The cannabis industry has a corporate governance problem. It is a topic that legal analysts have discussed at length, and yet it continues to be an area that is especially important to emerging cannabis companies and mature cannabis companies alike.
In the world of startups and emerging companies, it is not uncommon to see founders sacrifice best corporate governance practices in an effort to become established faster and build their market presence. Early investors and shareholders are often tolerant of governance shortcomings as companies focus their energy on growth and market-share. After all, the consequences of lacking sufficient corporate governance controls are not always a clear deterrent in the early stages of a closely held company. However, many cannabis companies do not have the luxury of a normal growth period, with time to mature and adopt normal governance policies. With stringent (and ever-changing) regulatory requirements, and an ongoing demand for transparency, cannabis companies can avoid headaches (and potentially worse) by implementing strong corporate governance practices early on.
When it comes to corporate governance, best practices suggest that, among other things, (i) boards (whether board of directors or board of managers) should consist of diverse and independent members, (ii) management and boards should maintain independence from one another, with preferably minimal overlap, and (iii) conflicts of interest (whether actual or perceived) should be avoided and/or properly vetted when they arise. These areas become even more critical in cannabis companies, where principals often invest across multiple operations and undisclosed conflicts (whether real or perceived) or interested transactions can lead to disastrous results, including regulatory actions or licensure issues.
In February 2019, we saw what can happen to a company when it lacks the proper governance controls. The CEO and director of Toronto-based Namaste Technologies approved several transactions, including a sale of its U.S. subsidiary, in which the CEO’s beneficial interest was not properly disclosed. This led to the company firing its CEO and commencing legal action against him for damages and disgorgement of profits in connection with what was alleged to be self-interested transactions. This is an extreme example of what can happen when appropriate controls are not in place, but certainly not an isolated one.
More common examples include founders promising equity or stock options to employees or advisors, sometimes just verbally, which can lead to costly arguments down the road. Likewise, commercial relationships may be done with a handshake deal, or corporate restructurings done without proper documentation, each of which can result in expensive corporate clean-ups. Or, the Company undertakes some action without proper authorization (whether from its board or shareholders).
As the cannabis industry continues to mature, it is critical that such companies begin focusing on strong corporate governance practices from the start. An initial step should be reviewing the corporate governing documents of the company—such as the bylaws or operating agreement – to ensure that the Company properly and consistently operates within the structure established by such governing documents and all required steps are taken to approve actions that might require either board or shareholder approval.