Cannabis and Crypto-Currency-The Blind Leading the Blind

A few weeks back I wrote a blog article where I stated that I was not interested in preparing the legal paperwork for any company that was raising funds for a cannabis related company. In the same article I said that I would also decline the opportunity to prepare the paperwork for an initial coin offering (ICO).  Either would be lucrative for me but in both cases I saw significant problems for the investors.

I might have predicted that people would start sending me the paperwork for ICOs that were looking to fund cannabis businesses seeking my thoughts and comments. Two stick out as examples of how not to raise money for your cannabis business.

In July, the US Securities and Exchange Commission (SEC) issued a report on ICOs. Crypto-currency is all the rage this year with some offerings raising millions of dollars in a matter of minutes and coins when issued quickly appreciating in price. Bitcoins for example have been appreciated significantly this year and some people think that Bitcoins are a legitimate investment, an assertion that is questionable at best.

The SEC correctly concluded that most crypto-currency offerings would fall within the definition of a security and thus its jurisdiction.  There was really no surprise as the SEC initiated about a dozen enforcement actions against crypto-currency issuers before it wrote its report.

Because an ICO is the offering of securities it is required by law to either 1) register with the SEC or 2) be exempt from registration assuming that an exemption is available. In either case, the issuer of the coins is required to give potential investors all the facts that would be material to making an investment decision.

If investors who purchased the coins got a discount on an ounce or two of marijuana the coins might not be securities. These two cannabis ICO offerings are clearly offering securities.  In both of these cases, investors profit if the underlying business profits which is more than enough for these to be securities and the SEC to have jurisdiction.

There are some facts which the SEC and any securities lawyer would consider to be material. This would include who is running the company; how much money is being raised and what will it be used for; the basic structure of the company’s ownership; how investors get paid and how much they might expect; an idea of the size of the market in which the company intends to compete and the names of the companies that are its major competitors.

Nothing really earth shattering,but the SEC has been reviewing offerings and ruling on how these facts are disclosed for decades. Making the disclosures correctly requires a fairly good idea of what the SEC expects and an equally good idea of the operation of the business offering the securities which is why securities lawyers who prepare offerings really have to know what we are doing.

The first cannabis ICO I looked at was for a company called Growers International.  Like all ICOs it uses a “White Paper” (which it prefers to call a “Green Paper”) instead of a traditional prospectus.  I doubt that it was prepared by a securities attorney. (I would suggest that you might add the words “Like, cool” or Yeah, man” between the sentences and it would read like the script of an old Cheech and Chong movie but I do not want to insult Cheech or Chong.)

From the Green Paper: “Q: Why should I trust the team? How do I know this isn’t a Pump & Dump situation?  A: We ask that all investors do their research on the people behind Growers International. Our lead developer has found success in both the cryptocurrency arena as well as in the cannabis industry. If there is any question regarding the legitimacy of the project, we encourage investors to reach out to Ryan (Lead Dev) personally on slack.”

It is always a good idea to research the people who are running any company into which you are making an investment.  In this case the “Green Paper” discloses the management to be: “Lead Developer: Ryan Wright (34, California / Taipei); Blockchain Programmer: Eddie E. (48, New Zealand); Web / API Developer: Michael J. (32, Maidenhead, England); Social Media Director: Devvie @Devnullius (40, Sweden); Community Coordinator: Jeremy Toman @MadHatt (37, Canada) who prefers the name ‘Tyler Dirden’ or ‘MadHatt’;Graphic Designer & Cryptocurrency Consultant: Chris S. @Elypse (26, Detroit); Community Manager: @DayVidd and Bitcointalk Manager & Financial Consultant: Dr. Charles @drcharles (26, USA).”

I suspect that if you contact Mr.Wright as suggested he will vouch for them all if he bothered to ask their last names. Do not bother to ask about Members of the Board of Directors as they have apparently not yet been appointed, so one Director might turn out to be Pablo@Escobar.

The other cannabis related ICO I reviewed is prepared more professionally but still, in my opinion, misses the mark by a good country mile. The company is called Paragon Coin, Inc. It is in the process of raising $100 million through the ICO. Just to be clear Paragon supports the cannabis industry, it does not appear that it intends to grow or distribute cannabis itself.

