Colorado Easing Rules on Out-of-State Investments in Cannabis Companies – With Some Big Caveats

marijauna investments

Note: This story has been updated and clarified, as Marijuana Business Daily initially received incorrect and incomplete information from the sponsor of the investment bill. See full clarification at end of story.

By John Schroyer

Colorado is finally loosening rules for out-of-state investors interested in its booming marijuana industry, which could lead to a flood of new capital for dispensaries, retail stores, grow sites and infused products companies down the road.

State lawmakers have approved a measure directing the Marijuana Enforcement Division to set up a process for investors who don’t live in Colorado but plan on gaining residency to cement “contingency” financing agreements with licensed medical and recreational cannabis businesses.

Once the governor signs off on the bill as expected, officials will have until Jan. 1 to craft specific regulations on investments coming from other states.

Aside from providing Colorado’s marijuana industry with new sources of capital, the law will give investors nationwide a chance to tap into one of the hottest cannabis markets in the country.

There are a few significant caveats, though, and many details still need to be ironed out.

According to Rep. Dan Pabon, who was the primary sponsor of the bill in the state House of Representatives, investors can’t simply fork over cash to marijuana companies without living in Colorado for at least two years and clearing a background check.

But what they can do is sign an option agreement for future financing, he said.

That would basically equate to an intent to invest after the background check is done and the two-year residency requirement is satisfied, according to Pabon’s interpretation of the measure.

Granted, he said, that may not add up to huge investment opportunities right away for Colorado cannabis companies. But the industry is so promising that he believes it could make a big difference for marijuana firms looking for capital.

“Only the market will tell. But the investment and (return on investment) opportunities are enormous,” Pabon said.

The bill also still stipulates that only individuals – not corporations – can invest capital in Colorado marijuana companies, and state residents must maintain direct control over the businesses. Foreign investors will still be prohibited from pumping money into cannabis-touching firms.

Lobbyist Shawn Coleman, who helped shepherd the bill through the legislative process, said that investors could alternatively offer cannabis companies a loan, and then either structure a repayment plan however they want or wait for lawmakers to revisit the two-year requirement in next year’s session.

“The operative fine print is, ‘At the point at which the person becomes suitable for licensure,’” Coleman said. “Let’s say my background check was super-fast. Money could change hands Jan. 2, 2016. I just can’t make that equity until I’m suitable for licensure.”

And licensure includes the two-year residency requirement.

It’s also worth noting that it’s always been legal for Colorado marijuana companies to get loans from out-of-state financiers, it’s just that those loans aren’t allowed to be converted into equity.

The original bill as introduced would have been much broader and made it much easier for out of state investors to get involved in Colorado’s market. But because of technicalities with the state’s tax law, that approach turned out not to be as feasible as backers originally hoped. So they had to stick with the two-year residency requirement – at least for now.

Both Coleman and Pabon indicated they believe the issue will come up again, and it’s likely that at the very least policymakers will tackle the matter in 2016 and try to further open up Colorado for further investing.

And while investors and individuals who want to offer sizable loans to cannabis companies wait, they could also lobby policymakers to change the law, Coleman added.

Still, the change could spur millions of dollars in direct investments in Colorado cannabis firms, said Patrick Rea, co-founder of CanopyBoulder, a marijuana-focused business accelerator.

Rea said he knows personally of several companies that spent money on lobbyists to get the bill passed.

“It brings up Colorado to more of a level playing field with other states that don’t have that restrictive investment rule,” Rea said. “Business operators were looking at it as a way to increase their access to capital, for expansion. That’s how they viewed it primarily.”

The potential influx of capital could help a number of companies struggling with the high cost of overhead, Rea said, such as infused product manufacturers that have to spend cash on production machines.

“Machinery is very expensive. So that will spur on further investment in Colorado, to expand the infused products market,” Rea pointed out.

The bill could also lead to more chains and consolidation, he suggested.

“We’re starting to see the early stages of consolidation developing,” Rea said. “A year ago, there weren’t chains of eight, 10, 15, 20 stores. Now you’re starting to see those chains proliferate. And having the financial resources for some top-level operators to drive that consolidation will be good for the market and increase the quality of the dispensary operations in Colorado.”

Perhaps ironically, however, the switch wasn’t intended as a benefit for the marijuana industry, but rather as a watchdog regulation.

“What we discovered is there are many businesses that are using many of the devices we listed in our bill… and setting them up in a way that essentially allows out-of-state money to be invested in these Colorado dispensaries right now, but sort of through a backdoor, almost loophole kind of way,” Pabon said. “It’s a transparency measure of the greatest kind.”

Rea said many marijuana companies have worked around the in-state residency requirement to raise capital by getting investors to back holding companies that own intellectual property rights to various cannabis endeavors. But Pabon’s bill makes things easier for such companies by eliminating the need for such steps.

Gov. John Hickenlooper has not yet signed the measure into law, but a spokeswoman confirmed that he is planning to, and it’s just a question of when. Pabon said he expected the bill to get Hickenlooper’s support because it was intended as a step towards financial transparency.

“This aligns with our vision that marijuana should stay out of the hands of criminals and cartels, and this goes a long way to making sure we have background checks on every type of investor,” Pabon said.

John Schroyer can be reached at johns@mjbizmedia.com

Note: The original version of this story implied that out-of-state investors will be allowed to fund cannabis companies in Colorado without restrictions, which was based on information state Rep. Dan Pabon provided to Marijuana Business Daily. Pabon later said he was mistaken and that out-of-state investors will need to comply with various requirements to actually fund and purchase equity in Colorado companies, including a two-year residency rule.