Many folks in the cannabis industry – especially legacy operators – have little to no experience with corporate governance. I don’t mean to say that they don’t know how to run a business; they likely do. What I mean when I refer to corporate governance is the actual process of adhering to governance agreements, getting required votes, papering corporate actions correctly, and so on. This is an issue in a regulated market where operators are essentially forced to contend with organized entities that must be governed appropriately.
Last year, I looked at why corporate governance is important. In that post I talked about some common corporate governance mistakes. Today I want to get into detail on some of the common corporate governance mistakes our cannabis lawyers routinely see in the industry.
#1 OVERISSUING STOCK
Entities are formed by submitting documents to a state agency. In California, for example, the filing of articles of incorporation creates a corporation. Depending on the state and entity type, the incorporator or organizer must identify how many shares of stock the company can issue in this initial filing. If the entity wants to issue more stock than the initial filing authorizes, it must amend the initial filing.
The problem is that cannabis companies often ignore their initial authorization caps and issue stock above and beyond the cap. This is a huge problem! It could mean that the additional stock is unauthorized and even invalid, exposing the company to liability from the persons holding the unauthorized stock. There is a very simple way to resolve this: keep an eye on stock caps and amending articles of incorporation to allow more stock. Unfortunately, for many cannabis companies, this basic corporate governance feature often gets overlooked.
#2 IMPROPERLY CREATING MULTIPLE CLASSES OF EQUITY
Similarly, let’s say a corporation’s articles only authorize common stock but the board decides to issue preferred stock. If the corporation doesn’t amend its articles – which happens a lot – the issuance is put into question. That will be true even if the corporation has amended its shareholder agreement or other governing documents.
#3 NOT GETTING REQUIRED VOTES
Most corporate decisions require a majority vote. When drafting a startup’s governance documents, the owners routinely ask to make certain decisions subject to unanimous or super majority (2/3 or 3/4 depending on how you define it) votes. Usually higher thresholds are reserved for big-picture things. But not always! If the company is supposed to get super majority approval to take on new debt over $100,000 and doesn’t get the approval, the company will be in hot water with the owners and possibly the lender.
#4 KEEPING BAD RECORDS
This is probably the biggest issue we see on a regular basis: founders form a company and hire a law firm to prepare a clean set of corporate cannabis governance documents. They pay their lawyers, put the docs in a file cabinet, and never look at them again. Over the years they replace the board of directors, appoint new officers, and even issue new shares without papering any of it. Then, a time comes when they need to execute a deal that requires good governance.
It is a whole lot easier to pay a lawyer to draft up simple and short governance documents or assist with consents or resolutions on an ongoing basis than it is to dig out of a compliance cleanup nightmare like this. It’s also a whole lot cheaper and faster, and doesn’t delay inking a deal.
#5 NOT HAVING A SHAREHOLDER AGREEMENT
This is another big one and applies to corporations. Shareholder agreements are agreements among shareholders to govern a corporation. They generally are not necessary but as a company grows, it would be crazy not to have one.
Lots of founders put shareholder agreements on the backburner until they are necessary, but at that point it may be too late. If a company wants (or needs) a shareholder agreement to close out a deal but one shareholder refuses to sign, all bets are off and the deal could be killed.
These are only just a few examples of cannabis corporate governance mistakes, but they are mistakes we see on a routine basis. We’ll continue to cover more on cannabis corporate governance, so keep reading.
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