Paragon intends to bring block chain to the cannabis industry.  It intends to use a distributed ledger to bring order to this fragmented industry. According to the White Paper the company intends to “offer payment for industry related services and supplies through ParagonCoin; establish niche co-working spaces via ParagonSpace; organize and unite global legalization efforts through ParagonOnline; bring standardization of licensing, lab testing, transactions, supply chain and ID verification through apps built in ParagonAccelerator.”

All that is fair enough and the names and pictures of the operating personnel are included. Their education and work histories going back 10 years which I would have expected to see are not present.

The White Paper clearly notes that cannabis is not legal at the federal level and asserts that it will only operate in states where it is legal. This is the prime oxymoron of the cannabis industry.  Illegal at the federal level is illegal everywhere. Marijuana is a Schedule I drug and possession or sale is a felony in all 50 states. That is a fact about which that the cannabis industry does not want to think and largely ignores.

The Paragon White Paper describes one of the Risks of investing in its coin offering as follows:




This derives verbatim from the Cole Memorandum which was written in 2013 as a direction from the US Department of Justice to Federal prosecutors as to how they should allocate their resources when they decide who to prosecute and for what. It never made cannabis legal anywhere.

More importantly, the Cole Memo it is not an Act of Congress or Federal regulation and not binding on the current administration in any way. Any suggestion that it will continue to be followed under the current administration is wishful thinking given the Attorney General has repeatedly stated that it will not.

Medical marijuana has been legal in California for more than a decade. That did not stop the federal government from raiding and closing down a large medical dispensary in Oakland, CA in 2012. Parenthetically, Paragon’s initial co-working space is slated to open in Oakland, California.

Perhaps the most troubling aspect of this offering is that it intends to fund the use of block chain, a relatively unsecure distributed ledger to link the many growers and suppliers in the cannabis industry. If successful it may well deal a serious blow to the cannabis industry it is trying to support.

One of the leading ICO platforms, Coinbase, has been engaged in a two year battle with the Internal Revenue Service which wants a list of all the people who use its platform to trade Bitcoins. The IRS alleges that people are trading the coins profitably and not reporting the gains and paying the taxes. The US government has also alleged that drug cartels and other bad actors use crypto-currency to launder money.

If you are in the cannabis industry you have certainly heard stories of how the DEA would obtain the customer lists of hardware stores that sold supplies for hydroponic growing. Everyone who was a customer did not use these supplies to grow cannabis but the government used those lists to identify and prosecute people who did.

If you have a “decentralized” list of a large group of people who are on the list only because they are affirmatively in the cannabis business as Paragon wants to create, how long do you think it will take for the US Government to obtain it? Think that will be difficult because Paragon never touches any marijuana or sells it?

The CEO of Paragon, Jessica VerSteeg, is also CEO of AuBox which the White Paper describes as “an upscale marijuana delivery service in the SF Bay area”. That is more than enough “probable cause”for the DOJ to get its hands on Paragon’s distributed ledger and the names of every company that uses it. The icing on the cake will be when they tell the judge that the cannabis industry is full of drug cartels and money launders which, of course, it is.

When you write the risk factors for a securities offering, it is important to disclose all of the things that might reasonably occur.  Assuming that this ICO raises the $100 million that it seeks, it is certainly within the realm of possibility that the Attorney General might just seize that money under the federal asset forfeiture provisions. The people behind this offering somehow refuse to accept that there was an election last November and that there is a new sheriff in town.

What I took away from these two offerings was a sense that they were prepared by amateurs who were attempting to do something that was way over their head. In this current administration, raising money for a cannabis company waves a red flag in front of the US government. Compounding that fact by raising money through an ICO just increases the size of that red flag, exponentially.

I personally do not think that there is any hope for Green International but Paragon did not demonstrate that it needed $100 million and could have certainly raised a lesser, more reasonable amount in a more traditional fashion which is what I would have advised them to do if they had asked me.



Is Technology Changing Finance?

