Friends, an edifying tale.
As you may know, one of the most popular ways for early stage cannabis (and other) companies to raise capital is by issuing convertible debt (I kind of talked about this there. has been around here; convertible debt is also being used as a new tool by Canadian companies to gain a foothold in American cannabis, which I talked about here, but it’s different). Other alternatives for startups raising capital include common stocks (usually harder to document) and SAFEs (don’t ask), but convertible notes (or “converted,” if you want to sound like a security expert. finance) are easy to write and contain fairly straightforward terms, most decisions being economic. For the lender, if the business is doing well, the note converts to shares and the holder shares the upside. If the company does not fare so well, the note remains a debt to the company and the holder is a creditor (meaning it is paid before the shareholders).
It is the function of converting to stock that is our concern here Thoughts on cannabis. But, before I make my point, I need to explain usury, which is basically charging more interest on a loan than the law allows. Each state has its own usury laws, and whether a loan is too expensive can depend on a number of factors, such as whether the loan is given to an individual versus a business. This is how the state says “don’t be a chozzer”.
New York State has its own usury laws (where it can actually be a felony!). Interpreting these laws, the New York State Court of Appeals ruled earlier this month, in Adar Bays, LLC v GeneSYS ID, Inc., that a convertible loan with an interest rate below the legal limit may nonetheless violate state usury laws based on the value of the conversion function, which the court said “should be included in determining the interest rate on the loan for the purposes of usury articles. “In other words, at least in New York State, as a result of this case, the interest is not just the coupon (the actual and stated interest rate on the note), but can also now include the value to the lender of the option to convert the note to stock.
What’s my point? Just that even a seemingly simple fundraising vehicle – which is prevalent in the cannabis industry and beyond – comes with a hidden risk. This is why you need a lawyer to all.
By Scot T. Hasselman