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4 Things You Need to Know Before Investing in a Cannabis Business

Now that the cannabis green rush has cooled more patient investors are considering diving in.  While investing in a cannabis company has many similarities to other industries there are a few unique aspects that investors should be aware of.

Disclosure of investor information

Investing in most private companies does not give rise to any disclosure obligations.  Cannabis is different.  Depending on the jurisdiction and size of investment, the investor may be required to provide a livescan, and copy of driver’s license and social security card to city and state regulators.  Once the city and state receive this information it will be added to licensee’s webpage for anyone to see. 

The public nature of this can be a problem for investment funds, professional athletes and anyone in a regulated industry that has restrictions on cannabis use or investment.  To make matters worse some jurisdictions, like California, will require legal entities to provide ownership information down to an individual level.

Existence of federal and state tax liabilities

Many smaller businesses have some unresolved tax liabilities.  Cannabis companies, however, tend to have huge tax liabilities on the order of 7 figures.  This is caused by a combination of not filing federal returns, using inexperienced CPAs, and blind optimism.  The end result is that any thorough analysis of past tax filings will reveal serious problems and liabilities. 

Not only do these liabilities cause problems on a sale event but they can cripple the business if the IRS conducts an audit.  IRS audits in the cannabis space almost always result in the cannabis company having unpaid taxes plus penalties and interest which add up very quickly because they are imposed from the time the monies should have been paid. 

Verifying dual license status

Cannabis firms typically have a city license from the city they operate in and a state license for the categories of activities they are engaged in.  Investors need to verify the current status of both licenses. 

Verification is made harder because in some jurisdictions nobody has an annual license there are only temporary or provisional licenses.  A best practice is to ask the licensee for copies of all correspondence with the city and state over some period of time.  This information will allow the investor to confirm the license status and gauge the likelihood of future problems. 

Performing a background search on the principals and majority shareholders

Very few private companies conduct background checks on their key persons.  Outside of the cannabis industry, the personal legal and financial problems of management are usually an irritation at most. 

Since cannabis companies often have continuing reporting obligations to regulators with respect to control persons (management and majority owners) investors are well served to examine the background of these key persons. 

Reportable events include things like criminal convictions, civil penalties or judgments, and administrative orders or civil judgments for violations of labor standards.  Any one of these events might jeopardize the cannabis license if the person involved is not removed from control.  Failure to report any such event could also result in fines or administrative proceedings against the license.  For all of these reasons investors need to have a comfort level with the background of key persons before investing.