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How CO HB1090 Cements Importance of Due Diligence in the Cannabis Industry

Colorado House Bill 19-1090 has dramatically altered cannabis business ownership and investment across the Centennial State.

Prior to its passage in late 2019, ownership in a Colorado marijuana business was limited to private companies of 15 or fewer individual owners. Regardless of an individual’s percentage of ownership or control, every owner was required to pass a thorough background check performed by the Colorado Marijuana Enforcement Division (MED). But as of Nov. 1, 2019, publicly traded corporations, as well as qualified private funds, became eligible to hold an interest in a Colorado cannabis business upon MED approval.

While the concept of opening the door for more investments in the cannabis space appears great at first glance, by allowing greater investment flexibility and publicly traded corporations to invest in licensed Colorado marijuana businesses, the bill attracts a substantial amount of out-of-state interest and investment, which could spell trouble in the long run.

CO HB1090’s Impact

Concerns surrounding the bill existed before its passage, highlighted by a flood of lawsuits and securities fraud surrounding the cannabis industry in other states. Other worries included:

  • How the bill would intersect with the SEC (take cannabis out of the equation, we’re still taking in foreign securities investments that should be regulated by the SEC).
  • Will the MED or any state agency have the resources to regulate foreign securities? This is brand new terrain for the MED, and it seems irresponsible to ask an agency with no experience to regulate something normally not in its purview.
  • Whether the bill would violate anti-trust by creating an anti-competitive landscape.
    The lack of safeguards around disclosure requirements in the bill, specifically on the OTC market and penny stocks, which historically have been ripe for exploitation.
  • What is happening with cannabis companies taking investments in other states? Are investors being defrauded? (It turns out that the answer is yes. There have been several SEC actions and lawsuits surrounding investments and fraud.) 

Opponents argued HB1090 would open the door for similar securities fraud actions in Colorado and that the bill would accelerate a homogenization and conglomeration of the cannabis industry that effectively shuts out smaller and mid-size companies, while allowing larger companies to shape a national footprint outside of Colorado. Most importantly, the fear was that this bill would prevent many cannabis companies from doing their due diligence when looking at acquisitions and investments within cannabis.

Even though proponents maintained the bill would keep money within Colorado’s borders, all HB1090 has done thus far, according to recent news, is allow massive, well-corporatized, branded cannabis companies to take in more shareholder money in attempts to expand their national footprints and execute acquisitions in Colorado.

Schwazze, formerly Medicine Man Technologies, recently terminated a pair of acquisitions of Colorado marijuana businesses — cultivator Los Sueños Farms and concentrates company Dabble Extracts — due to limited due diligence. Other companies, such as Pure Harvest, are working to build vertically integrated holding companies through a series of inorganic growth initiatives levered to the Colorado market. With these recent acquisitions, Pure Harvest aims to aggressively grow, centering their growth strategy around the management team’s ability to quickly complete such additions. The “wholesaling” of Colorado’s cannabis industry has apparently begun.

Additionally, before the ink had even dried on HB1090, The Green Solution, one of Colorado’s largest marijuana dispensary chains, announced it had been purchased by Columbia Care, a publicly traded cannabis corporation from Canada. In announcing the sale, The Green Solution’s co-founder said the brand is likely to expand into more states as part of the deal. However, it has come to light that despite being one of the largest fully integrated operators in the global medical cannabis industry, Columbia Care not only plans to compensate The Green Solution with much more stock in their respective companies than actual cash but also that the Canadian cannabis giant is in a precarious financial situation itself. 


The result to this point has been that many smaller, “mom-and-pop” cannabis shops that need financial investment are either being bought up or shut out because investors are focused on investing in massive corporate brands that show up on Google and in the news. And because a lot of investors, shareholders and even cannabis companies themselves aren’t doing their proper due diligence, a lot of these deals are being squashed.

Crucial Importance of Due Diligence

The aforementioned recent examples highlight the crucial nature of due diligence in cannabis investments. While consequential when investing in any industry, due diligence is even more important in cannabis. Being a new industry that lacks proper federal oversight, there’s a potential for there to be nefarious characters on both sides — investors and companies being invested in.

We all know cannabis is one of the country’s fastest-growing industries. Since 2014, Colorado has been one of the greatest beneficiaries of the legal cannabis movement, having sold more than $7 billion of product in that time. Despite the allure of the “green rush,” investors who want to become millionaires overnight can pose grave danger to cannabis companies.

