Clear Rules Still Needed for Crowdfunding in the Cannabis Industry

The populist wave surging through U.S. politics is also reinforcing the developing cannabis industry nationwide as major institutional financing sources continue to shy away from lending to the stigmatized industry due to the legal gray space between federal and state laws and regulations. As a result, investors are reluctant to risk putting their money in businesses that the federal government consider illegal, but is legal in some states.

But filling the void is the populist, high-tech financial source of crowdfunding. Today, there are four main online crowdfunding sites raising money for the cannabis industry. Combined, these sites have raised over $18 million in new money for about 134,000 new ventures nationwide, according to published reports.

The money has been used to open a variety of cannabis-related businesses in agriculture, arts, charities, marijuana dispensaries, products, and plant grow sites, but this is not without risks, especially when it comes to unanticipated actions by the SEC, DEA and the Justice Department which can challenge or enforce laws against the company itself, its products or the actual capital raising activities.

Without crowdfunding as an alternative source of new capital, cannabis industry entrepreneurs relied on their own financial sources. Over 80% of cannabis business owners relied only used their own savings and credit cards to launch their operations since banks avoid this industry, according tocrowdmapped.com.

But since the financial industry capitalizes on any voids, online lending emerged as individual became willing to assume the risks and, in the process, invest in one of the few agricultural product that are declared illegal by the federal government.. So despite the legal uncertainties, and possibly as a result of the surging populist sentiment, more investors and business are partnering in the crowdfunding industry.  According to Randy Shipley, founder of Cannafundr based in Chicago, his group has done about one dozen deals with private investors, so far in 2015.

But like most aspects of the cannabis industry today, there is always a legal hurdle to clear.  Since crowdfunding requires online commerce, but faces financing problems, legal experts have jumped into the fundraising activities to promote industry growth. This is especially important for states which have currently made cannabis legal and want to promote the industry.

In raising money on an intrastate basis, a state can enact their own legislation making an exemption for “intrastate” crowdfunding. This pertains to a person or business seeking funding where the parties reside in the same state. Currently, 12 states have crowdfunding laws in the books. Of those states, six (Colorado, Maine, Maryland, Michigan, Washington and Wisconsin) have legalized medical marijuana. These six states have passed legislation to encourage crowdfunding, as well as to legalize the growth and sale of marijuana for medical purposes.

But the crowdfunding market is changing.  According to Thomas Coke, a crowdfunding expert and a former state securities regulator in Michigan who helped work on the policy behind the crowdfunding legislation, crowdfunding still must educate investors about the risks involved. He also said state and federal laws and regulations are at odds in some crowdfunding issues and this has to be resolved before the industry can move ahead significantly.

There is also a need for the SEC needs to clarify how social media can be used at the state level to raise money.  For instance, he said some daily men in Michigan made goat cheese and wanted to advertise their intent to raise money for expansion, but they could not use social media for their crowd funding. “As crowdfunding becomes more popular, more people will figure it out,” Coke said. “But there is still the disconnect between crowdfunding that works in traditional industries, but not in the cannabis space.”

Coke said there is a new regulation being developed that will offer crowdfunding to individual investors in any amount. This would change laws in a state so anyone can participate in a crowdfunding offering.  To date, 24 states have changed their rules to allow state resident to invest in a company that is registered in that state, Coke said, but it cannot be marketed to people outside the state.

In addition, there are restrictions on the use of social media, but it can be done with certain restrictions.  Some business owners have used crowdfunding, such as Kickstarter, to raise money and then used that capital to help secure more lending from traditional sources.  That happened in Michigan, Coke said, when a bank matched money raised via crowdfunding.  In another twist, some state banking associations do not view crowdfunding as competition. For example, the Michigan Bankers Association has endorsed crowdfunding as a way to stimulate the local economy.

Coke also noted that it is important for investors to fully understand the risk factors involved in any cannabis-related business crowdfunding deal “because the SEC can shut it down at any time, and investors have to understand this.”  Investors should also understand the risks between THC vs non-THC companies and product investments, he added.

Looking ahead, some experts predict that in a few years, the cannabis industry will be larger than the beer industry in terms of dollars.  In the United States alone, cannabis sales generate over $90 billion annually. Next year legal marijuana sales will easily more than double and although only now in its infancy the industry is already on the radar of many crowdfund investors and crowdfunding industry trend watchers worldwide, according to the site www.crowdmapped.com.

Chuck Epstein is an award-winning writer, who has held senior-level marketing and communications positions at the New York Futures Exchange, Chicago Mercantile Exchange, Lind-Waldock, Zacks Investment Research, Russell Investments and Principal Financial.  He has won national awards from the Mutual Fund Education Alliance (MFEA) and his site, www.mutualfundreform.com, was named best small blog in 2009 by the Society of American Business Editors and Writers (SABEW).