[co-author: Elena Markos]
Congratulations to those who won a cannabis social equity license in the Maryland lottery! To take advantage of this exciting business endeavor, check out these suggested priority actions and read on for essential considerations around raising capital. (Note that this article is current as of May 6, 2024, and cannabis regulations and guidance can change quickly.)
Background: Maryland Cannabis Administration Awards Social Equity Licenses
The Maryland Cannabis Administration (MCA) recently concluded a social equity licensing application process that ran from November 13, 2023, to December 12, 2023. On March 14, 2024, MCA conducted a license lottery for the social equity licensing round. Licenses were awarded for micro and standard grower, processor, and dispensary categories.
The MCA received 1,708 applicants for the 179 new social equity licenses. A limited number of applications did not satisfy the MCA's minimum criteria. These applicants were notified and could attend a records review with MCA to identify specific deficiencies in their application.
License Application Breakdown
(by licensing category)
If you were among the lucky winners, what is next (besides these priority items)? For most winners, raising money to build their businesses is the top priority. Across the U.S., cannabis license holders struggle to raise capital. And, importantly, if a capital raise for a Maryland cannabis social equity licensee is improperly structured, well-intended efforts to raise money may violate Maryland law and result in revocation of a license or even jail time.
Maryland Requirements for Social Equity Cannabis Licenses
To properly understand a state regulatory system, you must understand the applicable statutes, regulations, and published guidance. (Of course, you also need practical experience with enforcement trends.)
For structuring social equity financings in Maryland, these are the relevant sources of information:
- transfer of ownership guidance
- transfer of ownership during pre-approval or conditional licensure guidance
- the latest adult-use cannabis regulations (which will go into effect by June 30, 2024)
- Alcoholic Beverages and Cannabis Article, §36, Annotated Code of Maryland (note one statute covers both medical and adult use in Maryland)
- the recently signed House Bill 272.
- (Please note there are also final medical cannabis regulations, which are outside the scope of this article.)
To save you time, we have summarized the applicable documentation and key provisions:
Ban on Conditional License Ownership Changes and Transfers
No ownership interest changes are permissible before the award of a conditional license, and conditional licenses are not transferable.
Equity Ownership Requirements
Social Equity Applicants must hold at least 65% of the equity, and the individual(s) listed as SEA on the application must maintain at least 51% of the equity in the business.
Mergers & Acquisitions Prohibited for Five Years
No transfers of control are permissible for five years after final licensure.
Definition of Control
Control means the decision–making authority over the management, operations, or policies of the business or authority over the technical aspects of the company. "Control" includes the right to veto significant events, appoint or remove directors and officers, make major marketing, production, and financial decisions, or execute contracts totaling $10,000 or more.
Equity Transfers – Material and Non-Material
Upon final licensure, transfers of five percent or less of equity that do not result in a transferee holding more than five percent of the license do not require final review and approval by the MCA (do not try this during the conditional period). Transfers above the five percent threshold require a background check and MCA approval.
Option Restrictions
Investors may not hold options or other convertible instruments that would allow them to purchase control after the five-year lapse period.
Management Agreement (MSA) Restrictions
- MCA approval is needed for an MSA
- Caps on fees (the cap is the greater of 25% of revenue, 50% of net profits, and $250,000)
- Limits on management company controls over IP and product sales
- A prohibition on transferring control via an MSA
Debt
Maryland's statute and regulations do not discuss debt. However, guidance issued by the MCA states that a secured creditor may obtain a security interest in the proceeds of the sale of a cannabis license. These secured creditors must be (i) "lending institution defined under the Financial Institutions Article, §1-101, Annotated Code of Maryland, and (ii) approved by the MCA. In addition, approved lenders can effectuate a transfer of ownership under receivership if permitted by the loan agreement.
Transfer Waiver
Limited circumstances may waive the five-year restriction on transfers of ownership: disability, incapacity, death of the licensee's owner, bankruptcy, receivership (authorized in the new regulations discussed above), or court order.
License Caps
A person or entity may not own or control more than one cannabis grower license (standard or micro), one cannabis processor license (standard or micro), and four cannabis dispensary licenses (standard or micro). These restrictions do not apply to passive investors who hold less than 5% equity and do not control the licensed business.
Strawman Ownership and Criminal Penalties
Maryland has also passed House Bill 272, which includes maximum penalties for strawman ownership of a social equity license (i.e., ownership that is purely nominal and purely for meeting the requirements of social equity licensure). The maximum penalties are a fine of not more than $2,500 and imprisonment for up to one year. Imprisonment as an explicit penalty is a new evolution in cannabis regulations around ownership.
How to Structure Cannabis Social Equity Financings in Maryland
Financing a social equity business requires a delicate balance between the typical challenges of dealmaking and adhering to the governing regulatory requirements. Success in non-social equity investments requires the deal to be a win-win for the investor and the company. However, success in social equity investments must be a win-win-win for the licensee, the investor, and the regulators. All three parties must feel that their needs are met (with the regulator's needs being the adherence to their laws and regulations).
Meeting all three goals is an exercise in balance. A deal that is too rich for the company may not attract investors. At the same time, a deal that is too pro-investor may not pass regulatory muster. All parties must be willing to compromise and strike the right balance that hits all three targets.
Social equity licensees raising capital must ensure that all investment documents meet regulatory requirements. Finally, due to HB 272, parties must be extra vigilant in structuring social equity deals in Maryland because of the risk of incarceration.
State Financing for Maryland Cannabis Social Equity Applicants
Social equity licensees should consider applying for a loan through the Cannabis Business Assistance Fund (CBAF). Learn more about this funding opportunity for Maryland social equity cannabis business applicants.
Next Maryland Cannabis Licensing Round
There is still uncertainty regarding the timing and structure of the second licensing round. The nature of the licensing round will depend on the outcome of a disparity study, the goal of which will be to determine if there is a need for measures to assist minorities and women. Again, depending on the results of this study, the second round may be open to general applicants. However, micro-licenses will remain only available to social equity applicants. The second round should result in the award of the following licenses:
- Standard licenses: 25 growers, 25 processors, and 120 dispensary licenses
- Micro Licenses: 70 growers, 70 processors, and 190 dispensary micro licenses
- 10 incubator space licenses
- 15 on-site consumption lounge licenses
