So, you’ve decided to get involved in the ever-evolving and rapidly expanding cannabis industry? Congratulations! You and many others like you have made career-changing opportunities a reality and have given this industry a lease on life. But, fast growth does not always equal smooth-sailing. If you are looking to enter this new and promising field, you will need to move fast and differentiate yourself from the rest, all while avoiding regulatory pitfalls and common mistakes. Below is a guide on how to go about starting a cannabis business (cannabusiness), and it is designed to help you decide whether or not this type of venture is really something you want to take on, and if so, in which aspect of the industry.
Differentiate Yourself in the Ever-Expanding Marijuana Industry
No matter what industry you are attempting to enter, seperating yourself from others with a unique idea that helps to fill an identified unmet need will help ensure the probability of your business’s success.
In the marijuana industry, the first step is to decide which sector of the industry you want your business to participate in. For most, when thinking about the different types of cannabis businesses, dispensaries and cultivators are the first that come to mind, but there are numerous sectors of the marijuana industry in which you and your business can thrive.
Decide How Risky of a Cannabis Business Venture You’re Willing to Undertake
People often look at large dispensary operations in Colorado or California, turning large profits every quarter, and assume this is the most lucrative, and most sure-bet sector to enter. But, don’t be fooled by dollar signs, as dispensaries can actually be among the riskiest business areas to choose, often with the tightest profit margins, especially in the initial 2-3 years. As the push for varying degrees of legalization spread throughout the United States, the average price per pound of flower will continue to decline, leaving those in the cultivation and dispensing sectors with tighter profit margins as time goes on.
Additionally, dispensaries and cultivators often find themselves with large amounts of cash and few ways of securing it. That is because many banks throughout the country still refuse to work with marijuana industry businesses that have ‘hands-on” access to flower. In time, this will change, but for now it is wise to fundraise enough capital without assuming you will have access to loan assistance. How much are we talking about? Well, many states in the past have required proof of $1 million in liquidated assets to obtain a dispensary license.
Science is a huge driver in the cannabis industry, especially concerning agricultural endeavors. This means labs are needed for testing potency and genetics of cannabis, processors are needed for harvesting oils and other tinctures, and ongoing medical research helps drive specific uses for cannabis in medical treatment.
Consider the Advantages of Choosing an Ancillary Cannabis Business
Assuredly, the least risky kind of cannabis business to start is one that doesn’t directly touch the controversial marijuana plant at all. Via the Controlled Substances Act, the majority of the applicable regulations for businesses in the cannabis industry apply to cannabis growers, processors, and sellers. That means these ancillary providers are typically not subject to the strict cannabis-specific regulations and face much lower legislative hurdles. The opportunities in the ancillary marijuana businesses sectors are limitless, from hydroponics and cultivation products (like lighting and tables), to professional training, consultancies, media companies, and many more. Because this is still considered an emerging industry, the need for quality ancillary service providers is at a premium, with many cannabis businesses partnering with ancillary providers before even putting seeds in the ground, or flower on the shelves.
Your business may be able to differentiate itself from others by also offering a service, or experience, that customers wouldn’t find anywhere else. Cannabis tourism, or “cannatourism” is a rapidly growing segment of the industry due to the fragmentation of the legalization process, by in which millions of Americans travel to “oasis” states each year to tour grow operations, visit dispensaries, and just spend money in cannabis friendly localities. Even once this market matures, tourism will remain a popular business model for all businesses in the cannabis industry. Need proof? Just look at the massive tourism found within the craft brewing/distilling industry, which has been in full swing for the last decade with no indications of slowing down.
Classify Your Business
Now that you have decided what sector of the industry you plan to enter, the next step is to decide what your company will look like. Your company’s structure will affect how much you pay in taxes, your ability to raise money, the paperwork you will need to file, and most importantly—your personal liability. You’ll need to choose a business structure before you register your business with your State. Make sure you choose wisely, as tax consequences and unintended dissolution, among other complications, may result if you try to later convert to a different business structure.
Why Select a Partnership for Your Marijuana Business Structure
Partnerships are arguably the simplest business structure for two or more people to own a business together. The two most common kinds of partnerships are limited partnerships (LP) and limited liability partnerships (LLP). LPPs have only one general partner with unlimited liability, with the remaining partner(s) having limited liability. With limited liability comes limited control over the company, which is often the case for the non-general partners in an LP. Profits from the company are passed through personal tax returns, with the general partner also being responsible for self-employment taxes. LLPs are similar to LPs, but differentiate in that they give limited liability to every owner. An LLP works to protect each partner from debts against the partnership, while also relieving liability for partners from the actions of other partners.
