It’s Time for Cannabis to “Grow-Up”

Torys Quarterly: The Future of Business in Canada

The Canadian cannabis industry is in a speed race to the start line.

The early entrants have enjoyed the first mover advantage and benefits of a fast growing field (no pun intended) with large capital inflows. With a market capitalization of a select few of over a billion dollars, and many more in the hundreds of millions of dollars, now is the time to backfill on matters that companies of such value would normally have a decade or more to develop through a more typical maturation process.

Among those matters requiring such catch up is a corporate governance structure typical of similarly valued companies. With institutional investors increasingly interested in what was a sector initially funded primarily by high net worth individuals, good corporate governance is now a “must,” not an option.

To start, generally it is desirable to have the roles of chair of the board and CEO filled by different individuals to ensure proper oversight of management. Also, as these companies scale up and confront the myriad of challenges that accompany rapid growth, board composition must also evolve from friends of the CEO to include individuals with relevant skills and experience—including knowledge of how to operate in a highly regulated industry—who can provide impartial guidance and oversight without regard to personal loyalty to the founder or other senior managers.

In addition to independence from management, ideally directors should also be independent from each other. Many officers and directors of cannabis companies have invested in several different companies in the industry together. Decisions with respect to each company must be made on their own merits and not be influenced by any other business relationships a director may have with managers or other directors in the company or, for that matter, those of any other company. Any conflict of interest, real or perceived, should be declared before any discussion of a matter related to that conflict and, in accordance with best practices, the conflicted director should be recused from that discussion and any subsequent vote on the matter.

As consolidation through merger and acquisition activity is expected to be prolific in this industry in the short term, cannabis companies must consider themselves as both potential targets and potential acquirers.

Attracting experienced directors with diverse backgrounds to the board of directors is particularly important in this nascent and evolving industry. As well, because the industry is changing week by week and there is substantial activity, whether it be financings, mergers and acquisitions or joint ventures, directors for these companies must be active and need to expect to make a significant time commitment in the next several years. In other words, this is not for individuals who are merely looking to show up to an occasional board meeting and collect some fees.

Each director is responsible for the decisions of the board, so anyone considering joining a board should consider the competency and ethics of the other directors. Companies with significant price volatility, which will likely be the state of play for cannabis companies for the foreseeable future, can become targets of lawsuits from disgruntled shareholders or even class actions.

Directors and officers should take care to ensure they are provided with adequate indemnification by the company as well as directors and officers (D&O) insurance. Companies should consider providing Side A DIC (Difference in Conditions) coverage, which benefits directors and officers but does not share coverage with the company, and even possibly Independent Directors Side A coverage, which is only for the independent directors.

The long-term winners in cannabis will retain their ability to react quickly and nimbly while putting in place a solid corporate governance structure.

As consolidation through merger and acquisition activity is expected to be prolific in this industry in the short term, cannabis companies must consider themselves as both potential targets and potential acquirers. Boards should carefully consider adopting policies and plans best suited to maximize value for the shareholder group as a whole.

Companies had to move quickly to get an early lead in Canada’s burgeoning cannabis industry, sometimes at the expense of corporate governance. The long-term winners will be those firms that can retain their ability to react quickly and nimbly while putting in place a corporate governance structure that will provide confidence to investors and regulators. Such adoption will pave the way for the cannabis industry to gain general acceptance akin to any other legal industry.

Cheryl V. Reicin and Shane Thomas authored this editorial, published in the Globe and Mail on March 18, 2018.

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