The greenrush in Canada continues to build momentum as the industry looks to meet the expected demand for recreational cannabis, beginning July 1, 2018. From humble beginnings less than one or two years ago, many Canadian licensed producers (LPs) and other cannabis industry companies have quickly grown into formidable entities, a few with multi-billion dollar market caps.
A symptom of this overnight growth, however, is that these companies have not had the luxury of a normal maturation process to build proper corporate governance controls that are typical of similarly valued companies. While early financing rounds were often funded by high net worth individuals, as institutional investors now enter the fray these companies can no longer be run like mom and pops and proper governance and transparency requires near term focus.
As a first step, roles of the chair of the board of directors and the CEO should be separated and filled by different individuals so as to provide proper oversight of management. Likewise, the composition of the board needs to evolve from friends of the CEO, to include senior executives of other highly regulated areas (such as the pharmaceutical industry), operators of complex organizations, financial experts and the like. Good directors are not cronies or rubber stamps, but those who can bring new views and insights and challenge management as appropriate, and can make decisions regarding hiring and firing senior management as required, without regard to personal loyalty. Moreover, since this is a new industry with many unknowns, directors of these companies need to have the time and energy to delve into the company affairs (rather than merely show up to meetings and collect directors fees and/or stock options), especially as the light shines brighter on this industry.
Many officers and directors of cannabis companies have invested in multiple companies in the industry together. It is an incestuous industry. It is important that decisions with respect to each company are made on their own merits, without regard to the other business relationships that a director may have with management or other directors on the board.
In selecting directors, consideration should be given not only to independence from management but independence from other directors on the board. In addition, all conflicts should be declared to all directors, not only before a decision of the board, but before any board discussion of a matter with which a director has a conflict. Best practice is for the conflicted director to be recused from all discussions relating to the subject matter of the conflict.
Each of the directors is responsible for decisions of the board. Therefore when one is contemplating whether to join a board, the competency and ethics of the other directors should be considered. Also, since companies in sectors with high share price volatility, which we expect will be the norm in the cannabis industry for the foreseeable future, are particularly vulnerable to lawsuits from individual shareholders as well as class actions—one must take precautions. Typically, directors will require indemnification from the company as well as directors and officers (D&O) insurance. The limits of the D&O insurance may increase as the value of the company increases and may include Side A DIC (Difference in Conditions) coverage, which is only for the benefit of the directors and officers and does not share coverage with the company. A more limited number of companies obtain Independent Directors Side A coverage, which is only for the benefit of the independent directors.
Those who have succeeded in getting an early lead in this industry had to move quickly and have been rewarded for doing so, but often formalities were overlooked. Companies “issued” stock options or “issued” stock without properly memorializing such issuances and now memories differ as to what in fact was issued and the terms and conditions of such issuances. Likewise, agreements were made orally without a document or without approval of the board. Reverse mergers were consummated into shells that were not clean. The mess created by the shortcuts is now rearing its ugly head and the cost and expense of this clean-up is not attractive. However, the quicker these issues are addressed, the less painful they will be.
The winners in this industry will be those that can retain their ability to react quickly and be nimble, while at the same time creating systems and policies that gain the support and confidence of a wider investor group. More traditional investors are now ready to jump into this industry. Are you ready for them?
- By Cheryl V. Reicin and Shane Thomas
Featured image by Paul Bica.
Cheryl V. Reicin is a Partner and Chair of the Life Science Practice of Torys LLP. Shane Thomas is an articling student at Torys LLP.
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