Raising Capital for Maryland Social Equity Cannabis Businesses

By Charles Alovisetti, Elena Markos

Sep 27, 2024

This article was originally published on May 7, 2024, and has been updated as of September 27, 2024 to reflect recently published guidance.

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.

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)

License Category	Total Applications	Number Passed	Available Awards
Dispensary	Standard (716)	632	75
Dispensary	Micro (264)	220	8
Grower	Standard (217)	190	16
Grower	Micro (286)	244	24
Processor	Standard (110)	101	32
Processor	Micro (115)	87	24
Total	1708	1474	179

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
Financing options guidance
Webinar on conditional license process and supplemental application presentation
(Please note there are also final medical cannabis regulations, which are outside the scope of this article.)
(The cannabis policy FAQs do not directly address financings and link to the other documents.)

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

For conditional licenses, Social Equity Applicants must hold at least 65% of the equity. And the individual(s) listed as SEA on the application must collectively maintain at least 51% of the equity in the business for a five-year period.

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.

Return of Capital

The new financing options guidance explains that investors may get priority repayment, with a condition. Once their investment is fully repaid, the business must revert to a payment structure that aligns with its ownership structure, distributing profits proportionately. It's important to note that the priority repayment amount must be in proportion to the original investment made.

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 in much detail, other than with respect to the creation of a receivership process.

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.

The link to apply as a creditor is now live.

Receiverships

Maryland regulations allow for receiverships for cannabis businesses.

Transfer Waiver

Limited circumstances may waive the five-year restriction on transfers of ownership: disability, incapacity, death of the licensee's owner, bankruptcy, receivership, 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

Vicente is here to help you bring your cannabis business vision to life. Contact us if you need assistance with debt or equity financings, license applications, or compliance.

Sign up for Maryland cannabis regulatory and licensing updates from Vicente LLP.