Committee Insights | 12.7.22 | How To Use A Marketing Mindset To Raise Capital For Your Cannabis Company
NCIA’s #IndustryEssentials webinar series is our premier digital educational series featuring a variety of interactive programs allowing us to provide you timely, engaging and essential education when you need it most.
In this edition of our NCIA Committee Insights series, originally aired on December 7 and produced by NCIA’s Marketing & Advertising Committee, our panel of cannabis finance specialists, leading operators and capital raising experts will guide you through best marketing practices and considerations to deploy when fundraising in the cannabis industry from a marketing perspective.
Learn tips and tricks and do’s and don’ts from marketing pro’s and industry insiders to best position your company to get the attention of investors in the current market conditions just as you’ve done when targeting consumers.
So, you discovered a pain point in the cannabis industry while brushing your teeth. You go on to craft a business plan and begin to execute on a minimal viable product to prove your hypothesis and test the market interest in your product. To date, you have funded this by volunteering your time and convincing some other contacts to contribute their time as well. You still have your full-time job, but it’s time to create a formal entity and grow this thing. How are you going to fund this? Well, there are some options and some of them have greater odds depending on your demographic. Are you considered ‘touching the plant” or not? Are you male or female? Are you a person of color or not? Do you have a track record of building businesses and raising funds?
Unfortunately, the data shows that it’s much more difficult to raise funds from angel and VC investors if you are a female or person of color. The following statistic is actually based on the traditional market, so level up the challenge if you are in cannabis:
“Venture dollars invested in sole female founders in 2020 represented 2.4 percent of overall venture funding… the percentage of U.S. venture dollars that went to sole female founders in 2020 dropped dramatically by stage. At the seed stage, 7 percent of VC dollars went to startups with only female founders. At the early stage, that figure was 4 percent, and at the late stage, a mere 1 percent.” – Crunchbase News.
Fortunately, the cannabis investment industry has approached this issue with several new funds and structures. We will touch on that later in this series.
Does your idea involve ‘touching the plant’? Currently, cannabis is illegal at the federal level. This comes with a whole host of challenges and opportunities. With federal illegality comes the opportunity for a startup to solve a problem before the more established, traditional market entities are willing to enter the industry. If you build it well enough, you are likely to be acquired once the market opens up. But you will have to deal with lack of access or restricted access to banking and processing, the IRS and 280E, the certainty of audits, and working within the boundaries of your state’s regulatory structure.
Now you have an idea, so, how to fund? Well, the first thing anyone considering investing in you wants to know is, what is your investment in yourself? Do you have savings, credit cards, personal real estate? For the earliest stages, this is often the first step. This is the “three peeps and a PowerPoint stage” — ideas and iteration come fast. There is no real cost for you to walk away. It is on your dime. You are living off of your day job and everyresource you can apply for This shows commitment and the effort will be a key to demonstrating value in the future. Be scrappy.
You will also need to establish a banking relationship. If you are touching the plant this can be quite the struggle. Federal banks have to comply with the KYC – or Know Your Customer – rules and most are unwilling to take on the extra tasks and time it takes to manage a cannabis account and file Suspicious Activity Reports (SARS). Be ready to navigate the business world in cash – which includes security and safety and paying your taxes. Many local-based credit unions are rising up to the challenge, but that often involves extra, costly fees. And even if you are ancillary, if you choose a “green” enough name you are exposing yourself to having your account closed. This goes for processing too. It really behooves you to be as honest and clear about what you are doing and establish a relationship with your banker. NCIA has successfully advocated for the SAFE (Secure and Fair Enforcement) Banking Act (S. 1200, H.R. 2215) which provides a safe harbor to financial institutions doing business with state-legal cannabis providers. It sits in the Senate after having passed the House twice now, although now a new House version will still need to be approved.
As your concept solidifies, its demands of capital increase, with personal, social, business, and financial needs starting to grow past what you can provide alone. You need help. If you have a buddy willing to put an LLC together for you, that’s bootstrapping. If she wants something in return, you are at friends and family time. This is a good stage to build your early financial network and can really help with those next steps. This is a small round of insiders and is as much about personal capital as financial capital. A friend and family round is a direct contact on your part, and those relationships you made in the boot-strapping are good places to start. These early champions will build your social capital as they talk positively about you. Being a small group also creates scarcity. These subtle behaviors will help your valuation when it comes time for that. A good friend and family round will get you off to a right start with the resources for securing an accountant and other professional services to determine the right way to structure your company.
