As appeared in Marijuana Venture / October 2016

By Neil M. Kaufman

Many cannabis companies seeking to raise capital appear to have some misunderstand­ings about how to do so. In order to clarify these prevailing mis­conceptions. here’s a look at five common myths within the cannabis industry about raising capital.

Myth: Cannabis businesses cannot obtain financing.
Unfortunately, many banks will not extend financing to companies within the cannabis industry because marijuana is prohibited by federal law. However, the availability of alternative financing, such as private equity and convertible notes, has increased as acceptance of cannabis in various U.S. jurisdictions has created new medical and recreational cannabis markets. Accordingly, cannabis compa­nies can, and do, successfully raise var­ious types of growth capital.

While the industry has its own set of uncertainties, investment in cannabis companies has been rapidly growing.

Companies can raise money without making substantive disclosures in offering documents, such as a private placement memorandum or term sheet with a business plan and risk factors.

Although cannabis businesses may technically be in violation or federal con­trolled substances laws, they are still re­quired to comply with federal and state securities laws.

Many types of offerings have specif­ic disclosure requirements that must be made to prospective investors. While pri­vate placement offerings are exempt from federal registration, they are still required to provide fair disclosure to investors. For example, all offerings are subject to Se­curities Exchange Commission Rule 10b-5, which imposes on the issuer a duty to disclose all material information (i.e., that which would affect a reasonable inves­tor’s investment decision) and to not omit any information which, under the circum­stances, would render the disclosed infor­mation misleading. If an issuer is found to have violated Rule 10b-5, the investors will have a right of rescission, which en­titles them to a refund of their investment. Generally speaking, only offerings made exclusively to institutional or very highly sophisticated investors can safely be made without full disclosure.

Just because other companies have seemingly avoided a lawsuit or an indictment so far, that does not mean they are in compliance with the applicable legal requirements. A securities law violation can result in being required to return in­vestor money, criminal prosecution, civil injunctive actions and considerable regu­latory penalties and fines. in addition to very high legal fees. Furthermore, com­panies that are caught violating the secu­rities laws may never again be able to be involved with a company raising capital.

Raising capital does not re­quire disclosures or offering documents for companies that are: (a) only raising a small amount; (b) only raising money from family and friends; or (c) only sell­ing notes or convertible notes.

U.S. securities laws apply to both eq­uity and debt, regardless of how much is raised or the relationship with the inves­tor, unless the investor actively partici­pates in operating the business. Notes and convertible notes are “securities” that are subject to the same legal restrictions as stock and other equity.

Due diligence is not necessary.                                                                                                                              In order to prepare offering documents that contain appropriate disclosures, a rea­sonable due diligence investigation of the issuer will need to be conducted. With a proper due diligence review, issuers can avoid deficiencies in the offering docu­ments that may give rise to liability. Any registered broker-dealer that raises capital for a company is required to complete a thorough due diligence investigation. In addition, legal counsel to the company is required to conduct a reasonable due dili­gence investigation; otherwise, they would be subject to the same level of liability to investors as the issuer (typically, the amount raised). 

Cannabis companies do not need to worry about state securities laws or “blue sky” filings or registrations.

State securities or “blue sky” laws are designed to protect investors against mis­leading or fraudulent practices within that state. While an exemption from federal registration may relieve an issuer from filing or registering with the Securities and Exchange Commission, issuers rely­ing on such exemptions may still need to make certain filings to comply with state securities laws. Even offerings exempt from SEC registration (such as private placements) may be subject to state no­tice filing requirements, filing fees and anti fraud liability. In many states, filing a copy of a federal Form D with the appro­priate state agency is all that is required, but the laws of each state where the offer­ing is conducted (the issuer’s home state and all states where investors are located) must be examined.

Neil M. Kaufman is the managing member of Kaufman McGowan PLLC (, a corporate and securities law firm with offices in New York. He has more than 35 years of experience in corporate and securities law. Member Sean J. McGowan contributed to this article. 


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