05 Jun Corporate Governance II: Protecting Your Investment
Licensees should exercise great care when diluting their ownership interests or giving up control of their businesses for the purpose of obtaining financing. This blog addresses issues applicable to business owners as recipients of investment monies, and recommendations on how to enter into relevant agreements that protect their business interests. For a discussion of laws applicable to investors, including current restrictions on out-of-state investments, and the recent trend of states to relax these residency requirements, read Corporate Governance I: Investors in Cannabis Businesses.
Protecting Your Investment
In most cases, the best way to avoid risk when accepting funds is to follow through with corporate formalities. Examples include putting governing documents in place for your business, following the procedures outlined in the governing documents, and making sure to document or otherwise record all investment agreements in writing.
While governing documents go by different names depending on whether they apply to partnerships, companies, or corporations, they are, at their most basic level, substantively the same. For General or Limited Partnerships, the document is called a Partnership Agreement, for Limited Liability Companies, the document is called an Operating Agreement, and a Corporation will have Bylaws.
If you are only obtaining financing from an investor, and they are not taking an interest in the business itself, it is equally important put your agreement in writing. In the case of an investment, this will likely occur in the form of a loan or promissory note. These documents will detail the terms of the investment, including how it is to be repaid, whether or not the investor has a secured interest in assets of the company, and what happens in the event of a default on payments by the company.
Governing documents, such as partnership agreements and operating agreements, provide basic rules that govern both the internal and external activities of the business. They also supply guidelines for the management of business affairs, and regulate the conduct of owners, members, managers, and employees of that business. An effective governing document will address characteristics unique to the industry and will anticipate and resolve problems that the respective business might encounter.
Well-drafted governing documents should include information regarding:
- How the business will be managed and how much control each owner or member has over the daily operation of the business;
- The amount and nature of the initial contribution expected of each participant and if and how that contribution is to be repaid;
- How profits and losses will be split between or among participants;
- How to handle an owner member who wishes to leave the business or have their interest assumed by a third party;
- Circumstances that could cause the business to terminate and how to handle each situation;
- What happens if an owner or member dies, commits a serious crime, or becomes otherwise incapacitated such that they can no longer participate in the business.
One significant benefit of anticipating and outlining as much as possible in your governing documents is that, in the event of a dispute, your governing documents will control the resolution of the case. In the event of a dispute, should the issue go to court for resolution, your company’s failure to include a relevant provision will cause the court to insert default provisions provided by applicable state law, which may not be favorable to one or both parties.
Because obtaining a marijuana business license in any state is a difficult process, licensees should protect their investments to the best of their abilities. Taking advantage of new opportunities for obtaining financing from investors is a good way to do that because it allows the licensee to expand and operate the business effectively. Just be sure not to get into bed with an investor who does not match your company’s goals, values, and ethics or the needs of the business. It is far too common that a business in need of funding gives away ownership in exchange for cash to a wealthy individual only to later realize that it is impossible for the company and investor to coexist.