For these early funding stages, bootstrapping and friends and family funding demonstrate your validity as an investable partner for later rounds. No matter your hurdles, starting your fund journey on the right path will pay off down the road.
In our next blog, we will discuss funding options such as debt, angels, and venture capitalists, and where to find them.
Guest Post: Changes to Colorado Residency Requirements
By Charles Alovisetti, Senior Associate at Vicente Sederberg, LLC.
This is article is the second in a series, which will provide a general overview of the laws that impact raising money in the cannabis industry.
Introduction
Colorado currently has the strictest residency requirements for ownership of marijuana establishments in the United States, imposing a two-year residency requirement for any owner of a licensed business. In addition to the constraints imposed by such a lengthy residency requirement, the Colorado Marijuana Enforcement Division (the “MED”), which is the regulatory body concerned with the marijuana industry, takes a broad view of what constitutes ownership (e.g., guarantying the debt of a licensed entity can constitute ownership). Earlier this year, on May 11, 2016, in order to address the funding difficulties created by the strict residency requirements (note that because the changes to the residency requirements apply to both medical and retail marijuana businesses, this article will not distinguish between the two when discussing the legislative changes and will simply refer to licensed entities, which shall mean both medical and retail licensed entities), the Colorado Senate passed Senate Bill 16-040, as amended by the House, commonly referred to as the “Residency Bill” (the “Bill”). The Bill was subsequently signed into law by Governor Hickenlooper on June 10, 2016. The Bill, which goes into effect on January 1, 2017, will radically change the residency requirements imposed on licensed businesses. These changes are addressed in detail below. This article, with limited exceptions, only addresses the changes explicitly described in the Bill and does not address the further complexities raised by draft rules promulgated by the MED regarding the Bill since these rules are not yet final.
Current State of Colorado Law
As noted above, in addition to requiring that all owners of a licensed business be at least two-year Colorado residents (and must also meet certain background requirements), Colorado takes the view that a person or entity that has a beneficial interest in a marijuana business and/or substantial control over a marijuana business is considered an “owner.” A beneficial interest has been informally defined as being paid based on profits (whether gross or net). In determining if a person or entity has an ownership interest in a marijuana business, the state considers a non-exhaustive list of factors, including whether a person or entity 1) bears risk of loss and opportunity for profit; 2) is entitled to possession of the licensed premises; 3) has final operational decision-making authority over business; 4) guarantees the businesses’ debts or production levels; 5) is a beneficiary of the business’s insurance policies; 6) acknowledges tax liability for the business; 7) acts as an officer or director of the business; 8) is contracted to manage the overall operation of the business; 9) has a licensing agreement with the business (note that it is possible to structure licensing agreements so as to avoid triggering the determination of ownership, but this can be complicated); 10) has ownership of shares or other equity interests of the licensed business; 11) has a secured interest in furniture or fixtures directly used in the manufacture or cultivation of marijuana; or 12) has a secured loan with the business. In addition, any security interest in the furniture, equipment, or fixtures used directly in the manufacture or cultivation of marijuana or marijuana product may be considered ownership depending on the circumstances. Given the thoroughness of the foregoing list, it’s not difficult to understand why licensed entities have had difficulty raising capital from out-of-state investors.
However, Colorado laws do allow for out-of-state residents to invest in marijuana businesses through a permitted economic interest (“PEI”). A PEI is a financial interest in the form of an unsecured debt instrument, option agreement, warrant, or any other right to obtain ownership interest in a marijuana business, provided the conversion or transfer right is contingent on the holder qualifying as an owner and obtaining licensure as an owner by the MED – this could be upon the occurrence of either the holder meeting the two-year residency requirement or a change in law (which the Bill represents). A PEI may only be held by a natural person who is a U.S. resident. Holders of PEIs are subject to fingerprinting and criminal history background checks and must disclose financial and personal information with the MED in their applications. As of today, PEIs remain useful to licensed businesses since they allow them to accept out-of-state investment in advance of the Bill going into effect. On January 1, 2017, PEI holders will become eligible to have their interests converted into equity holdings in licensed businesses. After the Bill goes into effect, any kind of option, warrant, or similar convertible instrument will still be required to take the form of a PEI.
