Author: Dan Garfield
As the cannabis industry grows, old markets open to new money (for example, out of state ownership is now permitted in Oregon and will be permitted in Colorado in 2017), and new markets open, our clients at McAllister Garfield have been coming to us for advice on how to raise capital for that much-needed expansion or to buy out a recalcitrant partner. For any cannabis company seeking to raise capital, the owners and the executive team must ask and try to answer the following questions:
- What is the purpose of the capital raise?
A number of startups and small businesses, whether in the cannabis industry or elsewhere, fail to ask the basic question: what do we need this money for? Too many simply want capital to “grow,” “build our brand,” or “get my ex-wife out of the business.” Be specific about your needs. It will not only help you with your own planning; it will let capital sources know that you know your business and have thought deeply about what you want to do.
- Equity or debt?
So many issues exist here. Do you want a minority partner with cannabis experience? An investor? Or just a lender who wants its capital paid back with interest? Debt is still quite expensive. Debt in the cannabis industry is expensive because it remains illegal under federal law, no regulated financial institutions (banks, credit unions, insurance companies) will lend any significant amount, and most will not lend at all, and there is little collateral to be offered other than real estate.
Equity capital remains expensive for similar reasons. There are few sources of significant capital who will invest for the long term because of the federal issues (including IRS Section 280E), licensing requirements, heavy regulation, and the difficulty in moving into new states.
- Have we done our due diligence on our capital source?
In the months leading up to the legalization of retail marijuana in Colorado, a number of businesses took money from anyone with a checkbook because they were desperate for capital. Soon thereafter, some of these businesses discovered their capital source was a wolf in the henhouse. Make sure you do due diligence on your money source. Is the source litigious? Whom does the source do business with in other industries? What other deals has it done? Consider hiring an expert in the area to do a proper investigation.
- Do we have alternative plans if we don’t raise capital?
Do you have a Plan B if you can’t raise the needed capital? Family and friends are typical sources if other capital is unavailable. Can you raise capital from cash flow in your business? Is a smaller raise feasible?
- Have you hired professionals to look out for your interests?
Engage good counsel and a good accountant who know the industry and have done capital raises. They’ll know whether you should use a private placement memorandum, how the securities laws can affect how you raise money and whom you can raise money from They will save you time and money, explain the process and the deal documents and, perhaps, save you from making a desperate deal that leads to the courthouse many months later, or worse.