California cannabis financing

For cannabis companies in California, 2017 is a period when neither companies nor investors are living in the moment. In addition to all of the risk factors cannabis investors need to heed, everyone is planning for future uncertainty because of  the recent passage of MAUCRSA. The state is currently working on MAUCRSA regulations, and local governments are changing policies with what seems like every public hearing – not to mention comments from our federal leadership that seem tailor-made for cooling investment into cannabis companies (the job creators!).

At the same time, California cannabis companies need funding now to scale up their operations in anticipation of future licensure under MAUCRSA and to appease local regulators through local licensing and permitting processes. The result of all this is that our California cannabis lawyers are seeing and working on many deals involving hybrid financing structures – an element of cash investment now, and warrants, options, and convertible debt later. Each has different triggers and rights for the cannabis company and investors, but all are in essence a different form of “kicking the can down the road” to 2018.

Three big factors are driving hybridized financing in The Golden State:

1. Regulatory Uncertainty and Red Tape.

Investors inherently accept risk in any investment, but they do not enjoy reading the tea leaves on major issues that are out of the control of company and investor – any of which could pose an existential threat to their entire investment. This means investors are searching for creative ways to mitigate these risks, and risks abound in cannabis regulations that change pretty much all the time. Many cannabis investors are uncertain whether they want to cross the 20% ownership threshold to be considered an “owner” under MAUCRSA, which ultimately requires they be disclosed to and heavily vetted by California state regulators.

2. License Transfer and Corporate Structuring Issues.

California’s draft cannabis business regulations make clear that future licenses are not transferable. And many local governments are also making sure cannabis operators cannot transfer their permits or local licenses after-the-fact. Further, most existing medical cannabis operators are organized as non-profit entities pursuant to Proposition 215, and there’s an outstanding question as to whether these entities will be able to merge into for-profits once they have their state licenses under MAUCRSA, though such a move could potentially jeopardize state and local licensure altogether. Though all parties should undertake their cannabis financings with this knowledge, investors understandably still want to reduce risk by withholding some of their investment until 2018 when more of these questions will likely have been resolved by state and local governments.

3. The Size of the Opportunity.

In the last two weeks, we’ve seen the situation in Nevada where despite a 33-37% tax on all retail sales, dispensaries simply cannot keep up with demand and are selling out of supply. In the event California has a similar supply crunch, we are seeing investors in California cannabis cultivators seeking warrants or options as a “kicker” for additional upside – more equity in the event the opportunities prove even greater than anticipated.

This is not to say that investors are dictating all terms in the world of cannabis finance. Cannabis companies, too, can and do negotiate for control of the trigger points or adjustments to the future exercise price (or regulatory triggers). Some cannabis companies are choosing hybrid investment structures because they, too, want to feel out the size of the opportunities and many believe they will be able to demand much greater valuations and investment terms in 2018, once the initial dust settles on the regulatory sphere.

What are you seeing out there by way of California cannabis funding?

 

The cannabis movement has always had a benevolent streak. Many people produce and disseminate the plant to alleviate illness and suffering. Others support legalization for social justice reasons– unwinding the prison industrial complex, for example. And still others are simply interested in solving hard problems, such as the outsized environmental footprint of cannabis grows. When people of this general orientation approach our cannabis attorneys to start cannabis businesses, they often ask about “benefit company” status.

Over the past several years, most states in the U.S. have adopted benefit company statutes. Generally speaking, a benefit company is a type of corporation or limited liability company that considers its impact on society in making decisions. Sometimes, B Corps and B LLCs are said to have a “triple bottom line” which includes not just profits, but also the community and the environment. A few well known benefit companies include Patagonia and Ben & Jerry’s.

Because of the triple bottom line ethos, benefit companies do not impose a strict duty on their directors, officers, managers or members to maximize profits. This differs from a traditional corporation, where governing individuals can be exposed to shareholder litigation for failing to make decisions that maximize profits. Cannabis entrepreneurs, like business people in other industries, may find this element of benefit company status attractive.