A lot of people seem to believe that technology will fundamentally change or disrupt finance and the financial markets.  Many, if not most, of those people seem to be developing technology, selling it or using it to sell products to investors and financial consumers.  Most of these people seem to have degrees or backgrounds in technology not finance.

Having a background in technology does not give you an understanding of finance or the financial markets.  You cannot fix or disrupt what you do not understand and the lack of understanding behind many of these products is simply ridiculous.

I only write about the law and the financial markets. I spent my career as an attorney working in and around the financial markets. I also taught Economics and Finance so I have a pretty well rounded idea about how the capital markets work and how they are evolving.

So I feel perfectly justified to call out the many techies who think they understand the financial markets even though they have never worked in the markets or studied finance. Nonetheless many seem hell-bent to create products that they think are making these markets better and are quick to label the products that they sell as “disruptive”.

I call these people the “algorithms fix everything” crowd.  It is an interesting thought, except that these mathematicians have no math to back up much of what they say about finance.

At the same time, there is an ongoing narrative that suggests that everyone who works in the financial markets is evil. I find it amazing how many people actually think that all bankers and stock brokers get up in the morning thinking “who can I screw today?”  I have personally brought more than 1000 claims on behalf of aggrieved investors against Wall Street firms and written a book about some of the really bad things that Wall Street firms can do, but even I know that Wall Street firms are not evil.

The capital markets handle millions of transactions every day involving trillions of dollars and the almost all of those transactions settle with both the buyer and seller happy. Banks and stockbrokers fund schools, universities, roads and hospitals and virtually every company since WWII, again without serious problems or complaints from anyone. Banks aggregate and intermediate capital and over all they do it quite well.  So what, exactly, needs disrupting?

Still there is a never ending stream of new products and services which claim to be revolutionary and which promise to disrupt the capital markets. On closer examination many of these innovations are more hype than substance. Say what you will, there is nothing disruptive here.  A few examples for your consideration:

1) Algorithmic stock trading – This is a good place to start because it is pure technology applied to the existing markets. “Quant” traders use computers to evaluate trends and trading patterns in the market of various securities. They attempt to anticipate the price at which the next trade or subsequent trades will occur.  Logic says that computers should be able to take in more information that is pertinent to stock trading, analyze it almost instantaneously and execute transactions in micro seconds.

It sounds right, but the reality is that all stock trading is binary; every buyer requires a seller. No one buys a stock unless they believe that the price will appreciate; sellers generally will only sell shares when they think the price will appreciate no further. Both sides to any trade cannot be correct.

Analyzing the information or executing faster is of no use unless each trade you make is profitable.  No one has yet figured out how to accomplish that, nor are they likely to do so.  What we are talking about is predicting the future which is difficult to do even if only a micro-second or two ahead.   And please do not suggest that artificial intelligence will change this.  If there is one right answer based on the current information, e.g. buy APPL, then who is going to sell it?

2) Robo investment advisors- These are similar but much less sophisticated. Robo-advisors do not actually attempt to anticipate future market performance. They make investment recommendations based solely on the past performance of the markets. Anyone who has ever bought a mutual fund is required by law to be told that past performance is not a basis for future results. But that is all you get with a robo-advisor.

FINRA did a study of a half dozen robo investment platforms and found that they provided widely divergent portfolios for the same types of investors. No robo is any better than any other and none is really worth anything.

3) Crypto currency- It was a discussion about Bitcoins that was the initial impetus for this article. Aficionados of crypto currency actually think that they are developing an alternative currency for an alternative financial system. People seem to want to just print their own money and on one level I can understand that.  But that level is more of a fantasy than reality.

The reality is that I can buy food or virtually anything else in most places in the world with US currency. Why do we need Bitcoins? What exactly, is their utility?   When I ask that question I get any number of weak responses. More often than not, I get a tirade about banks and/or governments being evil.

What proponents of crypto currencies never want to face is the fact that the crypto currency market has been full of people laundering money from illegal activities.  The banks that crypto currency fans love to hate are required by law to know their customers and have systems in place to prevent money laundering.  It costs money to follow the law and have those systems. It is money that the crypto currency platforms do not want to spend. If there is a common thread in the crypto currency world, it is that people want to skirt or simply ignore the regulations that keep the markets safe and functioning.

