Marijuana

Going Green: Marijuana Startup Financing Trends

How are cannabis startup investments usually structured?

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umbrella weed rainMy 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.

A slight variation on a convertible note is a “debtquity” arrangement where an investor provides the cannabis business a line of credit with a sliding scale of equity issuance based on the amount of capital accessed.

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Alternative Financing Arrangements. Cannabis companies are proposing some non-traditional financing structures, such as investment via equipment leases, consulting arrangements, turn-key real estate, or investor-funded capital improvements. These are often a product of investor preferences or investor residency restrictions. Though these alternative financing arrangements are sometimes trickier for the lawyers to structure than traditional investments, they often are a good way to provide cannabis companies with key resources needed at an early stage.

Hilary Bricken bio photoHilary Bricken is an attorney at Harris Bricken, PLLC in Seattle, and she chairs the firm’s Canna Law Group. Her practice consists of representing marijuana businesses of all sizes in multiple states on matters relating to licensing, corporate formation and contracts, commercial litigation, and intellectual property. Named one of the 100 most influential people in the cannabis industry in 2014, Hilary is also lead editor of the Canna Law Blog. You can reach her by email at [email protected].

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