — sitting within a loophole — are essentially completely unregulated at the federal level even. Nevertheless, these products are largely responsible for the sustainability of today’s hemp industry.

Raising cannabis funds in a nutshell: Lack of access to many traditional forms of capital

Accessing capital in the cannabis industry can be extremely difficult. This is a basic – if not the fundamental – obstacle to the development of the branch. Capital is oxygen for every company. In the cannabis world, capital means research, development and expansion of product lines and therapies for patients. So what’s the problem with accessing cash?

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

Raise marijuana capital

Lending for marijuana operations is virtually a non-starter from traditional banks. In addition to the reasons outlined above, there is a separate concern that the collateral (eg., the marijuana land, the equipment, or the proceeds) are subject to civil forfeiture under federal law. This means that the collateral securing the loan can essentially evaporate and leave the loan unsecured. Alternatively, banks may be unwilling to mortgage and take possession of property where ownership of the property could violate federal law.

There are private lenders that specialize in the cannabis industry. Such lenders — which typically offer cash loans — can be attractive without other sources of capital, but interest rates often make such loans unattractive or unsustainable for potential cannabis operators.

So who can you get money from? First off, it’s always nice to have wealthy and supportive friends and family who are willing and able to fund your business. However, even your closest friends and family members probably expect something in return for their generosity. Most companies looking to raise capital from investors offer one of two things in return: debt or equity. Debt financing or borrowing is when a company borrows money, typically in the form of a bond or promissory note, from an investor and agrees to repay it with interest at a later date. Equity financing, on the other hand, is when a company generates capital through the sale of its ownership interests. In addition to the interest, the downside of external financing is the high risk – principal and interest payments are due regardless of the actual course of business. With equity financing, the main disadvantage is that the company effectively sells portions of the company’s assets, resulting in dilution of the assets already held.

Private companies looking to raise capital by issuing debt or stock also have more traditional options – offering the securities to the public or through a private placement. An initial public offering, or “IPO,” refers to the process by which a private company’s stock is offered to the public for the first time. While this option allows companies to offer equity to millions of investors through the primary market, it typically only appeals to larger, more established private companies that are able to meet the requirements of the stock exchanges and the United States Securities and Exchange Commission (SEK) . And at least as of this writing, domestic exchanges aren’t available to most marijuana operators. Alternatively, a private placement is the sale of debt or equity to a limited number of qualified investors. These investors can include friends and family, as well as professional investors such as private equity firms and venture capitalists. Compared to IPOs, private placements are less regulated and more accessible to smaller, private companies and startups.

Of course, offering securities at both the federal and state levels comes with legal obligations. The Federal Securities Act of 1933 (Securities Act) requires that all offerings of securities be either registered with the SEC or be exempt from such registration. In particular, IPOs are not exempt from registration or the SEC’s ongoing corporate reporting requirements, both of which are known to be costly and burdensome. However, initial offerings to company founders and certain private placements are exempt from registration. In addition to the Securities Act and the SEC regulations contained therein, each state has its own securities laws and regulations. For example, companies making private placements are required to file disclosures and/or pay a small fee in each state where securities are issued.

Raise hemp capital

Getting capital for a hemp company shouldn’t be a problem. Finally, hemp is legal federally and (in most formulations) legal in all states. Provided you can find a lender that will provide funding that meets your needs, the law should not act as a bar to obtaining that funding.

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. And others are probably just prisoners of inertia.

Cannabis-specific fundraising considerations

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

  1. Fundraising for marijuana

Currently, because all marijuana regulations operate at the state level, raising funds for (or investing in) a marijuana business requires strict compliance with the laws of the state(s) in which you operate. Unfortunately, these laws are not uniform across the country. Here are some examples of key state differences that you need to seriously consider when raising capital or investing in a marijuana business.

All states that permit marijuana in any form require marijuana operators to be licensed. And most states have specific requirements for who can get a license. If you’re trying to raise money for a marijuana business, it’s important that you have all the appropriate licenses. And if you’re considering an investment in the marijuana business, your due diligence should include confirming appropriate licenses.

One also needs to consider whether the state allows shares in a marijuana company to be freely transferred or whether the transfer requires notification and/or approval from regulators. Also consider whether the investors need to meet the approval requirements themselves and what kind of due diligence is needed to confirm that the investment is appropriate from that perspective. Finally, keep in mind that most states require disclosure of all investors (or at least those with a significant interest), and consider whether the company and investors wish to make this information publicly available.

2. hemp fundraising

There are fewer and fewer roundabout considerations when fundraising for hemp, but there are still pitfalls for the unwary. Savvy banks and investors will require extensive due diligence to ensure the hemp business is operating within the extensive and evolving federal and state hemp regulations. In particular, there is concern that hemp can turn into marijuana if THC levels (regardless of intent) go above 0.3%. So, all of a sudden, a perfectly legal investment or loan starts violating federal laws and may involve money laundering concerns.

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Will you make money investing in cannabis? We do not know it. Some people certainly do and others don’t. What we do know is that you are much more likely to be successful as a fundraiser or investor if you take the time to understand the ins and outs of the cannabis business and work with professional service providers with experience in the industry.

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