Most of the cannabis business clients hire us with at least a vague understanding of what they want to get out of the representation. Whether it is for trademark registrations, corporate drafting, or a legal compliance audit, they understand enough about the law to know what help they need. Businesses and individuals involved in fundraising transactions often come to us without having any real clue about the securities law concerns. This makes sense as securities law is a challenging, complex, often misunderstood area of law, even by lawyers.
This post is intended to give a quick idea of when securities law issues may arise in your transactions so that you will better know when you need securities law help.
Federal and state securities laws are intended to protect investors. The need to protect investors became starkly apparent after the 1929 stock left so many investors penniless. Federal securities acts were passed in 1933 and 1934, with the express goal of making sure that investors receive full and fair disclosures from businesses before they invest. If investors have good information, we as a society are okay with their taking on the risk of an investment. But investors who have been lied to or not provided with enough information to understand fully the risks of their financial contributions have been provided with several legal avenues they can pursue against the company or individual that sold them the securities. In addition to federal securities laws, most states have passed their own securities laws, known as blue sky laws because they seek to protect investors against “speculative schemes which have no more basis than so many feet of ‘blue sky.’”
When working on anything investment-related, the first question is always whether it involves a security. What is a security? The federal definition and statute can be found here, and an example of a state law definition can be found here. In brief, securities are things like corporate stock, llc membership units, corporate bonds, etc. They are intangible rights to profit-sharing payments or guaranteed debt payments granted by businesses in exchange for money that the business takes in to grow or expand its operations. This is a very rough and simplistic description of a complicated issue, so rely on the text of the laws themselves and on your legal counsel’s assessment of those laws.
Securities laws are generally written so as to require that a securities offering have a huge, substantial registration and information filing unless it comes under one of many exceptions. The majority of securities offerings, especially those from small businesses, are exempt from those sorts of massive formal filings, but even those that are exempt typically require notice-type state and federal filings. And even those involving a transaction that does not require government registrations or notices still usually need to make certain specific informational disclosures to investors about the business before being able to engage in raising money.
At minimum, every business (cannabis or otherwise) that seeks to raise money through either a debt or an equity offering must inform its investors of its basic business plan, what it intends to do with the capital it is raising, its financial projections (including expected return window for the investor), and a list of risk factors that may lead the business to be unable to repay the investor. These risk factors are key, and they need to be drafted by securities counsel. They are not boilerplate, as each business has its own risks. They look scary and are the types of statements that should ward away risk-averse investors. That is sort of the point, as risk-averse people should not be investing their funds into private companies, an inherently risky proposition.
For cannabis businesses, the risk factors look even scarier. They will say things like: “the federal government may raid us, seize all of our equipment and inventory, and arrest all of our employees, officers, and investors, including you.” Companies are not supposed to downplay the risks of the investment. It may seem counterintuitive, but notifying investors at the outset of the full extent of their risks is what provides the company with legal protection. If the company ends registrations not being able to pay back its investors, it needs to be able to say that the investor knew all of the risks and knew that its investment was anything but guaranteed.
Sales of stock among investors also have securities laws implications, especially of company stock issued in a non-registered offering. Take a look at the SEC’s description of this issue.
Cannabis companies are hot commodities in the small business investment world right now. Many cannabis companies are desperate for capital and many investors see the cannabis industry as “the next big thing.” Be wary of any company looking for investment that is unwilling to disclose fully the risks of that investment or that in any other way fails to comply with applicable securities laws.