Cannabis has seen significant positive changes since it was decriminalized and made legal, but the industry’s expansion has been fueled by more than just a rise in consumer purchases. Businesses that were previously indifferent to cannabis (or even hostile) are suddenly investing heavily in the sector, driving it to explosive development. Many cannabis entrepreneurs are ready to use their know-how and skills in the industry to build successful enterprises, helped by the surge of investor opportunities.
With huge amounts of money now involved, the market is undoubtedly a good starting place for companies looking to work with investors to boost valuation and profitability. Having said that, it may also come back to bite a seasoned cannabis business owner who gets into a partnership without fully comprehending its conditions.
Cannabis industry veterans must be fully aware of how to maintain their business interests at the start of a new collaboration in order to avoid potentially costly and time-consuming legal disputes in the future.
These tactics can be useful for securing your ownership stake in a growing company, but keep in mind that wealthy investors frequently take the “our way or the highway” stance. Just because an investor put up the money doesn’t mean they have complete power over the deal. The investment opportunity would not have been possible without the cannabis professional’s abilities, goods, services, or experiences (whatever differentiates it from rivals). If you are essential to the company’s success, you have the power to negotiate terms or reject the offer if it doesn’t benefit you.
To guarantee that cannabis entrepreneurs are ready and protected, we have drawn up a useful roadmap. Our business consultants are available to assist as always. Contact us right away.
1. Start by keeping detailed records.
It’s common to get carried away with the exhilaration of new possibilities and the anticipated success of a new business venture in the early stages of creating a business. When you’re working to establish a common vision with your team and investors, it’s typically not given much thought to stop the momentum and ask challenging (but crucial) questions like:
How are management decisions going to be made?
What percentage of the company does each partner own?
What procedures will we use to resolve partner disputes?
How would my interests be protected in the following scenarios?
The business fails or never achieves enormous success?
Everything goes according to plan, and the company experiences mediocre success?
Your company’s founder’s shares are worth millions if we strike it rich?
This is why it’s crucial to formalize your partnership’s rules as soon as possible, so that expectations are clear and there are no unpleasant surprises or misunderstandings later on. You should begin documenting as soon as your main business partners are on board, even if all of your investors aren’t there yet.
2. Especially when interacting with possible investors, get a lawyer to represent you.
It is crucial to choose a knowledgeable, business-savvy attorney early on to represent your interests, especially when working with venture capital or outside investors. A competent attorney will guarantee that the proper information is recorded from the beginning, prepare operational agreements (more on this below), and ensure that your demands are addressed during discussions and business actions.
3. Use an operating agreement to specify roles and rights.
Your operating agreement, also known as a shareholder or partnership agreement, is a crucial document that spells out each member’s rights and establishes a framework of operations for situations that can prevent parties from being able to carry on doing business together. It might be viewed as a prenuptial agreement for a company, designed to safeguard each participant in the event of a dispute or if a member wishes to leave the company. It gets the company ready for typical incidents like:
If a partner wants to leave the company amicably, what happens to their shares?
How would it work for the new investor to join the thriving business?
What happens if the company’s main partners decide to sell it?
How do you resolve conflicts when partners disagree on important management choices or how to run the company?
You are most likely an expert on the actual product, whether it be in terms of growing, selling, or producing cannabis-related goods like concentrates and edibles. But if you’re talking to investors who want to put money into the company, you’ll want to make sure you’re getting the most out of the years you’ve spent working in the cannabis market and developing your knowledge during the challenging years prior to widespread legalization.
How can smaller shareholders safeguard their interests?
When working with angel investors, it’s likely that you’ll be a minority shareholder, which means you’ll possess less than 50% of the company’s shares or interest. As a minority shareholder, you might not possess a majority position in the business, but you shouldn’t sign a contract that restricts your rights right away. By putting clauses in the agreement that will guarantee your rights and stake are preserved, be sure to take advantage of the leverage you enjoy as a significant stakeholder in the firm.
