Colorado’s Restrictive Recreational Cannabis Rules Limiting Business Investments

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An event held by The ArcView Group in Denver this week is expected to result in more than $1 million in deals between investors and cannabis companies from around the country when the dust settles.

But the total could have been higher – perhaps significantly so – if it weren’t for Colorado’s restrictive rules on investments in the marijuana industry.

Under the state’s newly established adult-use marijuana regulations, investors must be residents for several years to participate in equity financing deals with companies that handle cannabis, such as retail stores, growing operations and infused-products manufacturers. The rules cover debt-to-equity deals as well, meaning out-of-state investors interested in these types of companies are pretty much limited to loans.

That’s stemming the tide of investment dollars flowing into Colorado – one of the hottest cannabis markets in the country after the passage of Amendment 64 last November.

As a result, many Colorado businesses planning to tap the recreational market will have to primarily rely on in-state investors, debt financing, funding from family and friends, and their own savings.

ArcView’s recent meeting highlights the difficulties facing both investors and businesses that want to sell or grow marijuana for recreational use. At least one potential deal resulting from the ArcView meeting went up in smoke because it involved an out-of-state investor and a Colorado company that handles cannabis, while numerous investors without residency have indicated they would likely pursue similar equity deals if they could.

“Unless they want to invest in ancillary businesses, they’re kind of shut out of the Colorado market,” said ArcView CEO Troy Dayton.

California-based ArcView previously only focused on those ancillary companies, or businesses that provide products and services tied to marijuana but don’t actually touch the plant. It has since broadened its focus, and the Denver event marked the first time it fielded pitches from businesses that sell or grow cannabis (including two dispensaries in Colorado that plan to tap the recreational market).

The strict rules in Colorado mean that more investment dollars could flow into Washington – the other state to legalize marijuana for adult use. Under Washington’s rules, investors need to be residents for just three months to fund cannabis companies.

While Washington might offer bigger opportunities for investors – equity deals can yield much more than debt-based investments – it also carries higher risks, Dayton and other experts said. The state’s cannabis market is not as mature, professional or advanced as Colorado’s, given that there are no statewide regulations on the medical marijuana industry.

In Colorado, medical marijuana businesses – which already operate under a host of strict rules and therefore should ease into the adult-use market – will get a sizable head start to open retail stores and grow operations.

So some investors might be more willing to take a smaller (yet still impressive) potential return by loaning money to Colorado businesses rather than take on the risks in Washington. After all, rates on business loans can hit 25% in the medical marijuana industry, so debt financing isn’t a bad way to go.

Still, businesses that handle marijuana in Colorado could have a tougher time in general raising money than their counterparts in Washington, especially those seeking large sums. While they’ll still be able to land loans from out-of-state investors – and enter into equity deals with locals – they’ll be missing out on a big chunk of the available money.

“I think that a lot of these establishments will have a tough time getting all the financing they need from Colorado,” Dayton said. “Everybody we talk to is expanding, looking to build out or move into a new spot as they get ready for (adult-use) sales in January. Many are will be profitable enough to self-finance, but a lot won’t. The states that are more open on this end will wind up getting a lot more investments.”

Free-flowing – and ample – investment dollars bring other benefits as well.

“When a business is better capitalized, it follows the rules better, and there’s less need to cut corners,” Dayton said.