Cannabis Startup 101: Financing Considerations for Early Stage Businesses

There are many considerations that come into play with financing early stage businesses, including how to budget appropriately for the business to be successful and how to structure capital raises, among other concerns.

Budgeting With Risks In Mind

Early stage companies – whether in the cannabis space or otherwise – often need more frequent infusions of capital than established businesses with known performance metrics and revenue models. As businesses navigate early product and business development and initial employment of staff, financial performance forecasts often run short of expectation and budgets often under-calculate the costs of starting a business.

This is especially a risk in industries such as the cannabis industry where becoming legally profitable is subject to outside variables such as becoming permitted at the local level and licensed at the state level (in order to operate legally) and operating in compliance with a complex ever-changing regulatory scheme.

Cannabis companies looking to raise money in initial stages should therefore consider the potential range of time before they will become fully permitted and licensed; costs for addressing compliance requirements and potential related issues; and costs for build out periods and pre-operations periods.

Ideally, companies should raise at least 20% more than they think they will need in order to achieve their desired goals (and perhaps more of a buffer, if necessary and possible).

How to Structure Financings

Other considerations are those around how to structure financings: Should it be a common stock sale (if it is a corporation) or a sale of membership interests (if it’s an LLC)? Should it be a preferred stock sale (if it is a corporation)? Should it take the form of a promissory note financing (debt financing)? If it is a note financing, should the debt be convertible or not convertible into equity? Should the conversion terms provide for a discount or a valuation cap benefit to the investors? Should it take the form of a SAFE (a simple agreement for future equity)?  

  • Note or SAFE Financing

Most of the time investor desires will strongly influence or control the structure of a financing. However, for companies looking for quick money with more simple terms, often the right fit is a note or SAFE financing. These documents are typically less negotiated and detailed than equity purchase documents.

  • Preferred Stock Financing

If a corporation is raising significant amounts of money from sophisticated investors and from a multitude of investors or funds, we often see the financing structured as a preferred stock financing, with preferred investment terms for the equity purchased by the investors.

  • Other Forms of Financing and the Factors At Play

Still, a company can raise significant amounts of money via a promissory note financing with a form of note and a form of note purchase agreement. There are many different factors and considerations that come into play in determining how to structure a financing, including, without limitation, the following:

  • How sophisticated are the investors and what is their preference?
  • Is it an insider (friends & family) or outsider (independent funds or other outside investors) raise?
  • How fast does the company need the money?
  • Is the company ok with taking on debt (verses selling equity)?
  • What stage is the funding required (has the company already raised prior capital)?
  • How fast does the company need the money?
  • What kind of entity is the company (is it a corporation that would sell shares or is it an LLC that would sell membership interests)?
  • What will the valuation implications be and how might that impact the company in the short and long term?

Here at Rogoway Law Group we help clients navigate these important inquiries, factors and business decisions. We understand that how a company approaches raising capital for its immediate business needs can have significant impact on the future of the company both in the long and short term of the business. We understand the nuanced issues that can arise with valuing the company in a transaction. There are many different considerations that are complex and not intuitive for early stage companies (even those with repeat entrepreneurs). Our years of experience in working with companies from formation to exit uniquely positions us for giving wholesome legal and business advice in the context of important business life cycle events, such as the event of a financing.

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