Benefit companies may sound a bit like non-profit corporations, but they aren’t. For state and federal tax purposes, benefit companies are considered for-profit entities. They also tend to be structured no differently than for-profit companies, in terms of underlying company paper and personnel. Benefit companies do behave like non-profits in the sense that they are mission-oriented, but that’s about it.

Almost all states now accept benefit companies and follow the model B Corp legislation, which hasn’t been around all that long. As a result, the process of becoming a benefit company is fairly consistent from state to state. Some especially progressive states, like Oregon, have adopted a broader version of the benefit corporation law that allows founders to form benefit LLCs, in addition to corporations. In the Oregon cannabis industry, we have formed both kinds of companies.

In most states, forming a benefit company isn’t terribly difficult: as far as filing, it’s typically a “check the box” election that is made in the entity’s Articles of Organization (LLC) or Articles of Incorporation (corporation). It’s what comes after the election that takes some thought. The benefit company is required to adopt a third party standard to judge its efforts to accomplish a public benefit (such as the B Labs Impact Statement). Each year, the company must also draft a benefit report detailing its efforts in achieving its public benefit, and distribute the report to its owners and through its website.

Benefit companies often help owners and investors feel good about their enterprises, and, from a branding point of view, the B Lab certification is a great look. Looking back, the cannabis industry has made big strides over the past few years with respect to community integration and acceptance. Let’s see whether recreational pot businesses continue to embrace the benefit model, especially as key states like California come online in 2018.

Cannabis tax lawyer
Sweat equity: it’s complicated

When our lawyers set up legal structures for cannabis companies, the choice of legal entity is one of the most important things we must consider. Many cannabis businesses use limited liability companies. For tax purposes, an LLC is typically treated as a partnership or as a disregarded entity. In both of these cases, the tax liabilities pass through to the partner/members. However, an LLC may check-the-box to be taxed as a corporation. In that instance, the LLC is subject to tax, whereas its partner/members do not pay tax. Once an LLC is formed, the next important decision is how to fund the LLC.

In this two-part series, we will outline some of the tax traps and opportunities in the initial funding of your LLC. Part I will discuss opportunities in capitalizing your businesses with equity and creating an ownership relationship with the business. Part II will discuss opportunities and risks in funding a cannabis business using debt and creating a debtor/creditor relationship with the business.

The Benefits of Contributing Property. Generally, the contribution of “property” in exchange for a membership interest is tax-free. Members often contribute cash, land, and equipment to a cannabis business in exchange for an interest in a partnership/LLC. This is a classic tax-free contribution. What is often overlooked is that intellectual property may be property for purposes of a contribution. Industrial processes, formulae, designs and “know-how” in the right circumstances are considered property and can be contributed to a partnership tax free. However, this approach should only be taken with careful consideration, analysis and documentation.

The most straight-forward contribution is a contribution of cash in exchange for a member interest in a Partnership/LLC. A member may contribute cash in exchange for a membership interest in an LLC. Such a contribution is typically tax free under federal partnership tax law. If an LLC elects to be taxed as a C corporation, a member may contribute cash in exchange for a deemed “stock interest”. Again, such contribution is typically tax-free. Many companies start with extremely small cash contributions, like $1.00 for each member. However, there is some risk there to equity holders, since some courts have pierced the corporate veil against undercapitalized entities. Nonetheless, there is no minimum amount of cash required to form a valid partnership or corporation for tax purposes. In determining the appropriate dollar amount of contribution, a cannabis business’s founders should use common sense and good business judgement.

Sweat Equity may be Painful but is not Prohibited. Investors often can bring valuable experience and “know-how” to a cannabis business and want to contribute such “know-how” in exchange for an ownership interest in the LLC. In general, a mere promise to contribute services in exchange for a membership interest is subject to tax. This is generally considered a “capital interest” in the partnership. Capital interests are defined by the IRS as ownership interests where the member has a right immediately following the contribution, to its share of the liquidation value of the partnership/LLC. To illustrate, imagine one member contributed $1,000,000 in cash to a new company, and the other member agrees to do all the work for the company, and they split the LLC up 50/50. Even if the business doesn’t generate any revenue, the member contributing sweat equity is going to be on the hook for $500,000 on that year’s tax returns. This is because if the LLC liquidated the next day, that member would be entitled to receive the $500,000 as a liquidating distribution. Although the guidance in this area can be complex, it is based on a simple, maxim – “You can’t get something for nothing (in tax)”

One way to get around this is for a member to receive a “profit interest” instead of a a standard equity interest. A profit interest is defined as an interest where the new member would not receive any value if the partnership were to be immediately liquidated after the contribution. Note however, that this treatment has some strict limitations and requires careful drafting of an operating agreement.

