On Oct. 30, 2015, the Securities and Exchange Commission adopted final rules under the mandate Congress gave it in Title III of the Jumpstart Our Business Startups (JOBS) Act, providing for equity crowdfunding. Along with the final rules, the agency also proposed amendments to certain existing rules designed to render them consistent with the rules of the JOBS Act.
Of course, the marijuana industry has not been waiting around passively for this day. It has been crowdfunding for some time. Cannabusiness’ have crowdfunded both in the debt and equity domain. Sometimes this has involved reliance on state level securities regulation, or on federal rules that preceded the JOBS Act. But the consensus of opinion has been that these alternative harbors for the practice have been mere ports of convenience, and that the JOBS Act rules would be very useful in regularizing the practice when they arrived.
So the sentiment of Mary Jo White, the SEC’s chair, is within the consensus view. In announcing the long-awaited final rules she said, “There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendment provide smaller companies with innovative ways to raise capital and give investors the protections they need.”
The Gist of It
The gist of it is this: the SEC is prepared to permit a company to raise an aggregate of $1 million through crowdfunding offerings in a 12-month period. Some companies will be ineligible, among them certain investment companies, certain companies excluded on “bad actor” grounds, companies with no business plan, or companies whose business plan is “to engage in a merger or acquisition with an unidentified company or companies.”
From the same practice from the investors’ side, it is prepared to allow individuals over a 12 month period, to invest the greater of these:
- an aggregate of $2,000 or
- 5 percent of the lesser of their annual income or net worth, if their annual income is less than $100,000.
If an investor’s annual income is equal to or greater than $100,000, though, the ceiling rises to 10 percent of the lesser of that annual income or net worth.
Meanwhile, under the newly proposed amendments, the aggregate amount that may be offered and sold pursuant to Rule 504 offerings has been increased from $1 million to $5 million.
Banks and Escrow Accounts
The early reaction to these rules by the portion of the investment services world that caters to cannabusinesses and mediates their sources of risk capital is this: the new rules will help, though they won’t produce any large immediate change.
One obvious question: since marijuana remains a prohibited substance under federal law, and the SEC is a federal agency, could the SEC not simply refuse to acknowledge cannabis-related business plans for purposes of this rule?
The answer: this seems unlikely to be an obstacle for platforms set up to get crowdsourced money to cannabusinesses under the new rules. After all, in January, the SEC permitted the registration of the shares of a California-based company, Terra Tech (OTCQX: TRTC), whose business model entailed both the cultivation and the sale of marijuana.
A more difficult question concerns the involvement of banks in any proposed new crowd funding system or platform.
Randy Shipley, the founder and CEO of CannaFundr.com, is among those who believe that the new SEC rules will “potentially” have a positive influence on the marijuana industry. But, he says, there are obstacles. The chief of these is that “there are a lot of issues with banks and their portals that will have to be worked out with regard to an issuer’s escrow.”
The problem is that, on the one hand—call this the “rock”—issuers will have to have escrow accounts in order to sell securities, yet on the other hand—the “hard place,” if you will—the portals which are expected to intermediate aren’t permitted to hold funds in escrow. So: who will? Presumably a bank, but—another rock?—the whole banking business, extensively federally regulated by several different agencies as it is, has been extremely wary of getting involved in the cannabis business at all.
An Ohio-based company, Apeks Supercritical, which has developed a system that extracts the oils from the marijuana plant, had to delay construction of a factory last year while it was repeatedly refused loans by skittish bankers.
Apeks did eventually get that factory built, which is a token of a broader fact: the banking issue hasn’t proved insurmountable, and the banking/escrow issue in crowdfunding probably won’t prove insurmountable either. It will, though, slow matters down.
Another Cautious Optimist
Troy Dayton, CEO of The ArcView Group, reacted to the news from the SEC along much the same lines as did Shipley. ArcView calls itself the “legal cannabis industry’s premier hub for investment, data and progress,” and its investor members have invested $35 million into 50 cannabis-related companies that pitched to its group, year to date.
Dayton said in an interview, “I think the new rules will have an impact over time, but there is a chicken-and-egg problem that has to be overcome.”
It’s a bit like creating a new industry for the sale and servicing of electric vehicles. The recharging and servicing sites have to be widespread enough to make it rational for an interested motorist to own such a vehicle, yet ownership of such vehicles, or demand for the same, has to be widespread enough to justify investing in the appropriately equipped service or recharging stations. Given this problem, the development of such vehicles has been and continues to be a tough slog.
Dayton believes that the portals will adapt to the SEC rules, as will investors and entrepreneurs, over time, and as these three players adjust to each other. He is even optimistic, given his caution as to the timing, that it will be possible to work around the bank issue.
In his words, “The first companies that will utilize these new rules will be ancillary business that never touch cannabis,” businesses such as software, research, cultivation assistance, etc.
The view from the trenches, then, is that a lot of work remains, but that the SEC rules are an important progressive fact for the state-legal marijuana industry and for the democratization of its financing.