Cannabis is a hot new industry, susceptible to illicit investment schemes. Layer on the uncertainty of disparate state and federal laws and regulations, and it’s easy to see why conservative investors are hesitant to get involved. But the promise of profits has led to an influx of money from a wide range of investors.
Hemp and marijuana are varieties of cannabis. The distinction between hemp and marijuana is the concentration of THC, a psychoactive compound. Hemp contains a minuscule amount of THC, while marijuana contains a much higher concentration. As a result, hemp cannot produce a “high.” CBD, the second commonly known compound in cannabis, is not psychoactive and can be found in high concentrations in hemp. CBD is often touted as having medicinal benefits such as reducing anxiety, relieving arthritis pain and aiding in the treatment of seizures. However, until recently all forms of cannabis (including hemp) were illegal at the federal level, and as a result there have been few trials on the medical efficacy of CBD.
A Shift in Federal Regulations
The Agricultural Improvement Act of 2018, known as the 2018 Farm Bill, distinguishes hemp from marijuana and removes hemp from the controlled substances list under the Controlled Substances Act (CSA). While the 2018 Farm Bill legalized hemp on the federal level, it also preserved the Food and Drug Administration’s regulation of cannabis-derived compounds, including CBD and THC.
Many companies have disregarded the FDA’s guidance and continue to produce consumable products containing CBD. The FDA has limited its actions to sending warning letters to companies selling CBD products that make unsubstantiated health-related claims.
The Cannabis Investment Canvas
Not all cannabis-related investments share the same legal and regulatory risk profile. Investments in companies that do not produce consumable products and do not deal directly with marijuana in the United States generally carry less risk than investments in companies that produce or otherwise work with marijuana in the United States.
Stock exchanges in the United States such as the NYSE and NASDAQ do not permit the listing of companies operating in violation of federal law. Accordingly, as general rule, public companies easily accessible on national exchanges do not operate in the marijuana space within the United States, or operate in a gray area, not “touching the leaf,” but part of the U.S. marijuana industry in tangential roles. For example, Innovative Industrial Properties Inc. (NYSE: IIPR), a REIT, focuses “on the acquisition, ownership and management of specialized industrial properties leased to experienced, state-licensed operators for their regulated state-licensed cannabis facilities.”
Publicly traded tobacco companies are also testing the boundaries. Turning Point Brands Inc. (NYSE: TPB), and “other tobacco products” company, owns Zig-Zag, a brand of rolling paper synonymous with marijuana in pop culture. More clearly illustrating Turning Point Brand’s foray into, or right up to, the cannabis industry, is its 2018 purchase of a 19.99 percent interest in Canadian American Standard Hemp (CASH) headquartered in Rhode Island, which manufactures CBD. The investment in CASH was followed by Turning Point Brand’s formation of Nu-X Ventures in 2019 which is working with CASH to bring CBD products to market.
Perhaps closest to a true publicly traded “U.S. cannabis company” is Greenlane Holdings, Inc. (NASDQ: GNLN). Greenlane, a Delaware corporation with principal offices in Florida, conducted its IPO in April 2019 and offers products to market in the head shop, smoke shop and dispensary channels. Though Greenlane does not touch the leaf, it represents a new level of transparency from a U.S. pubic company regarding its participation in the marijuana business.
Canadian companies listed on U.S. national exchanges and operating in the cannabis industry outside the United States present another channel to cannabis investing. Several Canadian companies, including Canopy Growth Corp. (NYSE: CGC), Tilray Inc. (NASDQ: TLRY) and Aurora Cannabis Inc. (NYSE: ACB), all maintain market caps well in excess of $1 billion.
Both U.S. public companies that do not touch the leaf and Canadian companies that do not operate in violation of U.S. federal law represent relatively conservative investments compared to companies directly involved in the production or sale of marijuana in the United States. These companies in the industry, but not directly involved in the production or sale of marijuana in the United States, can be viewed as striking a balance between risk and reward – poising for expansion if marijuana becomes legalized under U.S. federal law, but avoiding potential repercussions from violating federal law until such time.
With the emergence of cannabis stocks, several cannabis exchange traded funds are available. An ETF is an investment fund traded on a public exchange that allows investors to easily diversify throughout an industry. Cannabis ETFs now provide investors with the ability to diversify their investments within a subset of the cannabis industry, such as small cap companies or Canadian companies.
Private companies have greater flexibility than public companies to operate directly in the federally-illegal marijuana business. They remain susceptible to action by the federal government. As the cannabis industry expands, companies are increasingly looking to private investments as traditional sources of capital are often not available due to the unlawful nature of the businesses.
Investing in private placements of cannabis companies comes with risks. Without disclosure requirements, private companies may leave investors with little information relating to the operation and health of the business. Moreover, private companies’ ability to produce and sell marijuana, even in states where such activities are legal, brings the increased risks of operating in violation of federal laws.
Unrelated to cannabis, private placements often have limited liquidity, require reliance on forward-looking statements, are subject to significant dilution and present tax risks unique to each investor. Private placements are also generally only available to accredited investors.
The legalization of hemp at the U.S. federal level and expanding legalization of marijuana at the state level are attracting investors in the cannabis space. As the industry matures, more opportunities will become available. But risks remain, most notably that marijuana remains federally illegal as a controlled substance. Equipped with an understanding of the federal and state, legal and regulatory frameworks surrounding cannabis, investors can better assess the risk of a potential investment.
Guy Lander is a partner, Alexander Malyshev is counsel and Matthew Schwatrz is an associate at Carter Ledyard & Milburn. They are members of the firm’s Cannabis, Hemp and CBD Industry Group.