In capitalizing a cannabis business, founders all bring different skills and resources to the new venture. All founders should carefully consider the mechanics of offering equity interests to each new member. As we will discuss in Part II, the use of debt financing brings additional, flexibility, risks and opportunities to funding a new cannabis venture.

Cannabis real estateHaving a bank loan on your cannabis property is usually not the greatest business plan. If you already own a property encumbered by a bank loan, commencing cannabis operations is a risky proposition. If you don’t own property but apply for a bank loan on a parcel to grow, process or sell marijuana, the banker will likely send you away in ten seconds or less. In our experience, even equipment loan offerings by small credit unions to cannabis businesses are vanishingly rare.

Because it’s so hard to get institutional financing for cannabis properties, we have facilitated many seller-carried property transactions over the past few years. Those transactions are a breeze when the seller owns the land free and clear. When the seller does not, however, things can get interesting– especially so when the transaction happens anyway. The vehicle for many of these unusual transactions is a wrap-around mortgage.

A wrap-around mortgage (a “piggy-back” or “wrap”) is a junior mortgage where a seller has one or more existing trust deeds on his or her property– typically, with a bank as beneficiary. Together, the seller and pot farmer or processor, or what-have-you, enter into a land sale contract or a promissory note and trust deed. These documents cover the full purchase price, minus whatever earnest money is agreed upon, and minus any down payment. Every month, the buyer pays the seller, and the seller pays the bank. In a classic wrap, the parties agree not to notify the bank of the transfer, although sometimes a memorandum is recorded in the public record. The laws surrounding wraps differ state by state.

Why do sellers like wraps? Because they can be lucrative, especially in the cannabis industry, where land has premium pricing. If the bank loan is at 5%, and the seller is getting 10% or 12% on a junior note, for example, a wrap can be highly profitable. Why do buyers like wraps? Sometimes, it’s the only way for a cannabis business to get a foothold on a property. The big risk here for both buyer and seller is that the bank will cite the trust deed’s “due on sale” clause, wiping out the buyer’s interest, and resulting in foreclosure for seller. With a cannabis wrap, there may be several contractual levers a bank can pull to trigger this clause: the senior mortgagor is permitting “illegal activity” on the property; the senior mortgagor has given a deed to its junior mortgagee; etc.

Wrap mortgages were prevalent in traditional, non-cannabis property loans five to seven years back, especially in residential real estate. This was due to the slowdown in real estate generally and to the scarcity of bank financing at that time. With cannabis—where bank financing is nearly impossible, still—wraps are one of several creative real estate options for entrepreneurs looking to make an industry play.

It is critical for all parties, including attorneys and realtors, to be aware that a wrap mortgage in the cannabis context often involves a seller triggering the due on sale clause in the first lender’s deed of trust. For that reason alone, we generally steer our buyer and seller clients away from wraps. Do our clients always listen? No. Many cannabis businesses and landlords are already taking on mortgage risk, or are determined to do so, by facilitating weed activity on a mortgaged property. And many take heart in the reality that banks are loathe to call loans: banks love getting paid, hate owning property and often ignore the “due on sale” remedy for convenience.

Given the above, we expect to see a continuing stream of wrap-around mortgages on cannabis properties. After all, when your core business activity involves violating federal law, a little extra business risk may not seem so bad.

