Insight

Coronavirus and Capital Concerns

Coronavirus and Capital Concerns

Julie Herzog

Julie Herzog

September 30, 2020 12:56 PM

When the new year began, the North American cannabis industry already was reeling from a chaotic 2019. The first year of Canada’s legal market was anemic, plagued by supply problems, heavy regulatory burdens, and an inability to compete with illicit markets. In the United States, even bipartisan lawmaking couldn’t get needed banking reforms approved. The deadly vaping crisis in the latter half of the year revealed serious industry-threatening risks at all points along legal supply chains in North America and worldwide. As if all that weren’t bad enough, a series of high-profile cannabis company takeovers and closures left many wondering whether the industry’s green rush of optimism was beginning to fade for 2020.

And then the COVID-19 crisis hit.

The cannabis industry—all aspects of it: hemp, CBD, and marijuana, both medical and adult-use—now is facing immediate economic uncertainty as the world responds to coronavirus concerns. As tempting as it might be, it’s really too early to forecast what the long-term financial implications of COVID-19 may be on the industry, specifically when considering the pursuit of capital in the sector. Capital will be in even greater demand the longer the economy suffers.

For example, how the novel coronavirus outbreak possibly affects the long-term supply and public demand for cannabis is yet to be seen. Already, though, many public-health experts are predicting COVID-19 will affect public life globally through the summer months and, perhaps, even into the fall.

As states order their residents to shelter in place, cannabis has been viewed as an essential service in many parts of the country. Denver recently moved to shut down recreational dispensaries before rolling back that decision a couple of hours later. No doubt similar decisions will be considered in other metropolitan areas as the duration of the pandemic goes on.

Meanwhile, reported cases in the United States multiply, along with deaths attributed to the virus. As numbers rise, it’s easy to surmise that if the flow of venture capital was at risk of slowing at the start of the year, COVID-19 slowed it even more substantially before the official start of spring. And the longer the pandemic goes on, the more it will affect funding plans in the cannabis sector just as in all others.

Venture capitalists are adopting a cautious approach to the future like the rest of us. That means many cannabis companies probably will find themselves having to look elsewhere for capital investment in 2020. Two of the most immediate potential options are initial public offerings (IPOs) and mergers and acquisitions (M&As). Both are tried and true, yet both have some risks not always fully considered. As head of the corporate/securities practice at Full Velocity Consulting, here are a few issues I’ve addressed with clients.

More M&As? Maybe

If there is a prolonged economic downturn due to COVID-19, we may see more M&A activity and deal-making because many cannabis businesses simply will need to consolidate to survive. In a long-lasting slowdown, it’s easy to envision well-positioned national players most likely would continue to acquire regional and smaller brands, especially if other forms of venture funding are harder to come by in a down economy.

It’s also probably safe to say most company founders look favorably on having their business creations targeted for either merger or acquisition. It’s recognition, of sorts, for their companies’ profile in the industry. More importantly, though, it’s a lifeline for cash-strapped organizations caught in any kind of low earnings period.

So, while many founders seek a merger or acquisition along with a new role in the merged operation, it’s often easy to overlook some potential risks. One of the biggest challenges a founder faces can be earnouts affecting a continued role with the company.

Earnouts most often are tied to revenue targets or specific earnings before interest, taxes, depreciation, and amortization (EBITDA) benchmarks. If earnout clauses aren’t structured soundly in the beginning of any merger or acquisition, some founders can find themselves struggling early to achieve the financial benchmarks required. That means they are at greater risk of being contractually forced out of the company they created. Unfortunately, many of them are.

Another note about M&A deals in 2020: At the end of 2019, the U.S. Department of Justice (DOJ) appeared to be using the Hart–Scott–Rodino Antitrust Improvements Act to delay a sizable number of pending cannabis M&A proposals. The use of the HSR law—and the delays it can bring—prompted a concern in the industry that the lags were becoming more common…and costly. Fortunately, the postponements haven’t continued as stringently as before, but companies should take care to have a legal review conducted before any planned M&A activity. Such a review can indicate if there may be a need for companies to divest any particular operations before mergers take place.