4)  Crowdfunding Platforms- Crowdfunding clearly works and works well as evidenced by the significant amount of money that it has raised for real estate and real estate development projects.  At the same time the crowdfunding industry is populated by a great many people who fall into the “I do not care what the rules say, I am in this to make a buck” crowd.  I have written several articles about how some of the crowdfunding platforms do not take the time to properly verify the facts that they give to potential investors.  Due diligence can be expensive and some of the platforms just refuse to spend what it takes to do it correctly.

Crowdfunding replaces the role that stockbrokers typically fulfill in the process of raising capital with a website and do it yourself approach.  With a stockbroker, the company that was seeking capital got that money the vast majority of the time because the brokers were incentivized to sell the shares. With crowdfunding it is very much hit or miss whether the company will get funded. Many of the better crowdfunding platforms charge close to what a brokerage firm would charge and the investors get none of the protections or insurance that they would get with a stockbroker.

5) FinTech and FinApps – I can go to my bank’s website and send a payment to my electric utility company. I can do the same at the utility company’s website. I admit that it is convenient, but it is hardly disruptive.   Remittance companies like PayPal merely move money from my bank to a vendor’s bank.  And PayPal posted a $3 billion profit in the last fiscal quarter.  So they may charge less of a fee per transaction than a bank, but is not essentially different, and again while PayPal holds my money, I get no insurance against hacking or theft.

Apps that allow me to apply for a mortgage on my phone are really doing no more than eliminating a bank employee who would enter the same information from a written application into the bank’s computer. Again, it is convenient but not necessary.  And the money for the mortgage comes from either a bank or stock brokerage firm so there is nothing disruptive here, either.

Is there nothing truly new and disruptive in finance? Of course there is. They deservedly gave the 2006 Nobel Prize in Economics to Muhammad Yunus for developing a system of micro-finance that continues to create millions of entrepreneurs and lift millions more out of poverty. I doubt that one line of computer code was needed.

Micro-finance has the ability to put globalization on steroids.  Who will be disrupted?  Quite of few people with big school pedigrees and enormous student debt who write code to disrupt finance but who never understood finance in the first

The Start-up Funding Wars-Another Dispatch from the Front Lines

I speak with start-ups and business owners who are trying to raise capital for their businesses several times a week.  Some are my age or close to it; others are very much younger.  Most know their own business well, but few understand the ins and outs of raising capital which is why they call me in the first place.

If I take on the task of helping a start-up raise funds I can usually get them the funds they need.  That is not an idle boast. I will not even attempt to help a company solicit investors if I do not think that the company is a good investment.

That is unfortunately the case with the vast majority of the companies with which I speak.  I will review any pitch deck and offer comments and suggestions for free.  I will spend an hour of my time on the phone with any entrepreneur, no charge. Most simply do not measure up.

What I want to hear is that you have a business.  I want you to tell me that you have a product; that you know what it will cost to source your product and that you have actual customers who have bought or at least used the product and have reacted favorably to it.  If you are not yet at that stage, at the very least I want to know that you are close.

The difference between raising funds for a product that has been developed and raising funds to develop a product is huge. The number of investors who will take a chance on the latter is much smaller. It can still be done but it might take a little more time and money to reach them.

The two things that I do not want to hear is that your product will “disrupt” the market or that your company is destined to have a billion dollar plus valuation.  Neither is likely to come true.  I would rather hear that you have a good marketing and sales plan in place and have hired good, experienced people to execute it.

Please do not ask me to sign a non-disclosure agreement (NDA) before we speak.  In the first place, I am an attorney at law, so everything that you say to me is confidential if you want it to be.  In the second place, if your product or process is so novel, valuable and proprietary then get it patented.

Please do not send me a pitch deck that has no resemblance to a business plan. If your pitch is all flash and no substance it is not going to work. Investors want to see what you are going to do with their money and how and when your company will become profitable.

Please do not tell me that you have read all the books about funding a start-up and have attended several conferences featuring the best start-up “gurus”.  If you had read all the books that actually count, you would probably have an MBA in Finance.

Sometimes I can help a small company up its game by suggesting that it add some additional directors, patent its product, refine its business plan or change the terms or structure of its offering.  But more often than not, I find myself turning away business.