For more on the unique issues involved with cannabis real estate, check out the following:

Cannabis IPO going publicWe write a lot about cannabis business fundraising here, but it’s usually in the context of private offerings. Getting investment from friends and family or by directly pitching investor funds and venture capitalists is the traditional model for most new businesses, and cannabis is no different.  More companies, however, are starting to explore the idea of public financing — which creates its own unique set of issues. Investors like the idea of public financing because it potentially provides a short-term avenue for liquidity that doesn’t exist for private companies. Companies like it because they are more likely to get the valuation they want in large public capital markets than when pitching to individual venture capitalists. I’ll write a bit here about what is involved in public capital raising, but then I will bust the balloon by mentioning some of the reasons our cannabis business lawyers generally advise against it for cannabis companies.

Any type of financing that includes a “general solicitation” can be considered a “public” issuance of securities. Publicly traded companies are often associated with famous listed exchanges like the New York Stock Exchange and NASDAQ, but a company could list its shares on Craigslist and accept orders and be considered to have essentially gone public, though we certainly would not advise doing that. The primary barrier to companies going public are securities laws. Prior to initially offering publicly available shares, a company needs to register the class of shares being sold and file an S-1 to register the individual shares available for purchase. These registrations include significant substance and formal review by the Securities Exchange Commission (SEC) before being accepted.

To date, no cannabis company that we know of has successfully gone public in the United States using that traditional route. Instead, they use something called a reverse merger. A reverse merger happens when a private company purchases a controlling interest in a public company and transfers its primary line of business to the new combined public company. The only asset the public company generally has in this scenario is that it has already gone through the registration process with the SEC — the private company is benefitting by being able to skip the regulatory step involving registration of a share class. But the company still isn’t able to issue new shares to the public before it files an S-1 to register the new individual shares it wants to sell.

That S-1 step can be very expensive and and is often why you don’t see companies do a traditional public offering in the first place. That said, companies strapped for cash can still get there. New capital is still raised on private markets through a PIPE — private placement in public equity. A PIPE is simply a private fundraising transaction from a publicly reporting company. Because there still is no registration statement, stock issued in a PIPE has to be restricted against resale on the open market and is discounted in value because of the restriction. But after a successful PIPE, a company now has some money and a registered class of securities. It can engage in broader public fundraising and allow for trading of its shares on the open market as soon as it files an S-1 that gets accepted by the SEC. And though that can be challenging, we know the SEC has accepted S-1s for cannabis companies in the past.

All of that being said, we tend to advise our clients against public markets for a few reasons. First, for those of us based in Washington State, any type of public financing is impossible. Under Washington State regulations, every single shareholder in a licensed cannabis business must be vetted by the state prior to acquiring an interest in a licensed cannabis company. Other states have similar restrictions that make public company work impossible. But even if you are in a state like Oregon or Nevada that has looser restrictions on who can own shares in your company, having owners you don’t know presents some risks. One takeaway from the Department of Justice’s 2013 Cole Memo was that federal law enforcement was (and still is) worried about legal marijuana systems being used as a front for illegal activity. Any system that allows for even partial shadow ownership of a business is more likely to run against Cole Memo priorities. A marijuana business that is fully engaged in its compliance work should do its best to ensure that none of the value it is creating and none of the profits that it is distributing are being diverted to illegal destinations.

Practically speaking, the reverse merger we just discussed still involved a private placement using a PIPE, so the company often has at least some exposure to private markets. A lot of headache could be avoided by continuing to raise capital in private markets. There are reasons most tech companies avoid going public for years. Your early stage investors are looking to get value over time when the company really takes off — they don’t necessarily need the short-term liquidity public markets can provide. And there are still many cannabis investors. If you feel like the private investment market isn’t giving you what you want, it’s worth sitting back and thinking about whether those investors are correct before dismissing them and raising money from public shareholders. The government generally lets wealthy investors take what risks they want and it doesn’t make it easy for them to sue companies when their investments go sour. But if you have public shares, the SEC and your state agencies are going to be much more protective of those shareholders.

And that brings up the last point, which is that publicly traded markets of cannabis stock are rife with fraud. Even if you are raising money publicly for completely legitimate means, being public in the cannabis space will raise red flags from regulators, the public, and federal law enforcement. If that’s not the kind of attention you want, going public will probably not be the best route for you.

