By Khurshid Khoja
This is the first column in a two-part series
As the ongoing federal crackdown of dispensaries and cultivators erodes the medical cannabis industry’s base, the impacts have rippled throughout the industry. Ancillary companies — such as agricultural supply firms, human resource institutes, technology providers and other businesses providing legal goods and services to collectives — have been hit hard.
But recent federal legislation called the Jumpstarting Our Business Start-up (JOBS) Act may at least ease the regulatory burden on ancillary business startups and early-stage MMJ companies seeking investment capital. Ancillary companies knowledgeable about the resulting opportunities will be poised to succeed once scores of new MMJ businesses open in Arizona, New Jersey, Rhode Island, Vermont and Washington DC.
President Obama signed the JOBS Act into law on April 5, 2012, with bipartisan support, providing entrepreneurs with new tools to raise investment money. Some have criticized the legislation as a move to deregulate small and mid-sized private companies by exempting them from public disclosure and reporting requirements that the Securities and Exchange Commission (SEC) previously imposed on companies with far fewer assets and shareholders. Others have noted that its provisions undercut investor protections built into existing federal securities laws regulating public and private stock offerings.
Regardless, most ancillary companies won’t reap any immediate benefits from these controversial provisions, given their current market cap and shareholder base. That said, there are two specific features of the JOBS Act that could spur the development of ancillary companies by easing regulatory burdens on businesses seeking capital: the Crowdfund Act and the relaxation of rules against advertising private securities offerings.
Small Investments Add Up
Since the birth of the social media age, many startups have explored using the Internet as a platform to raise capital through small contributions from a large number of individuals, also known as “crowdfunding.” Until the passage of the Crowdfund Act, stock offerings funded in this way were unlawful — unless the issuing company first took on the expense and burden of registering with the SEC and complying with the agency’s disclosure and reporting rules.
Traditional registration exemptions were unavailable to such issuers due to the large number of unsophisticated, “unaccredited” investors potentially involved in a crowdfunded deal. The Crowdfund Act essentially exempts crowdfunded offerings from SEC registration requirements (subject to certain conditions) — providing crowdfunded offerings the same registration exemptions previously reserved for larger offerings of securities made to high net worth, “accredited” investors.
The new crowdfunding exemption will permit private companies to raise limited sums from an unlimited number of investors, each investing small amounts. The amount that can be raised is limited to $1 million during any 12-month period, and that includes amounts raised by means other than the crowdfunding exemption. Companies can sell equity shares to any number of investors, but only in amounts ranging from $2,000 to $100,000 (depending on the investor’s annual income or net worth).
Lastly, the offering must be made through a registered broker-dealer or through “funding portals” — newly created, SEC-regulated intermediaries using Internet-based fundraising platforms. Though early advocates of the Crowdfund Act had hoped that such funding portals would resemble existing crowdfunding platforms, these regulated portals bear little resemblance to Kickstarter.com and other crowdfunding pioneers due to the additional investor protections added by the Senate.
Don’t Try This at Home . . . Yet.
So what does all of this mean for the medical marijuana industry? It will allow ancillary MMJ companies and entrepreneurs to raise money from a deeper pool of investors, from wealthy individuals and personal friends to industry advocates, cannabis patients and even strangers looking to capitalize on medical marijuana opportunities.
But while the prospect of raising investment capital through a crowdfunded offering can be exciting, don’t try this at home just yet. The JOBS Act provides the SEC until the end of this year to adopt final crowdfunding regulations. As such, no one should rely upon the new crowdfunding exemption until the SEC adopts final rules.
Additionally, the JOBS Act’s relaxation of the advertising ban won’t apply to issuers of crowdfunded offerings. So, before you start sinking resources into a direct marketing campaign to entice medical cannabis patients to participate in your company’s crowdfunded offering, read on.
The SEC’s rules against “general solicitation” currently prevent a company making a private offering of securities (under the Regulation D exemption from SEC registration, also known as “Reg D”) from advertising the sale of those securities to the general public (which would make it a public offering requiring registration). Though this rule is seldom observed in the age of social media (when entrepreneurs and investors alike Tweet and Facebook about their latest deals), it was originally intended to protect less sophisticated investors from fraud.
Finally, financial industry observers note that the new law places difficult policing and enforcement obligations on crowdfunding portals. These obligations could in turn impose expensive regulatory burdens discouraging the growth of such portals and limiting the number of crowdfunded offerings made to non-accredited investors.
Angels Waiting in Wings
Despite these apparent obstacles to true crowdfunding, the relaxation of general solicitation rules could provide angel investor groups like the ArcView Angel Network the opportunity to “crowdfund” deals through their own proprietary and unregulated funding portals, albeit with only a small crowd of accredited investors participating. More on this and other opportunities created by the relaxation of the general solicitation rule in my next column on the effect of the JOBS Act on angel investors.
Khurshid Khoja is the principal and founder of Greenbridge Corporate Counsel and currently serves as the outside general counsel to The Emerald Growers Association and the ArcView Group. The information contained in this column does not constitute legal advice or a legal opinion and should not be viewed as a substitute for either.