On the Fringe of California Cannabis Investing: Avoiding “Ownership” and “Financial Interests”

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Passage of California’s Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA“) has opened the doors to institutional investing in California cannabis companies. California’s lack of a residency requirement for investors and its relatively limited investor disclosure and background requirements have made it popular for institutional investors looking to invest in cannabis. In that sense, California is building out its program to mirror wide-open states like Oregon, and not protective states like Washington.

There are two main types of California cannabis applicants: owners and financial interest holders. To be legally considered an “owner” under California’s cannabis regulations, one does not actually need equity in the applicant’s cannabis business. “Owner” means any of the following:

  1. A person with an aggregate ownership interest of 20 percent or more in the person applying for a license or a licensee, unless the interest is solely a security, lien, encumbrance;
  2. the chief executive officer of a nonprofit or other entity;
  3. a member of the board of directors of a nonprofit; and
  4. and any individual who will be participating in the direction, control, or management of the person applying for a license.

An individual who directs, controls, or manages the business includes any of the following: a partner of a commercial cannabis business that is organized as a partnership; a member of a limited liability company of a commercial cannabis business that is organized as a limited liability company; and an officer or director of a commercial cannabis business that is organized as a corporation. These are all fairly standard definitions, as far as cannabis regulation goes.

Even if someone is not an “owner,” however, that person or company may still be deemed a financial interest holder (“FIH”). “Financial interest” is broadly defined to mean “an investment into a commercial cannabis business, a loan provided to a commercial cannabis business, or any other ‘equity interest’ in a commercial cannabis business.” California cannabis regulators consider the term “equity interest” to include less than a 20% ownership in the cannabis applicant and pretty much any profit-sharing arrangement or entitlement to profits from cannabis licensee, including IP licensing royalties and percentage rent arrangements. The following are not considered FIHs: banks and financial institutions; diversified mutual funds, blind trusts or similar instruments; holders of security interests, liens, or encumbrances on property that will be used by the commercial cannabis business; and individuals holding less than 5 percent of the total shares in a publicly traded company.

California requires FIHs be disclosed to and vetted by the state upon application for annual cannabis licenses. The license applicant must provide a complete list of all financing it receives. Specifically, the license application mandates that applicants include the name, birthdate, and government-issued identification type and number (i.e., driver’s license) for any individual with a financial interest in a commercial cannabis business. FIHs are not required to submit to criminal background checks but they will still undergo some vetting by state regulators.

Even with these new rules, most institutional investment in the cannabis space is still concentrated in “ancillary services“, i.e. services that support cannabis businesses but do not “touch the plant.” Examples include turnkey real estateequipment and materials leasing and salesintellectual property licensing, consulting services, and tech platforms. Many institutional investors still want to stay one or two steps removed from touch-the-plant cannabis businesses and do not like the idea of being listed in a state database as being an owner or FIH. However, given California’s wide-reaching definition of owner and FIH, even these companies and their investors can be deemed by the state to have a direct cannabis business interest. To avoid being considered owners or FIHs in California, ancillary service providers will need to avoid directly providing financing, using profit-sharing or similar performance-based payment schemes with cannabis businesses. They will also need to avoid managing, directing, or controlling the licensed entity.

Editor’s Note: A version of this post originally appeared in an Above the Law column, also by Hilary Bricken.

Source: https://www.cannalawblog.com/on-the-fringe-of-california-cannabis-investing-avoiding-ownership-and-financial-interests/

 

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