As New York’s legal cannabis market heats up, many who are intended to benefit struggle with financing the launch of a new business and are at risk of becoming victims of predatory lending practices.

While New York state offers licensing priority to its residents who were negatively impacted by cannabis laws in the past and will be giving priority to other social equity applicants as well, many of these prioritized license candidates need capital financing from external sources to launch their businesses. Due to the illegality of marijuana at the federal level, cannabis businesses are faced with financing challenges and complexity other start-ups don’t face. For example, federal Small Business Administration loan facilities, which are common amongst start-ups due to their low interest rates and borrower-friendly terms, are not available to cannabis-related companies. In fact, loans from banking institutions, which are subject to federal regulations, are not available to cannabis businesses at all. This compels cannabis businesses to operate on a cash basis and/or use alternative sources of capital financing, which often expect high yields due to the risk involved.

Harris Beach’s Cannabis Industry Team has experience with both cannabis entrepreneurs and potential investors and advises on capital raising options for cannabis-related companies.

Equity Financing

The most straightforward option is to line up investors willing to financially back the company in exchange for equity in the company. Many start-ups these days are backed by venture capital firms or other private investors who get a stake in the company for their investment.

In the case of cannabis-related businesses, with the considerable risk of investing in a venture that is illegal, investors are going to expect a significant return on that investment, and a cannabis licensee may have to share a substantial portion of the company’s profits with investors in order to achieve their desired return.

However, license applicants should be aware the current regulatory regime in New York requires the prioritized cannabis licensee to retain control of the company, and any agreement that relinquishes control of the company to any other person is likely to result in the cannabis license being revoked.

Debt Financing

While loans from banking institutions are not currently available due to the aforementioned discord with federal laws, private loans are another potential source of capital for cannabis companies. Again, any private lender taking on that risk is going to want high return, and therefore, interest rates are likely to be higher than the prevailing rates in the banking industry.

There are creative ways to structure a deal that provides reasonable financial incentives and benefits to the lender, whilst reserving requisite economic benefit to the licensee. Competent attorneys can help business owners avoid predatory loan practices.

Management Fees

One other way for investors to realize a return on their investment is through a management fee under a management services agreement, which are commonly used by early-stage investors (such as venture capital/private equity funds) across all industries. Management fees are paid to investors who are willing to provide administrative support to the business (sometimes referred to as back-office services and typically including preparation and maintenance of books, records and financial reports, which can be particularly burdensome in the cannabis industry because it is subject to stringent depository bank requirements), and these management fees can be structured to include a percentage of the company’s revenues.

Strategic Partnerships

Collaborating with established companies in the cannabis or related industries can be a good counterbalance to the pressures of capital needs. Strategic partnerships can involve licensing agreements, distribution agreements, or other mutually beneficial arrangements. These collaborations not only offer expertise, market access, and shared resources to a start-up cannabis company, but can also provide indirect access to capital.

Real Estate

Yet another way for an investor to profit from a cannabis-related company is to buy real estate and lease the property to the company, provided that the investor-landlord and the company-tenant are aware of the potential legal repercussions of lease terms that are out-of-market.

The key to all of these options is to comply with the rules and regulations promulgated by the Office of Cannabis Management and the Cannabis Control Board, which can be difficult to navigate. Harris Beach marijuana lawyers advise on what is both fair and acceptable, as well as what is likely to draw undesirable attention.

Harris Beach’s cannabis attorneys continue to follow developments throughout the industry. Our Cannabis Industry Team is on top of all regulatory developments and other pertinent industry news. For more information about our cannabis industry services, please contact attorney Bartholomew Chacchia at (585) 419-8926 and, or the Harris Beach attorney with whom you most frequently work.

This alert is not a substitute for advice of counsel on specific legal issues.

Harris Beach has offices throughout New York state, including Albany, Buffalo, Ithaca, Long Island, New York City, Rochester, Saratoga Springs, Syracuse and White Plains, as well as Washington D.C., New Haven, Connecticut and Newark, New Jersey.

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