Raising Capital for Cannabis and Cannabis-related Businesses
For companies within the cannabis industry that are interested in raising capital for their businesses, they need to know that legal compliance is particularly important. Not only is cannabis a highly regulated industry but offers and sales of securities by companies within this industry are generally subject to enhanced scrutiny by State and federal securities regulators.
More specifically, it appears that the Securities Exchange Commission (SEC) is increasing its scrutiny surrounding the financial reporting and disclosure requirements of cannabis businesses in connection with the offer and sale of securities. For instance, the SEC issued an “Investor Alert” on September 5, 2018 pointing out the increased fraud by cannabis business securities offerings. The “Investor Alert” directed investors to carefully examine offering materials and disclosures, including descriptions of the investment, its risks, and benefits. Despite the SEC’s warnings, financial fraud continues to exist with the offer and sale of securities by cannabis and cannabis-related businesses. These fraudulent acts often involve the issuers, their officers, promoters, and financial professionals.
Since 2017, the SEC has brought eleven enforcement actions in federal court against cannabis companies. The agency vigorously pursued these enforcement actions against the issuers, investment advisors, and broker-dealers for alleged securities violations. Examples of alleged securities violations include false statements of material facts or omissions of materials information by an issuer in its offering documents; the offer and sale of unregistered securities; the improper sales of securities to non-accredited investors; and the use of unregistered broker-dealers, investment advisors, or unlicensed representatives to help sell the securities.
Successful offerings by cannabis-related businesses have the same business and securities legal compliance as any other private company. However, due to uncertain market conditions, cannabis businesses need an even greater eye on structure and compliance. This means ensuring that their corporate and governance structures are set up correctly; that they are formed in a State that permits cannabis businesses; and that they have obtained their State cannabis license prior to making the offer and sale to investors. This is especially true where the SEC has made the foregoing important factors to consider when regulating offers by cannabis businesses.
Likewise, the cannabis business needs to pay particular attention to their disclosure materials, especially the financial disclosures, and to ensure that they are disclosing all of the particular risk factors of engaging in the business of cannabis, including the fact that the cannabis industry is still illegal at the federal level and in most States. Risk factors for a cannabis business can include any pertinent regulatory information, including State and federal rules, up-to-date copies of all relevant licenses and related cannabis applications, as well as any memorandums regarding how the company and its affiliates are structured.
According to Bloomberg Law, companies should also anticipate and prepare cannabis-specific due diligence requests from investors. As stated and unlike other private companies , cannabis businesses have the additional hurdle of informing prospective investors of the risks of investing in a federally illegal operation. This may cause a great concern for prospective investors and therefore, it may be harder for the cannabis business to raise the capital that it needs. Although there may be ways to convince the prospective investors to invest in the business despite its illegality, it is better if the business did not try to convince prospective investors that its offer is entirely legal or without risk from securities violations or other legal compliance issues, such as the risk of not being able to use a federally-insured bank.
In order to minimize risk, cannabis companies should pay close attention to the investors that they seek out. Selecting the right investors is a critical step. According to Bloomberg Law, the best investors are those that have previously made cannabis investments or are comfortable with the heightened risks and regulatory requirements that are involved.
Likewise, cannabis companies can provide comfort to prospective investors by mitigating certain risks. This includes engaging in a regulatory compliance analysis at the outset that shows a clear pattern of stringent regulatory compliance with State and federal laws, including adherence to certain regulatory guidelines. Another strategy that a cannabis company can do to mitigate investment risks is to wean out prospective investors who are particularly uncomfortable undergoing a background check or being disclosed to State or local regulators as a potential investor. Cannabis companies should also avoid relying on investment commitments from first-time cannabis investors until they have cleared these background checks and other investment concerns.
Raising capital can be challenging in any industry, and this is especially true for businesses within the cannabis industry due to a highly regulated, uncertain, and ambiguous legal environment. However, many of these challenges can be mitigated by identifying, understanding, and disclosing the unique issues that exist among cannabis and cannabis-related businesses. These challenges can also be mitigated by either addressing or preparing for them in advance, such as preparing a regulatory compliance analysis that can help ease the worries of prospective investors, as well as the SEC. As such, cannabis businesses should hire a competent securities attorney who can help ensure that any securities offerings and related investor communications comply with federal and State regulations as it regards both the offering of securities and the relatively-new (and somewhat legal) cannabis business.
If you are interested in raising capital for your cannabis or cannabis-related business, then schedule a consultation with us today. We are happy to help!
*co-authored by Managing Attorney, Elizabeth L. Carter, Esq.