New Residency Bill
Before delving into the specifics of the Bill, it is worth noting that the summary attached to the Bill contradicts the actual law, as it was written prior to the passage of the final version of the Bill, and it should be ignored.
The Bill adds a number of new defined terms. Understanding these new terms is the key to understanding the Bill:
Direct Beneficial Interest Owner: Prior to the Bill, there was only a defined term for “Owner”; that concept has now been split in two – Direct Beneficial Interest Owner and Indirect Beneficial Interest Owner. Under the existing system, any level of control that the MED, using the 12-factor test outlined above, determined rose to the level of ownership resulted in the entity or individual being listed as a zero percent Owner (e.g., an individual who guaranteed the debts of a licensed entity might be considered as a zero percent Owner of that business, despite owning no equity in that entity). The term Direct Beneficial Interest Owner is meant to cover existing Owners who directly hold equity in a licensed entity. Direct Beneficial Interest Owners are subject to residency requirements and full background checks (except for Qualified Limited Passive Investors, a type of Direct Beneficial Interest Owner described in detail below). A Direct Beneficial Interest Owner must be either a resident of Colorado for at least one year or a US citizen. Publicly traded companies are explicitly barred from holding licenses.
Indirect Beneficial Interest Owner: The second new category that was previously included in Owner is Indirect Beneficial Interest Owner. No residency requirement exists for an Indirect Beneficial Owner. An Indirect Beneficial Interest Owner includes the following individuals and entities: (a) a holder of a PEI, (b) a recipient of a commercially reasonable royalty associated with the use of intellectual property by a licensee, (c) a licensed employee who receives a share of the profits from an employee benefit plan, (d) a qualified Institutional Investor (defined below), or another similarly situated person or entity as determined by the state licensing authority. The Bill does not explicitly state what kind of background check will be required for an Indirect Beneficial Interest Owner. Currently, the draft rules set forth an identical set of criteria to determine suitability to those for Direct Beneficial Interest Owners, but this may change in the final rules.
Institutional Investor: Up to 30% of a licensed business can be held by an Institutional Investor, and the Bill does not contemplate any residency requirement for an Institutional Investor since an Institutional Investor will be considered an Indirect Beneficial Interest Owner and residency requirements only apply to Direct Beneficial Interest Owners. The Bill sets out a list of entities that meet the definition: banks, registered investment companies, ERISA funds, and any other entities to be identified during the rule-making process. The current draft rules do not list any types of entities not specifically identified in the Bill. While not discussed in the Bill, the draft rules and legislative history make it clear that an Institutional Investor must be passive and may not have any control over a licensed company beyond voting its shares (meaning that the minority protections present in a typical non-control transaction cannot be present).
Qualified Limited Passive Investor: This is defined as a natural person who is a U.S. citizen and is a passive investor owning five percent or less of the equity of a licensed business.
New Residency Rule
In place of the existing rule that requires all Owners to be at least two-year residents of Colorado, the Bill now allows an entity to be either (i) held by an unlimited number of Direct Beneficial Interest Owners, each of whom must meet the one-year Colorado residency requirement, or (ii) if one or more Direct Beneficial Interest Owners do not meet the one-year residency, then the following conditions must be observed: (a) At least one officer of the licensed entity must be a Colorado resident of at least one year, (b) all officers with day-to-day operational control over the business must be Colorado residents of at least one year, and (c) there must be no more than 15 Direct Beneficial Interest Owners (this limitation is measured by natural persons on a look-through basis). A licensed business, whether wholly held by Coloradoans meeting the residency requirement or held by one or more Direct Beneficial Interest Owners who do not meet the residency requirement, may also have up to 30% of its equity held by qualified Institutional Investors.
