Colorado Expands Ownership of Cannabis Companies

Since the legal cannabis industry started in Colorado, state regulations have restricted the types of companies and persons who could own licensed cannabis businesses.

Originally, only Colorado residents who were natural persons could own licensed cannabis businesses. This made raising money for cannabis businesses difficult as it practically prevented them from selling a portion of the equity in the business for cash.

In 2016, Colorado loosened ownership restrictions to allow for out of state passive investors who owned less than 5% of a cannabis business and to provide that out of state investors could hold convertible securities, so long as such convertible securities did not convert into actual ownership without MED approval. In addition, out of state individuals could apply to MED to be Direct Beneficial Interest Owners, but companies were limited to up to 15 out of state individuals. Direct Beneficial Interest Owners were subject to background checks and investigation by MED. Licensed cannabis businesses still could not go public or raise capital from traditional venture funds.

Despite this change, fundraising activity with non-Colorado investors was difficult. It was difficult to structure in a way that met Colorado legal restrictions and allowed the parties to benefit from the transaction in a way that made sense for both parties. Transactions have cost more than they otherwise should have and took longer to negotiate.

In the interim, states such as California, Nevada and Oregon legalized recreational cannabis and did not impose similar ownership restrictions. As a result, companies in those states were able to successfully go public in Canada or in the United States on the OTCQX or the OTCQB. This generated significant investment capital for these companies and liquidity opportunities for their stockholders.

With the recent passage of HB-1090 by the Colorado Legislatures and the approval of Governor Polis this week, Colorado will now allow licensed cannabis businesses to be owned by public companies and private capital funds.

This is a big deal for the Colorado cannabis industry and will lead to significant capital markets and transactional activity. Non-Colorado investors will have their first opportunity to invest directly into equity of Colorado cannabis companies. Transactions should be easier to negotiate. Colorado cannabis companies will go public providing investment income and an opportunity for stockholders to achieve liquidity.

The new legislation creates two new ownership licenses: Controlling Beneficial Owner and Passive Beneficial Owner. A Controlling Beneficial Owner is a person that owns 10% or more of a licensed cannabis business or otherwise has some control over the business. This is a similar definition to the “Affiliate” definition under the Securities Act of 1933, as amended. Persons applying for such licenses will need to apply to MED for a finding of suitability( passing a background check). A Passive Beneficial Owner owns less than 10% of a licensed cannabis business and does not have any control over the license cannabis business.

Importantly, either of these ownership licenses may be held by Publicly Traded Corporations or Qualified Private Funds. Publicly Traded Corporations are companies that are registered with the SEC for periodic reporting and have securities traded on the NYSE, Nasdaq, OTCQX or OTCQB.  In addition, Publicly Traded Corporations include foreign private issuers in countries that have authorized the sale of cannabis, including companies that have securities trading on the Canadian Stock Exchange, the Toronto Stock Exchange or the TSX Venture Exchange. Unlike other licensed cannabis businesses, Publicly Traded Corporations are not required to report to MED every change in ownership percentages.

Publicly Traded Companies and Qualified Private Funds that are Controlling Beneficial Owners or Passive Beneficial Owners are required to disclose to MED their management and their own 10% or greater beneficial owners. Qualified Private Funds include venture capital funds, hedge funds and private equity funds so long as the fund is advised or managed by a registered Investment Advisor.

Colorado still requires each person who has day-to-day operational control of the licensed cannabis business to be a Colorado resident. Out-of-state Controlling Beneficial Owners are required to have a registered agent for service of process in Colorado.

The new law goes into effect in November 2019. MED has not yet issued rules implementing the change in law nor is it accepting ownership applications resulting from the new law.

Once the law is effective we expect to see increased capital markets transactions as Colorado companies go public in the United States or Canada. In addition, we expect to see public companies outside of Colorado acquire Colorado companies using their cash or publicly traded securities as currency for such acquisitions. We also expect to see more venture financings as Colorado companies seek new sources of investment income.