My firm has written previously on the options cannabis companies have when seeking financing. With legalization of marijuana spreading across the United States, investor activity is picking up as well. And since California approved Proposition 64 and the Medical Cannabis Regulation and Safety Act, venture capital is taking an acute interest in the Golden State, as California is home to the largest projected cannabis marketplace and roughly half our country’s venture capital investors.
How, though, are cannabis startup investments usually structured? Below is a list of the common types of cannabis investments we are seeing, in rough order of popularity:
Equity Financings. My firm’s corporate finance lawyers have been doing “priced rounds” in the form of Series A equity financings with multiple investors, as well as individual investors purchasing minority ownership interests in limited liability companies. In those states that restrict out-of-state cannabis investors, cannabis companies generally prefer to have all investors within their own state so they can do an intrastate offering for securities purposes.
Debt Financings. Cannabis companies with successful track records often prefer debt financing, as do investors who seek to avoid the exposure that comes with equity ownership. However, uncertainty on licensure processes and the timing when companies can fully operate sometimes plays havoc with loan payment schedules.
Convertible Notes. Convertible debt is traditionally used pre-Series A when a company is developing a product and still determining the size of the opportunity. A convertible note corrects for the difficulty in determining valuation at such an early stage by kicking the valuation can down the road to the Series A round, but ensuring the investor gets at least as much value (and almost always more value) for their invested dollar, compared to the Series A investor. Typically notes have low interest rates, as investors are seeking equity upon conversion, rather than by repayment.
For cannabis companies in California, convertible notes are taking on a new purpose: extending the question of valuation until 2018, when more will be known about the state’s cannabis regulatory regime. Conversion that is not automatic, but rather at the option of the investor, also gives the investor an “out” should the investor not like the political climate around cannabis in 2018.