What I really want to hear most in that first phone call with any entrepreneur is that he/she can close the sale. If you are going to deal with investors, you are going to have to do more than tell them about the great company that you are building. You are going to have to ask them for a check. To get it, you need to tell investors how they are likely to profit from the investment in your company and why you can make it happen.

I am not a philanthropist. I charge for my services albeit less than I used to charge when I was paying rent for an office in a financial district high rise.  I will not work for stock in your business and you cannot pay me later after we raise money for you.

It takes money to raise money.  If you raised seed capital from friends and family to develop your product and did not raise enough to take you to the next level of fundraising at the same time, let me say this judiciously, you blew it.

I generally tell people to budget between $35-$50,000 if you need to raise between $5-$15,000,000.  So far none of my clients have gone over budget and most have spent less, but running out of money would be aggravating to all concerned.

A lot of people ask me to introduce them to VCs. I know a few VCs on both coasts and a few in between.  Most are serious investors meaning that they want to invest in companies that will succeed and produce a good return on their investment.  This is true of all investors, not just VCs.

For most start-ups seeking venture capital is a waste of time.  VCs actually fund very few businesses every year and each has its own funding requirements. The process is time consuming (even companies that get funded can be at it a year or more) and often political (like a lot of things in life it is often who you know that is important).

For most start-ups and small companies, equity crowdfunding would be the preferred way to raise funds.  It can be quick (90-120 days) and inexpensive ($35-$50,000).  I work with several equity crowdfunding platforms and several different marketing companies.  If you start with the idea that you are just going to slap an offering together as inexpensively as possible, put it up on a crowdfunding platform that has dozens of competing offerings and send out an e-mail or two to prospective investors, you are more likely than not going to fail.

I know a lot of people in the crowdfunding industry and I think that I know the best of the best.  I can usually direct a client to an appropriate crowdfunding platform and a marketing firm that will get the job done. I use different firms for different offerings of companies in different industries and at different stages of their corporate development.

Funding is always a team effort. That is why I like to pick the team.  I try to use the best people for each job.  Some charge more than others but like everything else in life, you get what you pay for.

To save time here are three types of offerings that I do not do.

1) Anything to do with cannabis. It is not that I am a wimp on the subject of marijuana. I was in college in the 1960s.  It is just that I can read the handwriting on the wall. Cannabis is illegal in all 50 states, no matter what the state legislature may have enacted.  The current US Attorney General, Jeff Sessions, seems to be getting ready to start enforcing federal law and closing down the retail stores and medical dispensaries.  He recently loosened the rules on asset forfeiture, meaning that nice warehouse where some company is growing cannabis might be seized and sold without a trial.  If I was an investor who helped to fund the purchase of that building I would sue the principals for using my money to participate in an illegal enterprise.

2) Any Reg. A+ offering. Reg. A+ requires the registration of shares with the SEC so that they can be sold to smaller investors. There is more than enough money in the Reg. D private placement market to fund your business. A Reg. A+ offering will likely cost you $150,000 or more to raise the same amount of money. That does not scream “look how smart I am” to any investor.

3) Any ICO. Recently I have been asked by more than one company to do an Initial Coin Offering (ICO).  These are offerings denominated in crypto-currencies. Several have raised significant amounts of money.  The SEC has declared that depending on how these offerings are structured they may be securities. Most of the lawyers with whom I spoke would err on the side of caution if they were asked to prepare an ICO. I got quotes in the range of $150,000- $250,000 just for legal fees. Again why spend that much more than you need to spend to fund your business.  And if you need a gimmick like an ICO to fund raise funds, what does that say about your business?

By refusing to fund businesses selling cannabis, any Reg. A+ or any ICO, I am leaving a lot of money on the table because these offerings, especially the latter two, pay well.  I have the expertise but I also have a reputation. I will not advise a client to use Reg. A+ or an ICO when a Reg. D offering will work just as well and cost them much less.

Good businesses get funded. While 90% of start-ups fail,  the key is to convince investors that you are among the 10% that will not.  If you are unsure, you are welcome to try to convince me first.