CANNABIS VENTURE CAPITAL TERM SHEETS & EQUITY FINANCINGS ATTORNEY CALIFORNIA

Valuation and Economic Terms The pre-money valuation established in a cannabis venture capital term sheet determines the price per share for the investment and the extent to which existing shareholders are diluted by the new round. Cannabis company valuations are frequently complicated by § 280E: because adult-use/recreational cannabis businesses cannot deduct ordinary business expenses at the federal level, EBITDA comparisons to non-cannabis businesses are misleading, and investors must evaluate cannabis company performance on adjusted metrics that add back § 280E-disallowed expenses. A term sheet that does not address the basis for valuation may leave both parties with materially different expectations when the definitive documents are drafted. Liquidation preferences — the rights of preferred stockholders to receive a specified return of capital before common stockholders receive anything in an exit event — are among the most economically significant provisions in a cannabis venture term sheet. A 1x non-participating liquidation preference means the preferred investor receives its investment back (but no more) before common stockholders receive anything in an acquisition below a certain threshold. A participating preferred provision entitles the preferred investor to receive its liquidation preference and then participate pro rata in remaining proceeds — which can substantially reduce what founders and early employees receive in a sale. Board and Governance Rights Cannabis investors frequently negotiate for board seats or board observation rights as a condition of their investment. In a licensed cannabis business, board composition must be disclosed to the DCC, and any board member who qualifies as an “owner” under DCC regulations must be approved before taking a seat. The Law Office structures board representation terms with DCC disclosure and approval timelines built in, so that an investor’s board rights become effective only after regulatory approval — not upon execution of the Stock Purchase Agreement. Information rights negotiated in an Investor Rights Agreement typically include the right to receive quarterly unaudited financial statements and annual audited financials, along with inspection rights and management letters. In cannabis, information rights are particularly important because § 280E can create significant divergence between GAAP financials and the economic performance of the business, and investors need sufficient financial information to monitor their investment accurately. Anti-Dilution Provisions Anti-dilution provisions protect investors against future financing rounds in which the company issues shares at a price lower than the investor’s purchase price (a “down round”). Broad-based weighted average anti-dilution is the most common formulation and is generally viewed as balanced; full-ratchet anti-dilution, which adjusts the investor’s conversion price to the lower price in the down round regardless of the amount raised, is much more investor-favorable and can be particularly punishing in cannabis where down rounds are common due to market conditions and § 280E-driven financial pressure.