22 May Corporate Governance I: Investors in Cannabis Businesses
For investors, the marijuana industry can be difficult and expensive to buy into, so it is paramount to educate yourself and take steps to protect your investments. Part I of this blog addresses laws applicable to investors, including current restrictions on out-of-state investments, and the recent trend of states to relax these residency requirements. Part II, Corporate Governance II: Protecting Your Investment, will discuss business owners as recipients of investment monies, and recommendations on how to enter into relevant agreements that protect their business interests.
As the law now stands, each of the four states that have legalized recreational marijuana –Alaska, Colorado, Washington, and Oregon – either completely forbid or significantly restrict the ability of out-of-state investors (sometimes called “financiers”) to invest in any of their state’s legal marijuana businesses without satisfying state-specific residency requirements.
These restrictive laws affect not only financiers, but also restrict the financial structure and growth potential of cannabis businesses in these states as well. In an effort to reduce many of the disadvantages this restrictions pose to industry growth, it appears that states poised to implement their own recreational regulations in the upcoming year may lift this ban on out-of-state investors which will in turn put pressure on lawmakers in states like Colorado and Washington to lift or loosen their own.
California recently passed the Marijuana Legalization Initiative in November 2016. Currently, California, already an economic behemoth, does not ban out-of-state owners or investors from entering their marijuana industry; if recreational regulations follow suit, that could place other states’ more restrictive markets at a serious disadvantage. Currently, in addition to their inability to accept out-of-state investments, license holders in Washington or Colorado cannot go to a federal bank to get a loan, and thus cannot fund or grow their cannabis businesses at the same rate that competitors in California could soon be able to.
Washington law applicable to out-of-state investment is particularly strict. In Washington, a financier is defined broadly as “any person or entity, other than a banking institution, that has made or will make an investment in the licensed business.” Until recently, Washington law required a financier be a resident of the state for a minimum of six months before being able to gift or loan money or property. Washington law also sometimes required criminal background checks to be submitted to the Washington State Liquor and Cannabis Board (WSLCB) before a licensee properly receives investment money. Those rules changed effective July 1, 2016. The WSLCB has now adopted rules that remove the six-month residency requirement for out-of-state gifting or lending, but that particular rule lifts the restriction only with respect to gifting or lending – meaning an out-of-state investor would still only have the right to receive interest payments on top of the repayment of their principle investment. Any person or entity wishing to receive a percentage of the profits from a licensed marijuana business in Washington must still satisfy the six-month residency requirement.
The Washington State Legislature is considering out-of-state ownership of a licensed marijuana business, however, in a separate bill (HB 2364). The new law would allow a U.S. citizen living out-of-state to own up to a 49% interest in a Washington state licensed marijuana business, but reserves “discretionary authority” to the WSLCB to deny the license pending a background check. However, changes of this kind would not take place until January 2017 at the earliest, as the current legislative session has ended.
Colorado and Alaska are taking similar steps to relax residency requirements for investors, but have met their own problems passing those laws. Alaska’s marijuana business regulations were tightened in 2015 to require proof of one year of in-state residency for an entrepreneur who had never been an Alaska resident. Oregon, on the other hand, has taken the stance of allowing out-of-state money subject only to requisite criminal background and character and fitness evaluations.
Allowing out-of-state investors has the potential to expand the marijuana industry by allowing more traditional business funding. The industry is starting to elicit investments from large Venture Capital firms such as Founders Fund, which has previously brought more conventional funding structure to other cutting-edge businesses over the past decade such as Facebook, Airbnb, Lyft, and SpaceX. A cash infusion from more traditional business funding methods, such as VC funding, will play an important role in making sure the Colorado, Washington, Oregon, and Alaska marijuana markets keep up with the California market should recreational marijuana become legalized in November.
What does this mean for business owners and licensees? Generally, it is good news. Allowing out-of-state money increases the possible investor pool which will allow for greater business expansion as well as the ability to audition and find the right investor for your business: someone who will help you succeed rather than drive the company into the ground in order to be repaid.