On the flip side, companies are not always upfront about their financials. While publicly traded companies publish their revenue earnings, they don’t always explain how that connects to their overhead and debt. So, it can look like a company’s revenues are high, but that’s potentially because their footprint is spread across myriad legal markets.

Until there’s a blanket regulatory system from legal market to legal market, the industry must constantly increase due diligence because what is allowed in one state might not be in another — and failure to do research can cost stakeholders on both sides of the cannabis coin. At the end of the day, neither party wants to get in bed with the wrong type of people because in cannabis, one bad apple can indeed ruin the bunch for everyone else.

What Companies & Investors Should Look For

For cannabis companies, it’s important that an investor’s belief system and values align with that of the organization being invested in. Are they also invested in companies that operate in industries you feel might be too shady or otherwise conflict with your morals? Someone could have all of the money in the world, but if they’re a jerk or only in it to “get rich quick,” red flags should be flailing in the wind.

Instead, focus on investors looking for a place to park some money and watch it grow over time. Rather than hounding companies, asking “where’s my money?” the right investors are going to take more of a laissez faire approach to the investment. If you’re not honest about your financial situation, you’re unlikely to attract an honest investor with your best interest in mind.

While investors often believe the cannabis industry is printing money, for as much money that’s being taken in, investors may not realize a lot of it goes out the back door by way of taxes, general business costs, and regulatory and compliance costs. With stock brokers often hearing certain cannabis companies might be a good investment, it appears that many of them fail to do their research surrounding a company’s financial picture now and, in the future, as well as what their intentions might be, whether to flip the business or grow it.

Investors need to focus on the organic revenue growth of the company. Rather than seeking out the “cool” or “sexy” investment in a national brand with a massive footprint, they should look for companies that can prove steady growth over time, not rapid, uncontrolled growth brought on by scaling at an unsustainable rate. It’s important to conduct a market analysis looking at that footprint too — are some stores in certain locales propping up the revenues across the footprint or are all stores doing well?

Unfortunately, as HB1090 has revealed, entirely too many investors don’t find out how far in debt a company is until they go through acquisition deals and the financial modeling becomes public — and the deal falls apart.

Like Aesop’s fable of the tortoise and the hare, companies that grew too quickly are now being passed up by those built on a strong foundation of responsible business principles. While Colorado House Bill 19-1090 aims to bring new opportunities for those across Colorado and others hoping to join the industry, its passage, alongside the impact of the coronavirus crisis, has proven to be a good stress test for those two disparate ideologies. The bill’s impact has already shined a spotlight on the financial woes the massive growth of the cannabis industry is forcing on entirely too many companies. Indeed, a focus on slow and steady growth will poise organizations to win the race in the cannabis space.

Chris Woods

Chris Woods

Chris Woods is the CEO and founder of Terrapin Care Station, a consumer-focused cultivator, processor and provider of high-quality adult-use and  medical cannabis products in Colorado and Pennsylvania, respectively. The company also recently launched in Michigan where it operates a medical cannabis cultivation facility. Terrapin was recently awarded two medical cannabis retail licenses in Missouri, and the company applied for a medical marijuana retail license in New Jersey. The company started as a one-man operation led by Chris in 2009, growing into operations with over 300 employees. 

Today, Terrapin operates six grow operations, six dispensaries, and two labs. It has received numerous awards and accolades, including being named the “Innovative Business of the Year” in 2018 by the Boulder Chamber of Commerce. 

Since the beginning of legal marijuana sales, Terrapin has focused on positioning itself as an industry leader in the burgeoning cannabis marketplace. Chris recognizes the importance of providing high-quality, affordable products to the communities Terrapin has the privilege of serving. A new industry, especially one as sensitive as medical and recreational cannabis, requires a higher level of corporate responsibility in order to ensure a successful “experiment.” Terrapin has long placed a focus on the operational mechanics of the company in order to guarantee responsibility, safety, compliance and overall success. Chris also believes strongly in leaving a positive community footprint, which is why Terrapin has partnered with 19 nonprofits for over $600,000 in contributions.  

Chris is a graduate of Pennsylvania State University, where he also ran competitive track. He earned a graduate degree in applied math at the University of Colorado Boulder. Before founding Terrapin, and while still in Grad School, Chris took the reins of his father’s real estate company, managing the construction of a 50-unit tract of low-income housing. Today, Chris lives in Boulder and continues to run recreationally as well as being an avid skier, dog lover, and downhill mountain bike and skydiving enthusiast.

 

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