Raising capital is a challenging and often risky endeavor for any startup. However, when it comes to the cannabis industry, these risks are magnified due to the complex web of regulations that businesses must navigate. Cannabis companies face unique challenges as they work to attract investment while contending with inconsistencies between federal laws and the laws of over 40 states where cannabis is legal in some form. For investors and business owners alike, understanding these risks and developing effective strategies is crucial.
Key Considerations for Cannabis Startups
1. Forming a Corporate Entity
The first step in raising capital for any business is forming a corporate entity, and cannabis companies are no exception. While the process of entity formation is straightforward, it’s essential that it’s done properly. Engaging with a reputable attorney is often a better choice than relying on low-cost online services. This initial investment can help you avoid costly legal issues down the road. Entrepreneurs who approach the cannabis industry with a clear understanding and a solid business plan tend to have better odds of success, whether they’re working with marijuana or hemp.
2. Identifying Potential Investors
Once the corporate entity is in place, the next step is determining how you’ll raise capital. Are you seeking investment from friends and family, or are you looking to bring in a broader pool of investors? This decision significantly impacts the amount of legal paperwork and financial disclosure required. In the U.S., securities laws mandate that companies seeking capital disclose detailed information about their business practices and risks to investors. In the case of cannabis companies, this includes acknowledging the ongoing federal prohibition on marijuana and certain hemp products, despite state-level legalization in many regions.
The level of disclosure varies depending on the type of investor. If you’re dealing with friends, family, or accredited investors, your disclosure obligations are typically less stringent. However, for a broader pool of potential investors who may be attracted to the cannabis sector for its perceived profitability, full and transparent disclosures are necessary to minimize future legal risks.
3. Disclosure and Legal Obligations
Whether you’re raising capital from familiar faces or external investors, the goal is to ensure that all disclosures are comprehensive and legally sound. Investors must be aware of the risks, particularly the possibility of losing their investment if the business doesn’t succeed. Proper risk disclosures protect both the cannabis company and the investors by making the risks clear upfront. If done correctly, these disclosures can provide legal protection should the investment not yield the expected returns.
For businesses already operating, seeking additional capital follows similar rules, though with the added layer of sharing past performance data. Companies that have already launched will need to update their disclosures to reflect any changes in the business, particularly with ongoing legal updates in cannabis regulations across the country.
4. Strategic Investors and Capital Expansion
For cannabis companies that are already operational, additional capital may be needed to scale operations or expand into new markets. This could involve taking on strategic investors who bring not only financial resources but also industry expertise. However, expanding capital raises requires more detailed disclosures and often a more complex legal process, particularly when dealing with investors who might not be as familiar with the intricacies of the cannabis industry.
The Takeaway: Minimize Risk with Expert Legal Guidance
Raising capital is an essential part of growing a cannabis business, but it is not without its risks. For cannabis operators, particularly those new to the process or unfamiliar with the complex legal landscape, it is advisable to seek professional legal guidance. Lawyers can ensure that all regulatory requirements are met, protect businesses from potential pitfalls, and provide a solid framework for managing investor relationships.
Though cannabis entrepreneurs may have a higher risk tolerance, the process of raising capital requires careful attention to detail. By getting the legal aspects right from the start, you will be better prepared to handle the inevitable challenges that arise and minimize the risks of future legal complications.
