There are a lot of bad ways to set up a cannabis business, and we like to think that we’ve seen them all. But there’s probably no worse category than 50/50 ownership of a business – a recipe for all sorts of disasters. Let’s look and why that is, and some ways to avoid it.
When I talk about 50/50 ownership, I mean two people or entities who own all of the outstanding voting rights in a business. For example, this would mean two people who each own half of the voting shares in a corporation or half of the membership interest in an LLC. This is an extremely common set-up for smaller companies where two partners may want to have equal control of a business (I may use the term “partner” in this post for ease of reference even though they’d be referred to as shareholders in a corporation or members in an LLC). But we’ve even seen bigger or more established companies try to have 50/50 joint ventures.
50/50 ownership means that any decision that must be put to a vote effectively needs unanimous approval because the vote of one owner doesn’t hit the majority threshold. While at first, most partners are aligned, over time as a business has ups and downs, those partners’ visions for the company drift apart – especially where a company is underperforming or has taken on a lot of debt. So inevitably, the partners will disagree and if those disagreements become too pronounced, votes won’t succeed and the company will grind to a halt.
In cannabis, it’s very common for someone with zero cannabis experience but lots of money to link up with someone with tons of experience and no money. Inevitably, some big decision will need to get made. The “experience” partner will want to go one way and justify it with their years of experience in the industry. The “money” partner will think the decision is too risky or not smart and will say “I’m the one putting in the cash, I want to call the shots.” This isn’t just a problem in money v. experience partnerships. It happens in all forms of 50/50 partnerships.
What will inevitably happen is one of the partners will lawyer up and ask a lawyer to help them fix the issue. The first thing any (good) lawyer will do is ask to see all corporate governance documents of the company–things like bylaws or a shareholder agreement for a corporation or an operating agreement for an LLC. Here are the three most common scenarios:
- The company doesn’t have any written corporate governance documents. This is bad! And it happens ALL the time in cannabis. In this is case, the partners need to be prepared to kiss their business goodbye or end up in expensive or acrimonious litigation for a few years.
- The company has corporate governance documents, but they either suck or just don’t address deadlocks or have clear dispute resolution provisions. This too is bad, and it also happens ALL the time for cannabis companies. I can’t tell you how many times I’ve seen people pull governance docs they found on Google searches and try to just change a few names here and there to their great detriment.
- The company has good corporate governance documents that have clear deadlock and dispute provisions. The members will then follow those provisions and (hopefully) resolve the issues, though even that process is likely to be painful (not nearly as painful – or expensive – as 1 or 2).
The good news is that there are a lot of ways to avoid this mess, such as:
- Invest in good corporate governance documents at the beginning of the relationships. Partners can either pay a lawyer a small sum at the beginning of the relationship to structure their business, or pay them a very, very large sum later on to try to save it. Lawyers don’t often agree on anything, but this is something where any even somewhat credible lawyer would agree. If partners decide they don’t need governance docs or can just make them from scratch without legal training to avoid a few thousand dollars, it’s not hard to see them cutting corners in other areas (hint hint, compliance). This is by far the easiest way to avoid the above mess.
- Don’t be 50/50 partners! This is another very easy way to avoid grinding a business to a halt in the event of a deadlock.
- Delegate decisions to specific owners. If one owner, for example, gets to make all decisions related to X, and the other related to Y, it’s less likely to devolve.
- Have clear deadlock provisions. A deadlock provision is something in a governance document that will spell out how ties are broken. There are many ways to do this. Often, the decision is put to a neutral third party or a mediator. Sometimes partners may have the ability to withdraw from and be bought out of a company if deadlocks are too frequent. There are many, many ways to structure these and, like with my first point above, paying a lawyer a small sum at the beginning of a venture is a guaranteed way to avoid this.
You may be thinking this is all overly dramatic. It’s not. Our cannabis litigators have seen partnerships fail countless times, despite that it’s an issue that can be easily avoided with a little diligence and investment. Stay tuned to the Canna Law Blog, where we’ll be sure to highlight more bad ideas in the cannabis industry.