You should specify in the operating agreement the kinds of business actions that will need the approval of a supermajority of shareholders in light of that consideration. For decisions that will have an impact on the direction the company takes, a supermajority vote is advised. These choices can involve the sale of the business, the disposal of assets, a change in management, spending more than a specified sum of money, or taking on a certain level of debt. Identifying decisions that need a supermajority vote, for instance, will ensure that the angel investor can’t control the entire business or make decisions that favor them over minority shareholders if you’re one of several minority shareholders who jointly own the company with an investor who owns 60% of the company.
Another clause in the agreement to think about is tag-along rights, also referred to as co-sale rights. In this case, if a majority shareholder decides to sell their shares, tag-along rights give minority owners the opportunity to participate in the sale and sell their shares at the same price as the majority shareholder. Tag-along rights guarantee minority partners’ shares are just as tradable as those of large partners. Compared to a minority shareholder with fewer connections, angel investors and venture capitalists can find it simpler to sell shares valued at hundreds of thousands or even millions of dollars.
In a similar vein, if the majority shareholders agree to a sale, drag-along rights provide the majority shareholders the authority to compel minority shareholders to sell their shares. Drag-along rights ensure that minorities receive the same terms and circumstances in a business sale as the majority shareholder while prohibiting minorities from blocking the sale of the company. In the event of a sale, drag-along rights can be used to get rid of minority owners because they frequently benefit majority shareholders.
By establishing valuation formulae or designating an impartial valuation expert to decide on a just method for deciding buyout terms, minority investors might also be safeguarded by buyout provisions. A pre-negotiated value algorithm will be used to estimate how much your shares would be worth in the future in this scenario, where a majority shareholder wants to buy out your 15% holding in the company but you think they will be worth more in the future. A valuation equation may give you the means to take advantage of the company’s growth and raise the price per share you’ll receive if you’re compelled to sell when it’s in a period of expansion.
How does vesting function?
In some cases, the operating agreement may specify that minority shareholders receive their company shares on a vesting schedule, meaning that they do not become fully owned until certain requirements are satisfied, such as continuing to work for the firm for a specified amount of time. When a business partner contributes “sweat equity” (their time or talent) rather than genuine financial investments, vesting clauses are frequently used. According to the terms of the agreement, these vesting schedules are often designed to distribute a specific percentage of shares over the course of months, quarters, or even years. Schedules that vest more shares upfront or more frequently are more advantageous to minority shareholders.
A significant number of shares vest all at once after a certain period of time, which is known as “cliff vesting” (typically at a year). In most cases, this necessitates the shareholder’s continued employment with the company before they are able to exercise all of their ownership rights. The typical “cliff vesting” provision is written such that 25% of the authorized shares vest after the first year, and the remaining shares vest over the following three years in equal monthly allotments. Majority shareholders typically gain from this arrangement because it allows them to remove minority shareholders before a sizable number of their shares have vested.
Minority shareholders need to make sure that there is a clause that states that if a minority member is forced out of their position in the company, their shares would still vest according to plan as long as they were terminated peacefully or without cause. The unvested shares, on the other hand, would be forfeited if the member was fired for cause or quit without justification.
The term “Cause” is typically defined in the contract and will typically refer to “poor” behavior, such as a felony conviction, a fiduciary breach of duty, misconduct that harms the company, or a willful refusal to complete duties. The code of conduct ought to be adjusted to the needs and responsibilities of the company.
In the similar vein, a “good reason” clause establishes previously agreed-upon circumstances that are thought to be acceptable reasons to leave the company and which would likewise cause vesting or accelerate the timeline. The operating agreement should specify what constitutes “good reasons,” which may include:
moving more than 50 miles away from your house is necessary;
significant salary reductions;
a marked decrease in authority or responsibility in one’s role.
Remember that the established provisions in your operating agreement will determine how effective the preventive measures described here will be. Even though you might not be able to persuade each party to agree to all of your preferred clauses, hiring a lawyer will help you understand your rights before any disagreements arise and can increase the possibility that clauses that are favorable to minority members are included in the final agreement.
