KMK Law Cannabis & Craft Beer Blog

In this first post of a two-part series, we will examine five of the ten important risk factors that should be considered by medical marijuana companies and their investors.

The Ohio Medical Marijuana Control Program application process is now in full swing, and many license applicants are in the process of courting potential investors for their anticipated medical marijuana companies. Even for those applicants who have already secured an initial round of investment, it is expected that larger angel groups and venture capital investors will seek investment opportunities once the State of Ohio Board of Pharmacy issues licenses to applicants of cultivation, processing and dispensary businesses. Surveys suggest that nearly one out of five cannabis startups are likely to obtain venture capital or private equity funding within a year of their existence.

Equity fundraising at the startup stage is most commonly done through a private offering of securities. When conducting a private offering, the issuer of the securities must utilize a process to ensure that the securities will remain exempt from registration under federal and state securities laws, and that the offering will not run afoul of antifraud provisions. The antifraud provisions of federal and state securities laws require issuers to provide investors with full, fair and complete disclosures of all material facts about the issuer, its management, business, operations and finances.

Private offerings for medical marijuana companies are unique and require the company and its advisors to pay special attention to certain realities that may be material issues to investors considering an investment. For experienced investors and entrepreneurs, this means that it is not advisable to simply dust-off your old offering materials and re-use them for the medical marijuana venture. Special considerations, including the following risk factors, should be contemplated by all medical marijuana companies and their investors, and should be disclosed in the company’s private offering materials: 

1. Marijuana is an Illegal Substance Under Federal Law. This is the obvious disclosure that hopefully will not be overlooked in any offering. The Federal Controlled Substances Act classifies marijuana as a Schedule I drug. As such, marijuana-related practices, including the manufacture, importation, possession, use or distribution of marijuana, are illegal under federal law. Therefore, the company’s officers, directors and shareholders may be subject to criminal and civil penalties.
2. Limited Access to Bank Accounts. Federal prohibitions result in marijuana businesses being restricted from accessing the U.S. federal banking system, and such businesses likely cannot deposit funds in federally insured and licensed banking institutions. This leads to further related issues, such as the potential that a bank will freeze the company’s accounts and risks associated with uninsured deposit accounts. There are ways to resolve some of these limited access issues in Ohio, so it is best to consult with an experienced advisor before the company receives any funds.
3. Section 280E. Under Section 280E of the Internal Revenue Code, normal business expenses incurred in the trafficking of marijuana and its derivatives are not deductible in calculating income tax liability. Therefore, a medical marijuana company will be precluded from claiming certain deductions otherwise available to non-marijuana businesses. As a result, an otherwise profitable medical marijuana company may in fact operate at a loss after taking into account its income tax expenses.
4. Zoning Restrictions. As discussed in a previous blog post on medical cannabis dispensaries, certain municipalities have imposed or may impose zoning restrictions on cannabis cultivators, processors, and retailers. Limitations on location can have a detrimental effect on the company’s financial and growth objectives, and political influence could result in future zoning changes.
5. No Federal Trademark or Trade Secret Protection. The United States Patent and Trademark Office will not permit the registration of any trademark or patent that identifies marijuana products or processes. Although certain common law and state law trademark and trade secret protections may be utilized by the company, there are some federal remedies that cannot be used. For example, when using federal trade secret protections, an aggrieved party may obtain an ex parte court order to seize the stolen trade secret material, giving the aggrieved party the element of surprise when recovering stolen material. The same remedy may not be available under state law. A medical marijuana company should consult an experienced intellectual property attorney to determine the best methods to protect its intellectual property.

Be sure to check back in the upcoming days for a continuation of this discussion, including a list of the five remaining important risk factors.

Possession and distribution of marijuana for any purpose is illegal under federal law. KMK can only advise clients regarding compliance with Ohio state law on medical cannabis, specifically, Sub H.B. 523 of the 131^st General Assembly.