The startup-laden cannabis industry is probably just right for those who are willing to forego a few extra dollars on their paychecks for the possibility of a bigger payout later when the company grows or goes public.
Giving employees an equity stake is far from an uncommon practice in startups, and companies in turn may see it as a way to save money on payroll and encourage workers to do more.
Ownership interests in the often heavily regulated cannabis industry, however, typically come with regulatory implications by necessity.
In Colorado, which in 2012 along with Washington became the first two states to legalize recreational marijuana use, the practice of giving employees equity has been a heavily regulated process. In fact, some believe that it was too regulated, and what has resulted was not what may have been intended.
A few cannabis businesses, as a way of avoiding the regulations and cost, it seems have been giving employees equity in a sort of under-the-table manner, without proper steps or good documentation.
“Companies are giving equity, but not properly papering that,” said Christine Kessler Lamb, with Fortis Law Partners.
Her practice is largely in Colorado and is focused on employment law.
Lamb has been called in to fix a few such messes in which equity was handed out quickly, and later disputes arose over how much people owned in the business, or whether they owned anything at all.
In some cases employees filed lawsuits in which directors and officers or employment practices liability coverage may kick in, according to Lamb.
House Bill 1090, which was signed last year with effective date of November 2019 with additional work-ins effective in January, may have offered a fix.
Prior to the current framework, everyone was subject to disclosure and background requirements before owning any share of a cannabis business, and any change of ownership was subject to an application and approval process no matter how few shares were being offered.
The old framework seemed to offer good protections and require businesses to dot all the I’s and cross all the T’s, but it was onerous and costly those familiar with the regulations say.
HB 1090 changed part of the code, 2-230 Disclosure of Financial Interests in a Regulated Marijuana Business, which specified the information required to be disclosed in every initial, renewal and change of owner application.
The new law streamlines the ownership and investment framework to focus on those who control the cannabis businesses.
The threshold is now set at 10% or more ownership. Parties at and above that threshold are subject to application and suitability requirements, while the rest are referred to as “passive beneficial owners,” parities less than 10% who are also not in position to control the cannabis business.
Under the change, “indirect financial interest holders,” like financing firms, firms that lease equipment, are also exempt.
Rachel Gillette, chair of Greenspoon Marder’s cannabis law practice, believes the new law will encourage more cannabis businesses to offer equity and do so without fear of all the regulatory red tape involved.
“We probably had people that were not compliant with the regulatory environment prior to these January rule changes, and you also had people who were just not going to do it because it was too hard,” she said. “I think this is going to encourage employers to maybe offer some sort of equity program to their employees as a benefit.”
Both attorneys said they’ve seen equity become a legal matter when a company becomes successful, is acquired or it is about to go public.
Lamb pointed out numerous sticking points in the process of offering equity and then collecting on it, such as what type of equity was given, when it was given, how long an employee was with a company, how the company is structured.
“Equity means lots of different things,” Lamb said. “What we’ve been finding is there’s two different understandings of what was meant. And when there’s not documentation of what was meant, it’s a recipe for disaster.”
She’s getting a lot of business from such disasters.
“We’re starting to see people form class actions,” Lamb said. “The idea is in the right place. There’s nothing wrong with the idea (of equity). But they don’t think though what that means, or they don’t get legal advice on documenting it.”
One of the most noteworthy cases is when Colorado Springs company Folium Biosciences announced in December 2018 its plans to merge with Australis Capital Inc., a cannabis investment firm with roots in Canada, with the intent of building out a publicly traded CBD company, two employees soon after filed lawsuits over alleged contract breaches.
The suit involves disputes over percentages of ownership, verbal agreements and other matters.
There are at least a handful of other similar suits in Colorado, and Lamb believes more may come.
However, according to Dominque Mendiola, deputy director of the Colorado Marijuana Enforcement Division, which is part of the Colorado Department of Revenue, the main intent of HB 1090 was to clear some of the red tape for large corporations to have an interest in Colorado businesses.
“What we understood to be the focus in HB 1090 was to expand opportunity for investment in ownership of marijuana businesses in Colorado,” she said.
The law would enable businesses, as well as employees, to have small investments in Colorado firms, she explained.
Mendiola, who said the division has yet to see what she’d call an abundance of lawsuits or complaints over employee equity in cannabis firms, believes it’s too soon to tell if the new law will have the intended effects of bringing in more outside investors to the state’s cannabis industry.
If the law does work as intended, and more investors do start to take interest in Colorado cannabis businesses, more conflict could arise.
“There’s a lot of outside investors come in and they ask who owns this company, and sometimes that’s not a clear answer,” Lamb said.
Lamb recently worked with a Colorado company that was sold for a large sum of money to a big Canadian cannabis conglomerate.
After the company, which Lamb declined to name, was sold, current employees were given stock in the Canadian company.
“Everyone that has ever worked at this Colorado company said, ‘Hey, wait a minute, I used to work there, and when I worked there, I was promised some form of equity,’” she said. “I had a flood of ex-employees that all came forward when they heard the company was sold, all of them saying, ‘I get a piece of the sale.’”
She helped the company avoid litigation with six months of “clean up” work in which she went one-by-one to former employees and requested documentation, including when the employees worked for the company, when they were promised equity, and how much.
A sticking point became the time period during which employees said they were promised the equity and how big the company was at that time.
A startup that’s slightly more than just an idea, for example, may have no assets.
“And you’re an employee on the ground floor and you have 10%,” she added. “What’s that worth?”
At that point, an employee’s equity is probably worth roughly $0.
Lamb was able to either convince employees that they weren’t owed anything, or those who were owed something got paid out, she said.
“When I was picking off each individual person, I had to figure out when did they show up, when did they leave, what document they signed, if any, how long they worked there, were they there long enough to vest,” she said. “It affects the terms of the deal.”