Coincidentally, in March the Federal Trade Commission announced that, because of coronavirus concerns, DOJ will accept HSR filings only via a new electronic filing system.

What about IPOs? Well, perhaps

Some cannabis companies could turn to another favored form of raising money often seen as equally prestigious as acquisition by a larger company: an IPO. In economic downturns, there are heightened risks and uncertainties associated with going public. Yet many companies still do, especially those with a lot of debt and a need to leverage balance sheets.

For anyone holding stock in a company that has yet to go public, the possibility of an IPO is enticing. But in the cannabis industry, perhaps more than in any other, private-placement stock often is used as a way to compensate employees, vendors, and contractors of all kinds.

When the companies eventually do go public, these kinds of stockholders get paid. But many of these private-placement stockholders often forget their ownership stake in companies comes with restrictions to quick profit-making, thanks to applicable securities laws.

That rule is part of the U.S. Securities Act of 1933, the landmark investor-protection law that emerged in the wake of the stock-market crash of 1929. Rule 144 is a safe harbor for transactions in restricted securities, and it provides a way for individuals holding these kinds of stocks eventually to sell them to the public.

When a company is private, it can issue stock in what’s known as “private placements.” The shares in private placement are considered restricted. They aren’t registered with the U.S. Securities and Exchange Commission (SEC), and they can’t be publicly traded. The stock certificates of such shares even are stamped with a legend denoting them as being banned from sales or trades.

However, restricted stock can be resold to the public if the holder can attain an exemption to securities laws. That’s where Rule 144 comes in.

The rule stipulates a mandatory holding period for restricted securities. For a public company reporting to the SEC (for at least ninety days), that period is six months. For private companies under no such SEC reporting constraints, the hold is for one year. For any restricted-stock holders, the period is identified as beginning when the securities are fully purchased.

If a company relies on Rule 701 for issuances to employees or consultants who are individuals, stocks can be sold with no holding period (after the ninety-day reporting period).

Aside from the holding-period requirements of Rule 144, holders of restricted stock also need to be aware of the rule’s requirements concerning restriction labeling on stock certificates. Even if all other requirements of the rule are met, shareholders still will need to have any restriction warnings removed from the stock certificates before they can be traded. For public companies, only so-called “transfer agents” can make this happen—meaning it’s a requirement for companies to get a legal opinion to confirm the stock is “freely tradeable” under Rule 144.

The cost of coronavirus, human and otherwise

This year’s initial pullback on venture funding was at first an acknowledgement that no market—even a wildly popular and profitable one like cannabis—can support endless quarters of negative company earnings, regulatory uncertainty, and legal challenges. Now that COVID-19 has shaken the world, it’s clear the cannabis industry will have to respond in unique ways to finding capital, too, as investors remain cautious.

Otherwise, COVID-19 threatens to be just as deadly to some businesses as it can be to many human populations. There’s no comparison between the two costs, of course, but both will be hallmarks of the year ahead.

Related Articles

Colorado Attorney General Calls For Cannabis Reclassification


by Gregory Sirico

In this article, Best Lawyers highlights a recent call to action by the Colorado state attorney general, requesting a full drug reclassification of cannabis.

Cannabis buds sitting on a checkerboard tabletop

Mergers and Acquisitions Law in Texas: Top Legal Considerations for M&A Deals


by Best Lawyers

Mergers and acquisitions are major events for many stakeholders involved in businesses. Learn more about mergers and acquisitions law in the state of Texas.

