LA Cannabis Social Equity Partnerships

The Los Angeles Social Equity Verification period came to an end at 4pm on Monday, July 25th. Recall that verification is required to enter into the Social Equity Retail Lottery this Winter. The verification period will be followed by a 90-day review period. Then, the Department of Cannabis Regulation (DCR) will notify qualified applicants of their eligibility to enter this cannabis licensing lottery.

For those that don’t qualify or fail to obtain verification, consider forging a partnership with a verified applicant who wins a lottery ticket. We won’t know who those folks are until after the lottery this winter. However, it makes sense to begin considering your options. Even if a verified applicant doesn’t win the Social Equity Retail Lottery, other licensing options are available. For example, cultivation and delivery licensing will only be open to verified social equity applicants until 2025.

Moreover, for those of you who are social equity applicants awaiting verification, knowledge will be your greatest tool in establishing successful, balanced, partnerships with investors or incubators. This blog has written extensively about the risks that present themselves with these kinds of partnerships, and more generally about cannabis partnerships. As a general rule, partnerships last longer and produce greater benefits when all parties stand on equal footing.

Some social equity licensees won’t mind allowing a management company, investor, or incubator to take over the day-to-day operations of the company. Many will want to maintain decision-making authority over their business and brand. Either way, the regulations require that the social equity owner maintains voting and economic rights conducive to their ownership share (51% or more). And, either way, social equity partners should have adequate business acumen. More on this below.

How to forge a relationship with a compatible Social Equity licensee

Ultimately, this decision is about compatibility. Trying to force a social equity owner to accept a minimized role in their own corporation is bound to end in a lawsuit. Similarly, expecting an owner without cannabis business experience to make key decisions could result in financial loss for the company.

If you’re an individual investor (or group of individual investors) that knows very little about what it takes to operate a business in the cannabis space, it makes sense to find a social equity partner who possesses that knowledge to manage operations for the company. We’ve written on this blog before about entity selection. In this scenario, an LLC would be your best choice for most entities owned by a social equity applicant. This arrangement allows the social equity partner to manage the company. Meanwhile the partner-investor takes on the administrative roles related to finance and budgeting. In this way, the investor keeps an eye on the spending of their capital contribution, while the owner-operator focuses on building a successful business.

If you’re a management company, institutional investor, or incubator, you might seek out a social equity partner comfortable with just voting and economic rights and the accompanying right to elect a number of board seats. It also makes sense to form a C-Corporation in this scenario. A C-Corp allows for more flexible fundraising while maintaining the licensee’s control of the company. That way, the company’s structure satisfies regulatory requirements, affords the social equity partner adequate authority over their company, and enables the management company or incubator to conduct a profitable business.

There are of course important tax considerations that need to be made when choosing between a corporation and LLC, and social equity applicants and their partners should consider these with a qualified tax advisor. In general, having a solid operating plan will attract further investment to sustain the company through its start-up stage.

Social Equity licensees: Here’s what you should know before seeking investment

Social equity partners historically get the short end of the stick when it comes to these deals. To avoid that outcome, it makes sense to learn basics business. You should also find an attorney to represent you at the negotiating table. Once upon a time, my mother and I sought cannabis licensing and these are all things I wish we’d known at the start.

     1.  If you intend to operate your cannabis business, start drafting a business plan now

If you know the industry well, you probably have a lot of great ideas. But great ideas are best on paper. Begin the process now of evaluating whether they’ll work in practice. We have explained before that a cannabis business plan is a great tool for that. Good business plans contain:

an executive summary: self explanatory, just sums up the other sections and includes some information about yourself and anyone else who will operate the business with you.
an overview of the products and/or services: what will you contribute to the market? and how?
a marketing analysis with a corresponding marketing strategy: who is your consumer base? how will you reach them?
financial planning, and key budget elements: how much money will you need to operate? and how will you spend it wisely?

You can share your business plan with trusted friends and advisors for feedback.

Even if you don’t intend to operate, you should decide what kind of business you want to run, beyond just the license type. Do you want to be a retailer that serves high-end consumers and tourists, or a mom-and-pop shop that serves communities and patients? Knowing will help you identify the right kind of incubator or management company.

       2. You should consider who you’d want to employ to help you run your business

Having a team and a plan in place before you seek out start-up funding ensures that you’re taken seriously by investors. Even if you don’t plan to operate your business, you should still build a team of advisors who might even serve as board members for your C-Corp, or otherwise provide you with counsel in making key decisions.

If you’re a lone-wolf with a huge investment company or management company as a partner, you’re bound to feel outnumbered. It’s vital to have people who are knowledgeable about business in your corner. That person could be a family member, your pastor, or your barber who owns his own shop. The advice and support of someone you trust and the representation of a good attorney will keep you on relatively equal footing with even a large corporation.

     3.  Read and stay updated on the regulations

This represents one of the most important practices of a good owner-operator. You want to be the first to know when a new law or rule will effect your business. We write extensively about regulations on the Canna Law Blog. But if you can, read them for yourself, attend regulatory meetings, and discuss them with your team of trusted advisors. It might benefit you to join a trade organization. These groups often update their members when new laws affect the trade, and advocate on members’ behalf. This is key, as social equity licensing has been a regulatory rocky road from the start. I wrote a guide to advocating for better regulations earlier this summer, which I encourage you all to read.

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