Dear Californian cannabis entrepreneurs,

As you prepare to open your cannabis businesses under the MAUCRSA, perhaps with a few lifelong friends, you may be tempted to think “we’re friends, we don’t need to get the lawyers involved.” We don’t mean to be blunt, but you need to get it in writing regardless of the current camaraderie.

Cannabis contracts
Cannabis contracts. Because they make sense.

Failing to properly paper your company or your company’s transactions is a recipe for trouble in any cannabis state. In the rush to license, many Oregon and Washington State entrepreneurs skipped these vital steps. The result is that a few years after Oregon and Washington legalized recreational cannabis, we are seeing a rise in litigation among formerly friendly service contractors and marijuana businesses and especially between partners of marijuana businesses fighting over percentages, control, and responsibilities.

With the classic marijuana business ownership dispute, you have a case that makes attorneys, judges, and litigants pull their hair out. Two people start a business with the basic understanding that they are 50/50 partners. A third partner is introduced and they agree to give that person a stake but they never specify the amount of that stake nor whether the original partner shares will be equally diluted. The parties do not even know if they have entered into a binding contract. Nothing specific is in writing, but various emails and phone calls reference slightly different versions and iterations of the same deal. There is no right answer in a case like this, but everyone knows that if they do not settle, litigation will be expensive and contentious and risky.

Compare this to when a licensed marijuana business orally agrees on the basic terms for a future cannabis product transaction. We have written before about the Uniform Commercial Code (the “UCC”), which applies to transactions for the sale of goods. Though the lack of a written document in the business ownership matter (as discussed above) leads to all sorts of difficulties, in a sale of goods situation, the lack of a written contract can (but does not always) work out just fine. The default provisions in the UCC exist to protect parties with reasonable contract terms where they fail to bargain on those terms, even if there is nothing in writing. In other words, the UCC will fill in with clear-cut default provisions whatever the parties failed to agree upon. Nonetheless, having clearly worded and detailed contracts avoids any need to rely on the default provisions of the UCC, which may not be to your benefit if left ignored.

Without written agreements, these fights devolve into often intractable (and nearly always expensive) court battles over who said what and when. In many cases, these disputes would never occur if the parties could had a clearly worded set of bylaws, an operating agreement or services agreement. And if the dispute must go to litigation, it is often cheaper to argue over the meaning of a written contract, than to argue over what the parties orally agreed to in the first place.

Cannabis businesses need to take the same ordinary business steps as other business do to properly memorialize their business relationships. Please, take it from our lawyers who have operated in other highly regulated cannabis states–just get it in writing. You won’t regret it.

Sincerely,

Our Oregon and Washington cannabis lawyers

 

Oregon cannabis due diligenceWelcome to the latest installment in our series on Oregon cannabis company acquisitions. In Part I of this series, we wrote about the general deal structures these acquisitions tend to take. In Part II, we wrote about how those structures are outlined at a high level, through term sheets. Today, we offer additional details on a topic we have covered before, for purchasers: due diligence on the target company.

If you are the type of person who enjoys sifting through large stacks of files and correspondence, or more likely, wandering around online in a virtual data room, you will love due diligence. If you are not that type of person, well, you get to do it anyway. The good news is that a corporate cannabis lawyer skilled in acquisitions can start things off with a comprehensive due diligence checklist, and begin looking under rocks on your behalf. Note that the form of checklist provided will vary, depending on whether the acquisition of the cannabis company is an asset purchase agreement, stock sale, merger, or other form of agreement.

Because due diligence occurs after a term sheet is executed, but before an acquisition is final, the due diligence period is the parties’ last big chance to walk away from a deal. On several occasions over the past few years, we have spotted show-stopping issues during the due diligence period, on either side of a transaction. If the issues cannot be fixed, these deals tend to die. Other times, the due diligence period will turn up nothing remarkable at all. And that is what you want, because in the world of due diligence, turning over rocks and finding nothing is progress.

When we covered this topic in March, we wrote that too often cannabis deals involve two sides rushing to complete a transaction without having done adequate due diligence on the potential cannabis company purchase. We offered a top five of due diligence items for purchasers, including some of the big ones: state and local law compliance, state law procedures for ownership changes, corporate authority, real property, and financial liabilities. We recommend you revisit that post, and today offer five more crucial items to look for during the diligence period.