Two animated figures shaking hands and divided by red and white space

IN PARTNERSHIP

Beyond Business: The Personal Touch in M&A Transactions


by Justin Smulison

The stakes are always high in a business transaction because real people are often embarking on a once-in-a-lifetime event. Tiffany & Bosco M&A/Business Solutions Practice Group co-chairs Jim O’Sullivan and May Lu discuss their approach to helping business leaders make life-changing decisions and how professional partnerships strengthen their results.

Headshot of male lawyer in dark suit and red tie, and headshot of female lawyer in dark suit and gla

Big Updates in the Big Apple


by Nina M. Roket and Thomas D. Kearns

A Post-COVID-19 update on the commercial market for landlords, building investors and retail developers in New York.

Abstract skyscrapers and buildings in multi-color

Infrastructure Restructure


by David A. Lum

Developers are embracing creativity and ESG to continue their real estate projects amidst a backdrop of inflation, supply chain demands and pipeline issues.

Two figures standing in construction site

Does the Crystal Ball Predict a Fall?


by Kathleen Bernardo

In the post-pandemic climate, economists are making many predictions about what’s to come for the housing market. But one real estate lawyer with decades of experience says that this reset was crucial and not necessarily indicative of the doom and gloom we thought we were facing.

Multi-colored houses with purple backdrop

The Employment Pandemic


by Meredith Caiafa and Sarah Greene

The pandemic has had far-reaching effects on employment law since it officially took hold in 2020, but the litigation and lawmaking surrounding it are mutating faster than the variants. Here’s how lawmakers and businesses can keep up.

Employment Law During COVID-19

Measuring Success by Results


by John Fields

Recognized Best Lawyers®* recipient Joseph F. Brophy on how his Firm determines success.

Measuring Firm Success

"Lawyer of the Year"


Texas "Lawyer of the Year" 2022

Charla Truett

Immigration Law

Dallas/Fort Worth, TX

2022

Hybrid Work: Coping with Compliance Consequences


by Gregory Sirico

Communications platforms like Webex by Cisco, Zoom and Microsoft Teams are more popular than ever in the age of hybrid work, but are firms risking compliance for convenience?

Compliances Issues with Hybrid Work

Changes and Challenges


by Megan Norris

As the pandemic ebbs and many people return to the office, midsize law firms in particular must navigate a host of unprecedented questions about costs, culture and client expectations.

Changes, Challenges and Cost of the Pandemic

Forging Bonds, Building Business


by Crystal L. Howard and Lizl Leonardo

As disorienting and occasionally frightening as the pandemic has been, it has also forced lawyers to find innovative new ways to stay connected and do business.

Pandemic Sparks Innovative Ways of Conducting

Staunch Competition


by Andrea E. Nieto, Catherine H. Molloy and Jennifer W. Corinis

On the other side of the pandemic, after record numbers of employee resignation, protecting trade secrets is both challenging and being challenged.

Protecting Trade Secrets During Period of Res

Employment Entanglements


by Justin Smulison

As the United States approaches its third summer against the backdrop of the coronavirus, employers and employees still find themselves in a Gordian Knot of interconnected labor and employment challenges, with no clear way to untangle them all.

Post-Pandemic Employment Challenges Persist

Legal Trends in the Modern Workplace


by Emma R. Schuering and Meghan H. Hanson

Employees are reevaluating their jobs and the workforce, including issues like pay equity, forced arbitration, paid time off, discrimination and other such policies as they continue to navigate a post-pandemic work life.

Legal Trends In the Workplace Post-Pandemic

Courtroom Mastery


by Justin Smulison

Victor H. Pribanic recalled the excitement of returning to the courtroom in late 2021 for a medical negligence case that could help set a new course for Pribanic & Pribanic’s trial advocacy.

Victor H. Pribanic Makes Return to Courtroom

Trending Articles

Announcing the 2023 The Best Lawyers in America Honorees


by Best Lawyers

Only the top 5.3% of all practicing lawyers in the U.S. were selected by their peers for inclusion in the 29th edition of The Best Lawyers in America®.