Reasonable Royalties Now Allowed
One additional major change in the Bill is the allowance for commercially reasonable royalties to be paid to Indirect Beneficial Interest Owners. As the law currently stands, a royalty would be considered a form of ownership by the MED (as the royalty would likely be based on the profit of the licensed entity) and would thus make the recipient of the royalty subject to residency and other ownership requirements. In addition, the current system requires all of the Owners to be present at MED meetings—which presents a major obstacle to the operator of a licensed business who wants to enter into multiple licensing agreements since any licensor could potentially put a license at risk by refusing to attend a meeting or by committing a bad act. However, Indirect Beneficial Interest Owners, while still subject to background checks, are not subject to residency requirements or the limitation of 15 natural persons (as is the case for Direct Beneficial Interest Owners when one or more equity holders does not meet the one-year Colorado residency requirement). It may also be the case, though we will need to wait for the final rules, that removing an Indirect Beneficial Interest Owner is easier than removing a Direct Beneficial Interest Owner from a license.
Conclusion
As noted above, the MED is granted authority to promulgate rules pursuant to the Bill, and final analysis of the Bill will require careful study of these new rules. The MED is currently accepting written comments to the draft-proposed rules in advance of a formal, public hearing regarding the permanent rules on Friday, September 2, 2016. In addition, as with any other change in a regulatory regime, we will need to pay close attention to how the Bill plays out when actually put into practice.
This information is educational only and shall not be construed as legal advice. Please consult your attorney prior to relying on any information in this article.
Charlie Alovisetti, Vicente Sederberg LLC
Charlie Alovisetti is a senior associate and co-chair of the corporate department at Vicente Sederberg LLC. Prior to joining Vicente Sederberg, Charlie worked as an associate in the New York offices of Latham & Watkins and Goodwin where his practice focused on representing private equity sponsors and their portfolio companies, as well as public companies, in a range of corporate transactions, including mergers, stock and asset acquisitions and divestitures, growth equity investments, venture capital investments, and debt financings. In addition, Charlie has experience counseling portfolio and emerging growth companies with respect to general corporate and commercial matters and all aspects of compensation arrangements, including executive employment and consulting agreements, stock option plans, restricted stock plans, bonus plans, and other management incentive arrangements. Charlie has experience in both U.S. and cross-border transactions, and has advised clients across a range of industries including cannabis, technology, manufacturing, software, digital media, energy and clean tech, healthcare, and biotech. He holds a Bachelor of Arts, with honors, from McGill University and a law degree from Columbia Law School, where he was a Harlan Fiske Stone Scholar. Charlie is admitted to practice in both Colorado and New York.
Guest Post: Raising Money 101 – What’s an Offer and Why Does it Matter?
This is article is the first in a series, which will provide a general overview of the laws that impact raising money in the cannabis industry.
Any business owner planning to raise capital should consider the federal Securities Act of 1933, commonly referred to as the “Securities Act.” In addition to federal law, each state has its own set of laws that regulate securities sales, commonly referred to as the “Blue Sky Laws.” Both the Securities Act and any applicable Blue Sky Laws must be complied with in connection with the sale of securities – a security being proof of ownership or debt that has been assigned a value and may be sold (stocks and bonds are examples). Both the Securities Act and the Blue Sky Laws regulate the sale of securities by prohibiting the offer and sale of unregistered securities (other than pursuant to specified exceptions) and requiring companies to provide investors disclosure of all material facts concerning the securities for sale.
Crucially for business owners, it’s not only the actual documents to raise money that are governed by the Securities Act: so are those initial business plans and executive summaries that might be circulated to gauge interest. Ensuring that your business plans are not violating any securities laws is the focus of this article.
In analyzing whether a transaction or communication is in compliance with the Securities Act and Blue Sky Laws, it’s helpful to think through the following questions:
Does the transaction or communication constitute an offer or sale?
Is the offer or sale of a security (as defined in the Securities Act and the Blue Sky Laws)?
If there is an offer or sale of a security, is the security properly registered with federal and state authorities?
If there is an offer or sale of a security and the security is not registered, does the transaction fall within one or more of the specified exemptions to registration?
As you assess your materials for compliance, begin by asking whether an offer has been made. If a transaction or communication does not constitute an offer, then compliance with state and federal securities law is not a concern. However, if an offer is unintentionally made – a common mistake – it may trigger a violation of securities law since it is unlikely that the unintentional issuer will have taken into account the necessary disclosure items and determined the relevant exemption to registration. Note that in the context of securities law, “issuer” means any company that issues or proposes to issue a security.