Funky financial statements. Oregon cannabis companies tend to be new companies, and businesses with three or four years worth of financial statements, or even tax returns, are almost unheard of. Many cannabis companies stuff their skinny financial statements with unreasonable assumptions, under-estimates of working capital requirements, misleading margins, etc. If you are not comfortable auditing this type of information, enlist someone who is, and do not be afraid to ask lots of questions as you attempt to read the tea leaves.

Intellectual property. In an ordinary business transaction, a purchaser will be very interested in the target’s intellectual property. In the Oregon cannabis trade, brand power is important, but formally registered IP is less common than in other businesses, given the nature of federal law. That said, do not overlook: trade secrets (particularly for cultivators and processors), state trademark filings, and licensing agreements, to start.

Sales and Clients. Before investing in or purchasing a marijuana producer, processor or wholesale business, a buyer should understand who its top 5 or 10 clients are, whether these clients (who are usually other Oregon cannabis businesses) are loyal to the company, whether their operations will cause fluctuations in company revenues (common with producer clients, for example), and other factors. This means that in addition to doing diligence on the target company, it’s worth looking into the target company’s clients, at least in a cursory way.

Contracts. Like most businesses, a cannabis business will be party to numerous material contracts; and if the target business has no contracts for review, RUN. Types of contracts worth a close look include: customer and supplier contracts, equipment leases, real estate leases and purchase agreements, employment agreements, loans and credit agreements, and non-competes. Internal company contracts are also key, beginning with charter documents like shareholder and operating agreements.

Disclosure Schedules. As a part of any large or mid-sized acquisition, the target company will prepare a disclosure schedule addressing due diligence items, and identifying any exceptions to the representations and warranties requested by the buyer. If you are a target company, this will be the most important and laborious portion of the sale: so, it’s wise to start early, involve key employees and work with an attorney. If you are the buyer, this is the document you will cross-check against everything requested in your due diligence checklist.

If you make it through this vetting period, and are satisfied with what you have seen, congrats! It’s time to close the sale.

Today closes out our five part series on “How to Open an Oregon Recreational Grow Operation” (see parts 1, 2, 3, and 4) with a discussion on canopy sizes and the medical bump-up canopy program. I also touch on Oregon’s marijuana worker permit program and discuss what you can expect after you submit your OLCC (Oregon Liquor Control Commission) license application. Remember that the law in this area has been changing rapidly, so much of what we have discussed so far is potentially subject to change.

Canopy Sizes. Your “canopy” is the part of your licensed premises that can be used to cultivate cannabis plants. In your cannabis license application you must tell the OLCC how much square footage you intend to use for cannabis cultivation, and you must clearly designate canopy areas on your site plan (see here for an example). The larger the total area, the greater your annual license fee:

  • Micro Tier I – $1,000
    • Indoor: Up to 625 sq. ft.
    • Outdoor: Up to 2,500 sq. ft.
  • Micro Tier II – $2,000
    • Indoor: 626 to 1,250 sq. ft.
    • Outdoor: 2,501 to 5,000 sq. ft.
  • Tier I – $3,759
    • Indoor: 1,251 to 5,000 sq. ft.
    • Outdoor: 5,001 to 10,000 sq. ft.
  • Tier II – $5,750
    • Indoor: 5,001 to 10,000 sq. ft.
    • Outdoor: 20,001 to 40,000 sq. ft.

It gets a bit more complicated if you have a mixed use site, but generally one foot of indoor area is equivalent to four feet of outdoor area. So, for example, a mixed-use Tier II producer could have all 10,000 indoor, a mix of 5,000 indoor/20,000 outdoor, or all 40,000 outdoor.

Oregon cannabis grow licenses
Your canopy areas do not have a height restriction, so feel free to expand vertically.

When you are deciding on your cannabis canopy limits, keep in mind that the limits apply only to mature plants, not to immature plants. You can grow as many mature plants as you can fit in your canopy areas. As there are no height restrictions, you should be thinking vertically.

