Several months ago, we wrote about different ways to reward employees with equity in marijuana businesses. Since then, various other publications have written similar pieces. But there are some lingering challenges associated with cannabis businesses as they attempt to lure and incentivize high-performing employees.
Primarily, the complex regulatory systems maintained by the various cannabis-legal states present some issues to get past. In most of them, any individual with any ownership stake whatsoever in a cannabis business needs to go through criminal and financial background checks to qualify as business-owners. Though some states have de minimis rules — rules stating that anyone owning under, say, 5% of the business is exempt from the registration requirement — most states do not. This doesn’t present much of a barrier if you are issuing stock to a single manager, but imagine trying to provide equity compensation to 15-20 employees. The clearance process with state governments is a nightmare. There are a couple of solutions to this. The easiest is to have the state provide de minimis ownership exemptions from its background check rules. This would allow a cannabis company to offer stock or LLC profit units pursuant to a defined stock option or restricted unit plan. An alternative is to offer a cash bonus structure that mirrors what value the employees would get from stock ownership. Companies can set aside a bonus pool, and allow employees to earn specific shares of that bonus pool. Depending on the state and the size of the bonus pool, the employees can avoid unnecessary and time-consuming background checks and state registrations.
Another issue with providing equity-based compensation to employees is a major issue for all cannabis securities — there currently isn’t much of a resale market. If someone works at Amazon or Microsoft, a stock issuance isn’t much different from a cash payment because Amazon and Microsoft shares can immediately be sold for cash on the open market. For all but a few cannabis businesses, however, there is no open market. And cannabis companies are notoriously poor about taking necessary actions under state and federal securities laws to allow for any form of resale. Right now, holding a share of most cannabis companies is relatively valueless in the short term if the cannabis company isn’t making profit distributions. If the company is reinvesting its profits, and there is no resale market for the securities, what’s the point? This is something that employers and employees need to understand before entering into any major equity-sharing arrangement.
A final issue is just that the cannabis industry is still young. Most regulated cannabis businesses are still getting their footing. If you ask for two Section 409A valuations (something important for anyone considering a stock option plan), from two different appraisers, you may end up with two vastly different numbers. The metrics just aren’t that reliable yet. So crafting stock option plans is really hard. Providing something that is valuable to employees that won’t also cause investors to be horrified is walking a tight rope. We’re still a few years away from having really good industry-wide comparables that will lead to more reliable valuations. Until then, determining numbers will either be overly complicated or something of a crapshoot.