If you are reading this blog post, you may be thinking of applying for a cannabis license under the social equity program, during “Phase 2,” which offers qualified individuals priority for a cannabis license in Los Angeles. But what you might not know is that some experts believe the associated startup costs will exceed $250,000. Raising that kind of money, much as it has been an issue for other plant-touching businesses, will likely pose a challenge for many social equity applicants. Without access to traditional bank loans, you might encounter folks from the private markets looking to invest in your social equity business. But just as you wouldn’t run off to get married in Las Vegas after the first date, you should take it slow when evaluating these long-term business relationships.

With few opportunities in cannabis available to general applicants at the present time, many investors are looking to get in the Los Angeles market through the social equity program. With that in mind, let’s take a look at five red flags that you may encounter when seeking financing for your cannabis business.

1. Secret Owners: The regulated cannabis industry and social equity program are all about transparency. State and local regulators want to know who is profiting from a commercial cannabis business. A sign that a potential deal is not on the up and up is if the investors have secret owners who will not be disclosed to the regulators on the application, or a secret profit sharing agreement.
2. Management Companies: Legitimate management companies operate businesses for hire. But in the cannabis industry, management companies often use one-sided contracts to effectively takeover control of a cannabis business. Things to look out for are management agreements that delegate all control and profits to the management company. These contracts are very difficult to break and leave owners on the hook for the regulatory and legal risk and with no right to the profits. If you hear the term management company, you should seek advice from a professional about what rights you might be giving away in your business.
3. “Use My Attorney” and “Sign This Conflict Waiver”: An attorney owes their clients a duty of loyalty. This means the attorney must act in the best interest of the client at all times, especially when negotiating a deal or structuring an investment. However, an investor might insist that you use his or her attorney and ask you to sign a conflict waiver when structuring an investment. This means you and the investor would be sharing the same attorney and the attorney is no longer looking out for your best interest exclusively. While using the same attorney in the short term might save a couple thousand dollars, you may end up losing substantially more in the long run because your attorney wasn’t looking out for your interests only.
4. Monthly Stipends For Doing Nothing: Any investor on the up and up is going to expect the primary business owner to a) be doing the lion’s share of work and b) that investor is going to want to see results and progress. Any investor or investment group that’s offering “x amount of money” per month (a de facto salary if you will) is acting in an unsavory fashion, especially if you are being paid to sit at home.  Important to remember, too, is that a business owner will be losing equity and leverage on their own business by not taking a very active role in the day-to-day operations of their business, no matter who the investors are.
5. Talk of Bag Men and Bribes: We get it, bribery and bag men are always a thing when it comes to organizations and bids–Think boosters at big-time college football or basketball programs, or Jimmy Hoffa– but that should be a serious red flag for anyone trying to get in through social equity applications (or any app, really.) We hear gossip from time to time about applicants being promised a license if they hire a Councilman’s relative as a consultant. MJBiz Daily posted an excellent look at corruption and bribery issues within California a while back and it’s worth your time.

The bottom line? Financing can be a difficult process to work through, but at the end of the day you want to form a partnership built on trust, proven success, and mutual respect.

The decision to take on investors will impact your business more than almost any other business decision. Yet, folks in cannabis the cannabis space rush into partnerships of convenience in order to accomplish short term goals, like licensing or obtaining a location. Any potential investor should be looked at with skepticism until you have had a chance to fully examine the nature and structure of the proposed investment and the background of your proposed investor.

Have questions about the social equity programs, or just general questions about financing in the cannabis sector? Let us know: Facebook, Instagram, Email, Phone: 310.449.4528.