Pro

Stiiizy draft deal would stiff social equity partner: Lawyers

By Alex Halperin
May 26, 2022
story-image

A draft of a deal between Shryne Group, parent of popular vape brand Stiiizy, and a social equity partner would give the partner negligible control over the business, and little chance to share in its profits, according to four lawyers who reviewed the document. The unsigned operating agreement was submitted to Oakland in February 2020 as part of Shryne’s application for a social equity dispensary license.

The draft proposal, if executed, would make social equity partner Abinette Chandler, a “51% owner in name only,” SF-based attorney Jared Schwass said. Under it, he said Chandler lacks the power even to call a meeting, and would be unlikely to receive the profits implied by her majority stake.

Vertically integrated Shryne is among the largest operators in California. An outside spokesperson for the company said some terms in the draft deal were updated before the final deal was signed, but declined to provide specifics.

  • Additionally, the spokesperson said the final deal pays Chandler a six-figure annual fee.
  • Oakland has conditionally approved the application and Shryne expects the shop to open in Q3 or Q4 under its Authentic value brand.

“Veneer of mutual respect”

As of December 2020, there were reportedly more than 200 licensed social equity businesses in California across 16 jurisdictions. Partnerships between social equity eligible individuals and prominent companies have arisen out of mutual necessity since big cities prioritize social equity license applicants, but don’t offer means to finance the businesses.

For the generally low-income people eligible for social equity licenses, the state industry’s major players are the only plausible source of capital.

  • Putting together a successful application for a competitive market can cost tens of thousands of dollars.
  • Then there are start up costs. In its application (page 6), Shryne anticipates them reaching nearly $1.3M, including more than $400,000 in inventory.

These social equity deals have the potential to work as intended, roughly the way restaurant franchises can inject money into disadvantaged communities. Whether that happens depends largely on the contract terms between the parties, but these documents have rarely come to light.

  • Local ordinances vary in their requirements for how closely regulators scrutinize agreements between the parties in social equity deals.

Even though the specs aren’t final, the Stiiizy draft offers rare insight into how a major California company approached a social equity deal. (The document became available on the city of Oakland web site through a public records request.)

With social equity deals, the initial “veneer of mutual respect and equal rights” can wear off, Andrew Kingsdale, an attorney at the Law Offices of Omar Figueroa, wrote in an email. Under the terms in Shryne’s draft deal, “It does not appear that Chandler will even start with equal rights or responsibilities to control and profit.”

“Negotiation range”

In exchange for access to the Oakland market, Shryne’s draft operating agreement with Authentic 510 LLC (begins on page 32) proposes that Chandler receive two main assets:  

  1. Rent free space for her and a partner to “incubate” a cannabis company. (Oakland prioritizes applicants who offer incubator space.) 
  2. 51% ownership of an Oakland dispensary. Shryne puts in $1M for its 49% stake.

(It doesn’t mention the annual cash payments Shryne’s spokesperson said are part of the final deal.)

Four cannabis lawyers who commented for this story said that despite Chandler’s 51% stake in the company, the draft deal would give her essentially no say in the store’s direction. “The business and affairs of the LLC shall be exclusively managed by and under the direction of the Manager, who shall be Shryne,” the draft states.

  • The draft wouldn’t assign any responsibilities to Chandler.
  • It names then-Shryne CEO Brian Mitchell CEO of the LLC and co-founder James Kim its managing director.
  • Mitchell resigned from Shryne last year after pleading not guilty to insurance fraud and other state charges stemming from his time in a previous industry. (Shryne has no involvement in Mitchell’s case.)

As majority owner of the company, Chandler would ordinarily be entitled to a majority of the profits. Under the terms proposed in the draft, however, the lawyers said it was unlikely that she would see any profit.

  • The draft would give Shryne a management fee of 35% management fee of gross revenue.
  • Meital Manzuri, of Manzuri Law, who has negotiated both sides of social equity deals, said the proposed fee is the highest she’d seen.
  • She called 10% to 20% the usual “negotiation range,” with dispensary profit margins topping out at 20%, she said.

After the LLC pays Shryne’s management fee, the draft document would allocate any remaining cash to reimburse Shryne for its “outstanding capital expenditure contribution,” which includes the $1M it initially put into the LLC, at 15% annual interest.

  • “Initial contributions by LLC members are not usually repaid like loans to the members,” attorney Kingsdale wrote. “They are capital contributions in return for ownership interest (like stock in a corp[oration].).”
  • Shryne’s spokesperson said the draft’s 15% rate is the same at which Shryne borrowed the money.

Any further distributions would go to pay off the LLC’s loans, according to the draft. As with the capital expenditure spending, Shryne would have complete control over any loan agreements.

  • Chandler would get paid after the LLC’s loans are paid off.

Under most circumstances, owners can profit by selling their ownership in a company, but the draft proposal’s language would bar Chandler from selling any part of her interest. Instead it would give Shryne the right to buy out Chandler’s 51% stake “at any time” for $120,000, slightly less than 1% of projected revenue in its first year of operation. (Page 8)

  • Attorney Schwass called the proposed provision “ridiculous” and almost a non-starter. “The fact that they included it [in a draft] shows their intent in my opinion.”

Oakland has engaged a law firm to provide social equity applicants with free legal services, but a city representative said Chandler did not consult them.

  • Chandler, whose LinkedIn profile says she works part-time at an anti-racism non-profit, told WeedWeek she wasn’t available to comment before deadline.
  • Shryne’s spokesperson said Chandler had been represented by a “legal team” but declined to identify them.
  • Cannabis law consultant Yvette McDowell didn’t review the Shryne document but estimated that 90% of California social equity applicants go into their deals without a lawyer.

In a statement, Shryne’s spokesperson wrote:

“Per feedback from all of our partners to date, all of our partnerships have been described as mutually beneficial, and any feedback has been overwhelmingly positive. In this particular partnership, our partner is provided with an annual six-figure fee…retains all ownership rights, and also has rent/lease expenses covered for their manufacturing facility.” 

New York-based lawyer Jeffrey Hoffman disputed that Chandler “retains all ownership rights,” as described in the draft, since “an owner has control of their business.”

No matter how much Chandler receives in fees, Hoffman said the draft wouldn’t be possible under New York’s new cannabis law which requires social equity owners to have, among other criteria, day to day decision making power.