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Crowdfunding Cannabis: Marijuana Start-ups Get the Capital They Need

Ryan Allway

January 19th, 2016

Policy, Top News

The cannabis industry may be booming in terms of revenue, but marijuana start-ups looking to raise capital face a number of hurdles.

The traditional banking sector has shunned the industry, despite the Obama Administration’s attempts to open up access. In 2013, Attorney General Eric Holder created a “reduced prosecution safe harbor” for commercial banks, but that’s a far cry from legalization. Banking executives were quick to point out that prosecutorial discretion only works as long as the administration in power supports non-enforcement – and elections are coming this year.

Many venture capitalists and institutional investors have been equally reluctant to invest in the sector. MassRoots Inc.’s (OTCQB: MSRT) treatment at the Consumer Electronics Show (CES) and in previous years at Tech Crunch Disrupt is a sign of just how taboo cannabis start-ups remain in the general public. Of course, there are a few notable exceptions including Peter Thiel’s Founder’s Fund, which invested $75 million in Privateer Holdings.

These dynamics forced many companies to pursue one of two options. First, companies can undergo an expensive and time-consuming process to try and raise angel investment rounds from high net worth individuals, but that’s difficult because there’s no good exit strategy without VC involvement. Second, companies can list their stock on over-the-counter exchanges, but that involves regulatory hurdles and high costs associated with auditing and making filings.

Regulation A+ Crowdfunding Changes the Game

For the past 80 years, only accredited investors that make over $200,000 per year or have at least $1 million in assets (excluding their personal residence) could invest in start-ups and the process was difficult, but the so-called Crowdfunding Act is quickly changing the rules.

Title IV of the JOBS Act has opened the door for start-ups to raise up to $50 million from the general public under what is called Regulation A+ Tier 2, which was adopted by the SEC and went into effect in June 2015. While it still costs $50,000 to $100,000+ to audit financials and make regulatory filings, the process is far cheaper than the cost of a reverse merger, SB-1 transaction, or traditional IPO that can cost in the millions of dollars. The cost of remaining a publicly traded company are also much lower with Regulation A+ thanks to fewer mandated SEC audits, regulatory filings and other requirements.

“The original Reg A had a state-by-state registration requirement and was prohibitively expensive for issuers,” says Darren Marble, CEO of CrowdfundX. “Reg A+ Tier 2 offerings pre-empt state securities registration, which reduces costs for issuers. More importantly, Reg A+ allows for both unaccredited and accredited investors to invest in private companies, and empowers those companies to market their offerings through the Internet.”

Michael T. Williams, an SEC attorney with Williams Securities Law Firm, P.A. noted many other benefits of Regulation A+ compared to traditional S-1 offerings, including:

  • You can aggressively advertise your offering over social media and elsewhere in all 50 states BEFORE you spend any money to prepare and file a Form 1-A, which is the Regulation A+ equivalent of Form S-1 through a “Testing the Waters” pre-filing advertising campaign. You cannot do this in an S-1 offering.
  • Because you do not have to undergo separate review of your A+ offering by 50 states, think how well this A+ Offering structure works if you want to sell stock from your website not only to potential investors but also to your customers or visitors to your website!
  • All the securities you sell in you’re A+ Offering are fully non restricted free-trading, just like those in an S-1 Offering.
  • With A+, you only have two on-going SEC filings per year rather than four under S-1.
  • Although you have to do audits with an A+ Offering, you do not have to use an expensive PCAOB audit firm but only a competent CPA firm. On-going SEC reporting does not require PCAOB audit firms after going public.
  • With A+, you are not subject to the Proxy Rules and your Insider Stockholders are not subject to Ownership Reporting Rules.
  • Even with these reduced on-going reporting requirements you can secure a qualification for quotation of your securities on OTC Market’s OTCQB, just like with an S-1.

“A correctly designed A+ Offering Program can minimize your financial risk and significantly enhance your ability to raise money compared to an S-1 transaction,” he says.

Many companies have started to take this route, including Med-X Inc., a marijuana cultivator that has already raised nearly $1.3 million on StartEngine.

“We raised the seed capital for Med-X Inc. with Regulation D using 506(c), which allowed us to General Solicit investors,” said Matt Mills of Med-X Inc. “This was also enabled from the Jobs Act of 2012 like Reg A+. Our management has studied the Jobs Act of 2012 from the moment the discussions began to bring this to the general public. The decision to go in this direction was planned for many years while we educated ourselves. Refreshingly, the process has been very smooth and it seems everyone we discuss the Med-X project with wants to learn more.”

More Opportunities for Investors

Crowdfunding makes it a lot easier for cannabis start-ups to access the capital needed to grow their business. But of equal importance, it helps everyday investors participate in the enormous potential upside within the cannabis industry. These opportunities had been limited to accredited investors in the past, who were positioned to make sometimes-sizable returns that are only possible during seed-stage or venture-stage investing.

“Retail investors can participate in Reg A+ offerings through equity crowdfunding portals like StartEngine or SeedInvest,” adds Mr. Marble of CrowdfundX. “Reg A+ allows these investors to add a basket of high-risk but high-return investments to their portfolios. In general, these types of investments should not account for more than 10% of an investor’s portfolio due to their risk profile.”

Retail investors are best off taking the lead of venture capitalists when investing in start-ups – that is, assuming that only a fraction of them will actually make it. By some accounts, upwards of three-quarters of start-ups fail to return investors’ capital, making the asset class a lot riskier than traditional blue-chip stocks. Venture capitalists make the vast majority of their returns from the one or two success stories that yield substantial returns.

“We are offering this equity crowdfunding campaign to give Americans the chance to be a part of a positive phase in the rapidly growing cannabis industry,” says Med-X Inc. CEO Dr. David Toomey. “We see tremendous growth potential for the industry at large with both medical and recreational users, as well as a tremendous need for products that the public can trust not to be contaminated with pesticides, mold, or other problematic substances.”

Looking Towards a Larger Crowd

Cannabis enjoys widespread support among Americans, with the latest polls showing more than half of citizens supporting legalization. As cannabis legalization spreads to more states in November 2016, a growing number of these individuals may want to access the industry’s vast potential without buying over-the-counter stocks. And, a growing number of companies listed on crowdfunding portals could make all of that possible.

This article was published by CFN Enterprises Inc. (OTCQB: CNFN), owner and operator of CFN Media, the industry’s leading agency and digital financial media network dedicated to the burgeoning CBD and legal cannabis industries. Call +1 (833) 420-CNFN for more information.

About Ryan Allway

Mr. Allway has over a decade of experience in the financial markets as both a private investor and financial journalist. He has been actively involved in the cannabis industry since its inception, covering public and private companies.

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