Medical Bump-Up Canopy. Oregon’s legislature recently approved the “medical bump-up canopy” program, which allows recreational cannabis producers to set aside a small portion of their premises to cultivate medical cannabis. If you are interested in growing medical cannabis alongside your recreational cannabis, you can enter into a Producer-Patient Medical Canopy Agreement with up to 24 OMMP (Oregon Medical Marijuana Program) cardholding patients. These patients can reimburse you for your reasonable expenses, but you must give these patients their marijuana medicine free of charge.

Nevertheless, a medical canopy is still potentially profitable. Though you can grow up to six plants per patient, you can transfer no more than 3 pounds to a single patient in a year. This means you will likely have a surplus for each patient. The bump-up program allows you to generate some income from your medical marijuana crop by transferring up to 25% of that crop to registered producers and dispensaries.

Marijuana Worker Permit. Each of your employees must have a marijuana worker permit, including seasonal employees. Each permit costs $100 and each applicant must pass an online test and a background check. The OLCC has set up a simple website explaining the process, which includes a link to the study book.

What to Expect when the OLCC Follows Up. Once you submit your cannabis grow license application, the OLCC will conduct a preliminary review. You will likely receive a follow up letter from the OLCC identifying any deficiencies in your application you must resolve before you can obtain your grow license. To minimize delays, make sure your initial application is thorough and correct. The following are examples of issues that have come up:

  • Failing to properly identify the portion of a tax lot that will be leased to your company.
  • Including a residence within your licensed premises boundary.
  • Failing to properly label your site and floor plans, including the location of your cameras.
  • Failing to be consistent in your labels across site and floor plans.
  • Failing to provide dimensions for each structure on your property.
  • Failing to identify the materials that make up your fences/walls.
  • Failing to label each camera with a number on your security plan.

Once you are confident you have met all of your Oregon cannabis grow application requirements and you have the required documents in order, you will be ready to request an inspection. If all goes well, and you have complied with all local requirements, you will soon be a licensed recreational grow operation. Congratulations!

business-1320058_960_720Last week, I wrote on Oregon cannabis company acquisitions, and the types of deal structures these transactions tend to follow. I mentioned that before a transaction is consummated, but after discussions have commenced, the purchasing entity will typically discuss its plans with counsel. The lawyer will then draft a letter of intent or a term sheet to present to the target company. If the target company accepts outright, the transaction will proceed. If the target company does not accept outright (more common), it will submit proposed revisions.

Term sheets take many forms, but in a basic sense a term sheet describes the terms of the acquisition at hand. Because each transaction is a snowflake, each term sheet is also unique and must be carefully considered and prepared. Sometimes, the parties will skip the term sheet and simply proceed to the transaction in an attempt at “efficiency.” We strongly advise against this: it invites a substantial risk of misunderstanding as to which documents will follow, and when, and may even cause confusion as to deal points themselves.

Here is a basic list of items for inclusion in any term sheet for an Oregon cannabis company acquisition:

Binding vs. non-binding provisions. As a general concept, a well written term sheet will be organized by binding and non-binding provisions. The binding provisions will include items like non-disclosure, exclusivity, jurisdiction, and choice of law. The non-binding provisions will include the unique deal point items, such as purchase price, payment terms and collateral agreements (e.g. consulting agreement, non-compete, lease or land sale contract, etc.). When a non-binding provision is misplaced into the “binding” category, or vice versa, both buyer and seller can expose themselves to serious legal risk.

Nature of acquisition. The term sheet should clearly lay out whether the transaction is an asset sale, stock sale or merger, and whether the purchase price will be paid via cash, debt, equity swap, or other method. This portion of the document should also detail whether the buyer will proceed in its own name, or through a newly created entity.

Liabilities. In nearly all acquisitions, the purchaser will assume certain liabilities of the seller. These liabilities may include everything under the sun related to seller, or liabilities may be limited to select items, like assignable contracts. If specific liabilities are known at term sheet preparation, they should be listed, perhaps on a separate schedule.