Gold strings and dots connecting to form US map

Announcing the 2022 Best Lawyers® in the United States


by Best Lawyers

The results include an elite field of top lawyers listed in the 28th Edition of The Best Lawyers in America® and in the 2nd Edition of Best Lawyers: Ones to Watch in America for 2022.

2022 Best Lawyers Listings for United States

2021 Best Lawyers: The Global Issue


by Best Lawyers

The 2021 Global Issue features top legal talent from the most recent editions of Best Lawyers and Best Lawyers: Ones to Watch worldwide.

2021 Best Lawyers: The Global Issue

The U.S. Best Lawyers Voting Season Is Open


by Best Lawyers

The voting season for the 31st edition of The Best Lawyers in America® and the 5th edition of Best Lawyers: Ones to Watch® in America is officially underway, and we are offering some helpful advice to this year’s voters.

Golden figures of people standing on blue surface connected by white lines

How To Find A Pro Bono Lawyer


by Best Lawyers

Best Lawyers dives into the vital role pro bono lawyers play in ensuring access to justice for all and the transformative impact they have on communities.

Hands joined around a table with phone, paper, pen and glasses

What the Courts Say About Recording in the Classroom


by Christina Henagen Peer and Peter Zawadski

Students and parents are increasingly asking to use audio devices to record what's being said in the classroom. But is it legal? A recent ruling offer gives the answer to a question confusing parents and administrators alike.

Is It Legal for Students to Record Teachers?

How Palworld Is Testing the Limits of Nintendo’s Legal Power


by Gregory Sirico

Many are calling the new game Palworld “Pokémon GO with guns,” noting the games striking similarities. Experts speculate how Nintendo could take legal action.

Animated figures with guns stand on top of creatures

The Best Lawyers in Australia™ 2024 Launch


by Best Lawyers

Best Lawyers is excited to announce The Best Lawyers in Australia™ for 2023, including the top lawyers and law firms from Australia.

Australian Parliament beside water at sunset

Inflation Escalation


by Ashley S. Wagner

Inflation and rising costs are at the forefront of everyone’s mind as we enter 2023. The current volatile market makes it more important than ever to understand the rent escalation clauses in current and future commercial lease agreements.

Suited figure in front of rising market and inflated balloon

Best Lawyers: Ones to Watch in America for 2023


by Best Lawyers

The third edition of Best Lawyers: Ones to Watch in America™ highlights the legal talent of lawyers who have been in practice less than 10 years.

Three arrows made of lines and dots on blue background

A Celebration of Excellence: The Best Lawyers in Canada 2024 Awards


by Best Lawyers

As we embark on the 18th edition of The Best Lawyers in Canada™, we are excited to highlight excellence and top legal talent across the country.

Abstract image of red and white Canada flag in triangles

8 Different Types of Criminal Defenses in Law


by Best Lawyers

Learn about the different types of criminal defenses available in law, including innocence, self-defense, insanity and more. Protect your rights today.

Silver handcuffs laying on finger printed papers

Wage and Overtime Laws for Truck Drivers


by Greg Mansell

For truck drivers nationwide, underpayment and overtime violations are just the beginning of a long list of problems. Below we explore the wages you are entitled to but may not be receiving.

Truck Driver Wage and Overtime Laws in the US

The Upcycle Conundrum


by Karen Kreider Gaunt

Laudable or litigious? What you need to know about potential copyright and trademark infringement when repurposing products.

Repurposed Products and Copyright Infringemen

Choosing a Title Company: What a Seller Should Expect


by Roy D. Oppenheim

When it comes to choosing a title company, how much power exactly does a seller have?

Choosing the Title Company As Seller

The 2024 Best Lawyers in Spain™


by Best Lawyers

Best Lawyers is honored to announce the 16th edition of The Best Lawyers in Spain™ and the third edition of Best Lawyers: Ones to Watch in Spain™ for 2024.

Tall buildings and rushing traffic against clouds and sun in sky