Could equity crowdfunding for cannabis take off in Colorado? On July 16, 2015, Colorado’s Division of Securities sent a cease and desist letter to a man who posted ads on Craigslist looking for “high net worth investors to strategically partner with one of the largest MMJ chains in Colorado.” So, no, not for that guy.
But Colorado recently enacted the Colorado Crowdfunding Act which, when operational, may allow individual investors of modest means to get in on the green rush. A number of other states where marijuana is legal for at least some purposes, including Washington and Maine, have enacted similar statutes. The potential teases the imagination. The devil is in the details.
A Bit of Crowdfunding Background
Many people are familiar with donative and rewards-based crowdfunding. Equity crowdfunding is fundamentally different. When startups seek to raise money from investors who receive shares in the company in exchange, the transaction is subject to securities laws. Securities laws require financial disclosure, hence the failure of the entrepreneur in the first paragraph.
The federal Jumpstart Our Business Startups Act, also known as the JOBS Act, was intended to simplify and thus decrease the cost of financial disclosure for startups interested in soliciting equity financing from non-accredited investors via the Internet. Not coincidentally, it was also intended to lower the barriers for middle-income investors who might otherwise be prevented from getting in on the ground floor with the next Google or Facebook.
The response of the business community, even to the most recent iteration of JOBS regulations, has been tepid. The disclosure required is still extensive and expensive and investment caps make raising capital a difficult proposition. So states have stepped in with their own intrastate securities regulations, designed to ease those burdens.
The Colorado Crowdfunding Act will become law on August 5, 2015. On July 29, Colorado Securities Commissioner Gerald Rome signed off on the rules that will permit companies to raise capital through crowdfunding. It remains to be seen how entrepreneurs and the public will respond.
Under the regulations, in-state businesses will be able to raise money in a crowdfunded offering solely in Colorado to Colorado residents. Only Colorado residents may invest.
In addition an issuer may raise only $1 million through crowdfunding in any 12-month period, unless the issuer has audited financial statements on file with the Colorado securities commissioner, in which case the limit increases to $2 million.
There is no limit on how much accredited investors can buy in crowdfunding offers, but non-accredited investors cannot invest more than $5,000 in crowdfunding offers in any 12-month period. Individual accredited investors are those who have more than $1 million in assets, excluding the equity value in their home, or who make more than $200,000 a year, or $300,000 a year with their spouse.
Each crowdfunding offer must be accompanied by a disclosure document with certain required language, which by way of comparison, is not always required for private placements.
In Colorado, crowdfunding businesses cannot sell their shares directly to investors. The offering must be done through a licensed broker-dealer, a licensed sales representative, or on the Internet by a website authorized to make crowdfund offers, called an “intermediary.” An intermediary may not advertise or promote an offering. In addition, intermediaries who suspect sellers of wrong doing or noncompliance with securities rules must report the seller to the Securities Commissioner.
The reaction to the Colorado Crowdfunding Act has been mixed, and the jury is still out. As Randy Shipley, Founder and CEO of CannaFundr.com, pointed out, a threshold issue for an intrastate offering is the size of the potential investor pool within that state. In a recent conversation with MJINews, he noted, “To date [equity crowdfunding] has not been effective in other states. There are some deals done but not many. Colorado may prove tougher because of the size of the population.”
Andrew Stephenson, Director of Research Operations and Client Services at CrowdCheck, Inc. was more sanguine in his comments, “Marijuana is likely a good candidate for intrastate crowdfunding because the companies raising funds are likely to be organized and doing business in state, as well as not using marketing materials that extend outside of the state.”
But the real unknown, is how the market will react to the regulations. As Amanda Ostrowitz, Co-founder and Chief Strategy Officer of CannaRegs Ltd. noted to MJINews,
If the Securities Commissioner, in issuing the new regulations [is understood to be seeking] to homogenize the current exemptions to state securities laws with the crowdfunding idea, which appears to be the purpose of the law, then this presents a real opportunity for everyday folks to participate in a meaningful way and to indeed facilitate the availability of growth capital to the cannabis trade. If the Securities Commissioner [appears to have decided that] this as still too risky for unsophisticated and unaccredited investors, and thus promulgated regulations with a more restrictive and protectionist view, then this will not be much more than an opportunity missed or delayed.
The Shape of Things to Come
At the moment, the number of states that have both a cannabis industry and equity crowdfunding rules is quite small. Because of their relatively small populations, these may not be these may be the states where the potential for intrastate crowdfunding is greatest. Nonetheless, they may serve as the laboratories where different regulatory schemes can be tested and explored.
These schemes seem to have several characteristics in common:
- A cap on the aggregate amount of securities sold to all investors within a 12-month period;
- an annual limit on investment by non-accredited investors;
- filing requirements with the state;
- disclosure requirements to individuals; and
- a method of Internet access, whether through intermediaries, “portals” as in Texas, or via the issuer’s website.
These are the features with which regulators have to work in designing a workable equity crowdfunding plan in the states that choose to adopt one. Each will likely be different, especially during this developmental period.