Lately I have been spending a lot of time engaging with clients who are dealing with cannabis investors. I work with companies and investors.
Between public and private cannabis companies, the suite of investors runs the gamut from friends and family to key employees, executives, and board members with equity and synthetic equity grants, to single and group angel investors, through venture capital and into private equity. Even very early stage cannabis companies’ cap tables can get convoluted.
Cannabis Capital Raises Are Never Simple
As I discussed previously, any time a cannabis company or an individual takes money from outside sources, the company has issued securities. The legal work required for normal securities transactions is significant, even if you are raising only a modest amount of money from friends and family. Add a multistate patchwork of cannabis regulations over that, and the complexity increases. Then add international cannabis companies that are engaging cross-border transactions and potentially listing on public U.S. exchanges and you’re at an entirely different level.
What Cannabis Investors are Looking For
I often get asked what cannabis investors are looking for. The answer to that question depends significantly on the sophistication of your prospective investors. Friends and family investors are (depending on the amount) generally fine trusting you with their money, because they know you and trust you and your business acumen. They often do not worry about things like extensive due diligence; instead they may opt to discuss your business plans and accomplishments without asking for any company records or investment contracts. Taking such a light approach to your cannabis investors, even if they are friends and family, is not a good idea. You need more.
Normal Due Diligence Documents Requested by Investors and Attorneys
I recently spent two solid days reviewing hundreds of pages of securities-related contracts for both private and public cannabis companies and their investors. These included foundational company documents like articles of incorporation and certificates of formation. Those documents deal with basic but crucial components of how a cannabis company must do business, make decisions, and deal with its investors.
Bylaws, shareholder agreements, and operating agreements come next. These documents govern how cannabis company owners deal among themselves, their investors, and key employees.
Finally, you may see additional parallel shareholder agreements (or investor rights agreements) for different classes of ownership, including non-voting common interests, preferred interests, and ownership derivatives like synthetic equity, options, and SAFEs (simple agreements for future equity).
Companies that have been around for more than a few years will have amendments and permutations of these core entity agreements and a slew of the ancillary agreements, depending on the Company’s history.
Even More: The Cannabis Investor Due Diligence Request List
A typical due diligence request list from any securities attorney worth their salt will probably run 5-10 pages (our longest is 22 pages) and be more than you want to deal with. Rather than ask for “everything,” the investor’s counsel will ask for everything in a very detailed way. Categories typically include:
- Corporate Records
- Stockholder Information
- Securities Issuances
- Financing Documents
- Material Contracts
- Management and Employees
- Financial Information
- Sales and Marketing
- Real Property
- Intellectual Property
- IT Systems and Networks
- Privacy and Data Security
- Governmental Regulations and Compliance
- Litigation and Contingent Liabilities
Even if you are only dealing with a small group of investors, save yourself the time by organizing your files and uploading everything to a cloud-based data room for the investors and their attorneys to wade through. All investors will be interested in seeing your financials. Many will want to meet you and your team and visit with your key people. Many will want to visit your business site, especially if you have any type of physical operations (growing, manufacturing, and retail).
Relatively new companies may not even know where signed versions of their key agreements are, or whether they have fully executed versions. (Some companies never even took the time to draft them in the first place, always intending to do it later). These hiccups are often fine, but your investors will demand fully signed agreements, so you may have some significant clean-up to do before you are ready to open your due diligence locker to your prospective investors.
Moving Forward when Dealing with Your Cannabis Investors
Not everyone enjoys dealing with cannabis investors, but you should be prepared to interact with investors ranging from very “hands off” to very “hands on.” Their lawyers will all be involved and ensuring their clients are treated fairly and get every advantage possible in their investment relationship.
The worst thing you can do is take the money and not document anything. The best thing you can do is earmark some of those investment funds for dealing with your cannabis investors fairly, while ensuring the underlying company owners are protected from claims of investment fraud. You do not want to end up on the wrong side of an SEC enforcement action or in the headlines.