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How Cannabis Startups Can Prevent Internal Legal Disputes

Marijuana Startups fail more times than not because of organizational problems internal to the company. Here's why.

The Basic Problem

Perhaps the number one reason marijuana startups, and indeed all reasonably new companies, experience the much-feared “Founders breakdown” is due to lazy planning. Two best friends get together with a great idea and instead of working out the logistics and operational details in advance, they promise each other that they’ll figure it out. I am here to tell you that after working with many failed startups, the founders often do not figure it out. Indeed, the breakdown occurs when one of the founders believes that he is doing more work than his partner and is not receiving compensation commensurate to his workload. Next, arguments concerning equity split and time worked become increasingly severe and one of the founders not only threatens to quit but also demands a payout for his contribution to the company’s present success. And on and on it goes….

Document Document Document

The message here is clear; the best way to prevent, avoid, or mitigate the potential negative impacts of a business dispute are to ensure that the fundamental terms and conditions of the working arrangement of the founding partners is well articulated in advance. Having official operating agreements, bylaws, and shareholder agreements are crucial, as they put in place the much-needed contours of the company structure and all associated ownership rights and responsibilities. These documents should contain detailed information concerning each individual’s official role (and what powers the individual does not have), board representation, equity interest, and employment terms. Ownership issues or disputes commonly arise as a result of the “let’s not worry about it now” syndrome, so having the tough and understandably awkward conversation in advance really is absolutely essential.

Your Marijuana Startup Is Everything – Can You Trust Your Partner to be a Part of it?

The idea behind “Due diligence” is that an individual conducts sufficient research into a person’s background to either confirm certain alleged facts or discover new, non-disclosed information, prior to the formation of an agreement. Due diligence will of course involve different procedures and fact-checking activities, depending on the nature of the agreement, but the central point is to make sure you know what you are getting yourself involved in. Or more simply put, is your partner someone that you can trust?

Due diligence may entail reviewing financial records, including tax returns and bank statements, scouting out any pending lawsuits in the form judicial liens, or more worrisome, uncovering an unreported criminal history. Requesting your potential partner (with civility) to provide relevant documentation will allow you to evaluate the financial and legal viability of your partnership with him and determine if proceeding with the deal would be prudent.

Your Cannabis Startup Attorney IS NOT Your Personal lawyer

Founders are often unaware of this but it is critical to understand that the company lawyer’s duties are to the company and not the founder. Indeed, a company attorney may not be involved in any disputes between the founder and the partners and/or investors. Therefore, if the founder has a legal issue particular to him vis-à-vis the rest of the employees and company, he should (as a general matter) obtain private counsel. Indeed, marijuana startups with more experienced and financially able founders often obtain personal attorneys whose job it is to negotiate ownership rights and equity distribution for their individual client.

Marijuana Startup Conflict Resolutions

As this article has tried to impress upon the reader, well-written corporate documents and contracts should include detailed breakdowns of the roles you (the business owner), your partners, and investors play in handling the company. However, this means not only well-structured corporate documents involving company formation but rigorous written documentation involving the handling of internal disputes and voting powers. What happens if two founders disagree about a certain impending action (hiring a new employee, taking on more debt, giving away equity in exchange for x, etc.)? Does each partner have an equal say? Do certain decisions fall under the purview of different founders? Who gets to decide if the company should be sold? Does equity interest in the company mean veto power? These are tough decisions that must be made in advance.

Hiring Lawyers with Cannabis Industry Experience

Lawyers are often mistakenly believed to be experts in every area of the law. Like doctors, there seems to be a societal misconception that if someone is an attorney, he is by definition qualified to handle any legal matter. Our attorneys are often asked for advice on a variety of matters that we frankly have zero experience in (I can assure you that you would not want us to represent you in any divorce proceeding). Cannabis corporate law is uniquely complex because of its federal illegality and state-specific regulations. Make sure that your Marijuana Lawyer is deeply familiar with the idiosyncrasies of this industry.

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