Cannabusiness Advisory

Raising Capital in the Cannabis Industry: Fundraising Dos and Don’ts

January 15, 2020

   

 

Last year proved challenging for companies seeking to raise capital in the cannabis industry. The capital markets tightened and available funding dried up. Many of the industry’s publicly traded companies saw precipitous declines in valuations. Although fundraising efforts in the current environment still face genuine hurdles, there is cause for optimism that 2020 can be a banner year for companies seeking to raise capital in the industry.

It hasn’t been all doom and gloom for the industry’s capital raising efforts. In fact, venture capital firms invested almost $2 billion in U.S.-based cannabis startups alone through the first three quarters of last year – more than doubling the $835 million venture-backed investments in all of 2018. However, those taking a “glass half empty” view will focus on the decline in total funding from $967.1 million in the second quarter of 2019 to $452.8 million in the third quarter of the year.

With a hopeful eye toward further industry growth, this is the first installment of a series of posts that will discuss some of the important “fundraising dos and don’ts.”  While the volatility of many of the sector’s publicly traded companies has garnered the lion’s share of media attention, this series will focus largely on considerations for private cannabis companies seeking to raise capital from prospective investors.

To that end, this series will discuss key issues for companies to consider when raising capital, including:

  • Investor qualifications (e.g., “accredited investors under Rule 501 of Regulation D);
  • Private placement offering exemptions from registration under federal securities laws and state Blue Sky Laws;
  • Using intermediaries to solicit prospective investors (e.g., broker-dealers vs. unregistered “finders”); and
  • Risk factors and material disclosures in an issuer’s offering materials.

Legal compliance is particularly important for companies in the cannabis industry that seek to raise capital. Not only is this a highly regulated industry, but offers and sales of securities of companies within the industry are generally subject to enhanced scrutiny by state and federal securities regulators.

In September 2018, the U.S. Securities and Exchange Commission posted an alert posted on its website to warn investors about the risk of fraud marijuana investments.  The alert also states that the SEC “regularly receives complaints about marijuana-related investments, and the SEC continues to bring enforcement actions in this area.”

State regulators are also paying attention. For example, in Massachusetts, Secretary of the Commonwealth William F. Galvin announced in June 2019 that the state’s Securities Division was launching an inquiry into businesses raising money through investments in the state’s cannabis industry. Galvin stated that the “Securities Division intends to scrutinize these offerings to proactively prevent investor harm.” Significantly, Galvin highlighted investor disclosures as a central concern. Other states, such as Colorado, have also issued marijuana-investment related warnings.

Unsurprisingly, state securities enforcement divisions in Massachusetts, Colorado, among other states, have vigorously pursued enforcement actions against cannabis issuers, investment advisers, and broker-dealers, for alleged securities violations.  Examples of these alleged violations include:

  • Untrue statements of material facts or omissions contained in an issuer’s offering documents;
  • Fraud;
  • The offer and sale of unregistered securities;
  • Improper sales of securities to non-accredited investors; and
  • Use of unregistered broker-dealers, investment advisers, or their unlicensed representatives.

With all of this as a backdrop, companies raising capital in the industry are clearly navigating a potential regulatory minefield. Any company planning to engage in fundraising efforts – especially in the cannabis industry – would be well advised to proceed with caution by taking the necessary steps to ensure strict legal and securities regulatory compliance.

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