Indemnification. Limitations on both seller and buyer liability can be a heavily negotiated portion of any term sheet. The term sheet should deal with any potential claim that may arise out of the parties’ pending agreements. It should also address claims existing prior to the transaction, the possibility of breaches of representations and warranties, issues of title to assets, tax obligations, employee benefits, claims arising out of marijuana’s status as a controlled substance, etc.

Employment agreements. Every term sheet should deal with the seller’s employees. Will they stay, or will the seller be required to fire them? What happens with regular employees versus executives? When can employees be apprised of the transaction? Failure to address employment can cause serious headaches for both parties.

Conditions to closing (contingencies). This list may be long and varied, and include items from the acquisition of third-party financing, to approvals by the shareholders and/or directors of the purchasing and selling entity. The satisfactory completion of due diligence by the parties is always a crucial item, and in the cannabis context, licensing (see below) is a critical issue.

Marijuana licensing. Like other adult use states, Oregon requires its cannabis companies to maintain state licensure. In certain areas, a local license may also be required. The administrative protocol for changes in license ownership can be complex and time-consuming, and may take on a unique character, depending on the type of acquisition. The licensing update or transfer protocol must be carefully thought through and delineated in the term sheet.

If you made it this far, congratulations; but please note that the above list is not at all exhaustive. There are many nuances to a letter of intent or term sheet beyond the deal points highlighted here. Once a term sheet is negotiated and signed, the parties can move into the formal due diligence phase mentioned above, and ultimately, to closing.

Cannabis ComplianceWe have previously written about the need for cannabis businesses to systematize their policies and procedures. See Improving Systems and Structures for Cannabis Business Expansion and Understanding and Managing Cannabis Legal Compliance: No Excuses. Marijuana businesses are not standard startups — they are highly regulated and need to act like it from day one. But there is one thing worse than not having systematic procedures in place across your cannabis business — having systems in place but ignoring them.

For example, look at the employment side of the cannabis industry. Many cannabis businesses understand the need to have an employment policy manual, so they find a nice template online, find and replace some words, and adopt it themselves. Other businesses are savvier and work with attorneys or HR professionals to create professionally tailored employment policies. In both circumstances, that manual may include references to things like “performance management plans” or “performance improvement plans.” The plans can have step by step procedures for what happens in the case of employee performance problems. They often include a multi-step process for performance correction, review notes in the employee file, interim sanctions, and finally termination. But life moves fast, and it’s often easiest for business managers to talk to employees on the fly. Let’s say that an employee is consistently late. Instead of going through the formal process, the employer makes a couple of corrective comments, and then terminates the employee when the poor performance continues.

If a disgruntled former employee brings a complaint for wrongful termination, that employee’s case is immensely improved if she/he can show the employer did not comply with the employer’s written policies and procedures. At-will employees are still protected against termination for certain reasons. You can’t fire someone for reporting discrimination, for taking protected leave, and for several other reasons. Even if you had a good reason for the termination, if the former employee can connect the termination to a protected scenario, the employer’s lack of compliance with its own policies and procedures can be the kiss of death.

But employment isn’t the only area where this is important. We advise marijuana businesses to have compliance programs in place. Let’s say your written compliance program includes a weekly audit of your on-site security cameras and alarms to make sure they are all working. State laws often provide for penalty mitigation or even penalty waivers when companies act in accord with written compliance programs. But to get that mitigation or those waivers, you need to be able to document that you actually complied with your written procedures. In fact, if you submitted your written compliance program to the state as part of the licensing process, your noncompliance with that written compliance program can actually be considered an independent regulatory violation.

So what does this all mean? Written policies and procedures are vitally important for highly regulated businesses and any business looking to grow beyond a single location. But written procedures are not about putting in place a program that looks good on paper but is never really implemented. Your compliance programs for your cannabis business should be written and tailored so that the standard procedures set forth within them are achievable by your company’s management and staff. And once you have an achievable system in place, it is likewise supremely important that your company abide by it and stick with it. If you have written procedures and you find that you aren’t doing a good job complying with them, you need to either adjust your actions, adjust the procedures, or both. Otherwise, you will run into a host of problems.