When the Colorado Legislature last May enacted Senate Bill 16-40 (“SB40”) to permit out of state ownership of licensed marijuana businesses beginning on January 1, 2017, it also permitted “qualified institutional investors” to own up to 30% of those businesses. (Licensed marijuana businesses that are partially owned by qualified institutional investors may also have out of state owners).
In the initial days after passage of SB40, there was some confusion as to whether “private equity funds” or “hedge funds” would be able to invest in licensed marijuana businesses. In a word, “no,” at least not in the manner that private equity and hedge funds invest in other industries. The creation of this new investment category offers new opportunities for investors and new opportunities for licensed business to raise capital.
What qualifies as an institutional investor?
SB40 defines the following entities (or any combination of the following) as institutional investors that may own up to 30% of a licensed marijuana business:
- A bank;
- An insurance company;
- An investment company registered under section 8 of the federal Investment Company Act of 1940;
- An investment advisor registered under section 203 of the federal Investment Advisors Act of 1940, as amended;
- Collective trust funds as defined in section 3(c)(11) of the Investment Company Act of 1940, as amended;
- An employee benefit plan or pension fund subject to the federal Employee Retirement Income Security Act of 1974, as amended (but excluding employee benefit plans or pension plans sponsored by licensed marijuana businesses or an intermediary or holding company licensee that directly or indirectly owns five percent or more of a licensed marijuana business); or
- A state or federal government pension plan.
Given that marijuana remains illegal under federal law (and in many states) and will remain illegal for the foreseeable future, the only investment vehicles that will have the ability or willingness to invest in licensed marijuana businesses in Colorado are registered investment companies and registered investment advisors.
Investment companies and investment advisors are not only subject to laws and regulations specific to them, but are also regulated by the U.S. Securities and Exchange Commission and the securities regulator for their state of incorporation.
Regulation of qualified institutional investors
During the public rulemaking process for SB40 this summer (in which senior counsel Dan Garfield participated), officials for the Colorado Marijuana Enforcement Division (the “MED”), the agency that regulates licensed marijuana businesses, stated their intent to regulate and investigate qualified institutional investors generally in the same manner that the Colorado Division of Gaming regulates ownership of casinos by publicly traded companies or ownership through other public offerings of securities. For that reason, the final rules recently promulgated by the MED are quite stringent with regard to qualified institutional investors.
Under the new MED rules, a “qualified institutional investor” is an “Indirect Beneficial Interest Owner,” meaning the entity is not subject to the same invasive process as a “Direct Beneficial Interest Owner” (who must hold an associated key license and is subject to a background check and significant disclosures).
Nevertheless, a qualified institutional investor is subject to significant disclosures and procedures, among others, before it can take ownership of a licensed marijuana business, including a certification under oath that the investor is acquiring interest in the licensed business solely for investment purposes and not for the purpose of causing, directly or indirectly, the election of a majority of a licensed business’s board of directors or any change in the corporate charter, bylaws, management, policy, or operations of a licensed business. In addition, the investment entity must disclose to the MED the names of all persons and entities that own 5% or more that entity.
Typically, sophisticated investors cut their complicated deals with entities that they invest in, including taking board seats and a preferred return on their investment. While it appears that the MED will permit an institutional investor to place at least a minority of board members, given that such investors cannot cause a change in the “corporate charter, bylaws, management, policy, or operations of a licensed business,” it will remain unclear for some time the extent to which institutional investors may do anything more than take simple ownership of licensed marijuana businesses.