What, then, is an offer, from the federal standpoint and from that of the state of Colorado? Section 2(a)(3) of the federal Securities Act defines “offer” as “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.” Under the Colorado Securities Act, “offer to sell” includes any attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value and “offer” means an offer to sell or an offer to purchase. What constitutes an offer, furthermore, may be a matter of perceived intent rather than explicit proposal: the SEC has noted that “[t]he publication of information and statements, and publicity efforts, generally, made in advance of a proposed financing, although not couched in terms of an express offer, may in fact contribute to conditioning the public mind or arousing public interest in the issuer or in the securities of an issuer in a manner which raises a serious question whether the publicity is not in fact part of the selling effort.” As a practical matter, these definitions, as well as the SEC’s guidance, mean that many communications that would not be considered offers under contract law may well be considered offers for purposes of state and federal securities law.
From a practical point of view, then, how should an entrepreneur approach an action that might be considered an offer – distributing information about a new company, for example? To mitigate risk of a securities violation, consider the following factors before circulating information about your business:
Include Appropriate Disclaimers: If you do proceed with distribution, any documentation provided to potential investors should contain disclaimers that clearly indicate that the provided information is not an offer or a solicitation of an offer to buy securities. Note that such disclaimers do not necessarily mean the document will not be considered an offer.
Require Further Information: Any documentation should also state explicitly that further information about a purchaser will be required before an offer can be made.
Minimize Details: Generally speaking, the fewer details provided about a potential security, the better. Even high-level details can result in a document being considered an offer.
Ensure Accuracy: Make absolutely sure that any information provided is correct and not misleading (i.e., do not claim that cannabis is legal in the United States, note that it remains illegal at the federal level). Avoid selective disclosure and be prepared to stand behind any claims made.
Follow Best Practices: Every communication should adhere to best practices regarding offerings in general (e.g., avoiding general solicitations, keeping track of distributed documents, etc.)
Seek Legal Counsel: When in doubt, speak to a qualified securities attorney. It’s always easier to do things right the first time, whereas it may not be possible to fix certain mistakes.
This information is educational only and shall not be construed as legal advice. Please consult your attorney prior to relying on any information in this article.
Charlie Alovisetti, Vicente Sederberg LLC
Charlie Alovisetti is a senior associate at Vicente Sederberg LLC. Prior to joining Vicente Sederberg, Charlie worked as an associate in the New York offices of Latham & Watkins and Goodwin Procter where his practice focused on representing private equity sponsors and their portfolio companies, as well as public companies, in a range of corporate transactions, including mergers, stock and asset acquisitions and divestitures, growth equity investments, venture capital investments, and debt financings. In addition, Charlie has experience counseling portfolio and emerging growth companies with respect to general corporate and commercial matters and all aspects of compensation arrangements, including executive employment and consulting agreements, stock option plans, restricted stock plans, bonus plans, and other management incentive arrangements. Charlie has experience in both U.S. and cross-border transactions, and has advised clients across a range of industries including technology, manufacturing, software, digital media, energy and clean tech, healthcare, and biotech. He holds a Bachelor of Arts, with honors, from McGill University and a law degree from Columbia Law School, where he was a Harlan Fiske Stone Scholar.
*Currently only admitted in New York
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by Deborah Johnson, 
Colorado currently has the strictest residency requirements for ownership of marijuana establishments in the United States, imposing a two-year residency requirement for any owner of a licensed business. In addition to the constraints imposed by such a lengthy residency requirement, the Colorado Marijuana Enforcement Division (the “
One additional major change in the Bill is the allowance for commercially reasonable royalties to be paid to Indirect Beneficial Interest Owners. As the law currently stands, a royalty would be considered a form of ownership by the MED (as the royalty would likely be based on the profit of the licensed entity) and would thus make the recipient of the royalty subject to residency and other ownership requirements. In addition, the current system requires all of the Owners to be present at MED meetings—which presents a major obstacle to the operator of a licensed business who wants to enter into multiple licensing agreements since any licensor could potentially put a license at risk by refusing to attend a meeting or by committing a bad act. However, Indirect Beneficial Interest Owners, while still subject to background checks, are not subject to residency requirements or the limitation of 15 natural persons (as is the case for Direct Beneficial Interest Owners when one or more equity holders does not meet the one-year Colorado residency requirement). It may also be the case, though we will need to wait for the final rules, that removing an Indirect Beneficial Interest Owner is easier than removing a Direct Beneficial Interest Owner from a license. 