Why Select an LLC for Your Marijuana Business Structure
A limited liability company (LLC) allows you to take advantage of the benefits of both the corporation and partnership business structures. LLCs work to protect you from personal liability in most instances, and protects your personal assets (like your house, car, etc.) from risk of loss in the event your LLC faces bankruptcy or lawsuits. The profits and losses of the company can be passed through to your personal income, without facing the wrath of corporate taxes. However, there’s a tradeoff, as members of an LLC are considered self-employed and therefore are responsible for self-employment tax contributions. LLCs can be a good choice for higher-risk businesses, such as those in the cannabis industry, and for owners with significant personal assets they want to ensure are protected.
Why Select a Corporation for Your Marijuana Business Structure
If none of the above seems to be the right fit for you, then perhaps a corporation, commonly referred to as a “C corp,” is best for you. A C corp is a legal entity completely separate and distinct from its owners. Corporations can make a profit, be taxed, and held legally liable. As was the case above, there are trade-offs in choosing a C corp for your business. Corporations offer the strongest protection to their owners concerning personal liability, but the cost of forming a corporation is generally higher, and they often require more extensive operational processes, reporting, and record-keeping. Corporation business structures can be a good choice for higher-risk businesses and those that plan to eventually “go public” or be sold. Another type of corporation, an S corporation, is a special type of corporation designed to avoid double taxation of regular C corps. An S corp allows profits as well as some losses to pass directly to the owner(s)’ personal income without being subjected to corporate tax rates. S corps are required to file with the IRS to get S corp status, differentiating itself from the normal process of registering with your State.
Why Select a Co-op for Your Marijuana Business Structure
Finally, another business structure option is that of a Cooperative. A Co-op is a business or organization designed for the benefit of those using its services. Profits and earnings generated by the co-op are distributed among the members, also known as user-owners. Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative.
No matter which business structure you and your partners choose, make sure to legitimize your business with your State. This most often includes filing an Articles of Incorporation with your Secretary of State. You will also want to hire an attorney to help you and your partners draft an Operating Agreement (OA) in which the formalities of your business structure are represented. Your business’s OA will help to formalize the rights and responsibilities of the known parties involved at its formation, as well as help guide future business-based decisions.
Follow The Rules of Play in Your State
So you have an exciting business plan, you’ve decided on the structure of your company, and have secured funding, everything is accounted for, right? Not so fast. The most important aspect of owning and operating a cannabis business is locating and understanding the rules of your State. If you don’t play by the rules, you will soon find yourself facing hefty fines, getting shut down, or even spending some time in jail.
It is no contest that the rules and regulations surrounding cannabis businesses in every State are tediously confusing and complex. Beyond the federal prohibition, or perhaps as a result of it, differing state frameworks have led to an industry fragmented based on geography. From licensing to reporting, the processes for each vastly differ between states, making it difficult for a company to expand beyond its own State’s borders. This lack of federal guidance has created what some refer to as an experimental period, where states are borrowing what works from other states and scrapping what doesn’t. It is this author’s opinion that one of the first things you spend money on is securing an experienced attorney to aid you in navigating this process. Each State has different laws, so working with an experienced attorney in your State is crucial.
Tips for Making Sure Your Cannabis Business Plan Aligns With State Law
Both medical and adult-use businesses require, in most states, a license to operate, granted by the State, and valid in just that State. Thus, your business and operational plan need to comply with your State’s laws. Worried you will get lost in the process? Fear not, as every State’s application process serves as a roadmap on the rules and regulations that your business will be subject to, helping you better identify the parameters of your business’s operations. Remember, you don’t have to go it alone in this process, there are many experienced reputable consulting agencies throughout the country that will help you to efficiently navigate this process. Just be sure you pick your consulting agency after you have engaged in a thorough reference and background check. Smoking marijuana in college at a party doesn’t make someone a viable cannabis expert in a tightly regulated industry.
No matter which State you decide to open your cannabis business in, you will inevitably need to make sure your business is properly licensed, with any and all necessary permits, from your State. The process varies by State and can be tedious, and oftentimes daunting. In addition to identifying your policies and procedures, applicants must show an overview of who comprises their company, and most importantly prove that what they are claiming is true. This can be quite challenging, as often the applications are of limited length, which is why balancing this brevity with levels of detail have become a skill set of the consulting industry. It is often beneficial to work with a consulting firm with experience in drafting applications of this nature, as licenses are often awarded, or not, by less than 1.0 point.
Depending on where your business ultimately falls in the cannabis supply chain of your State, you could be required to obtain other types of permits or licenses as well. In addition to cultivation and retail licenses for growing and dispensing cannabis, there are processor licenses for value-added companies like extractors or edible businesses, research licenses for universities, and transportation licenses.
Taxation Under Federal Criminalization of Marijuana
Due to cannabis remaining federally illegal, at least for now, cannabis companies face unique taxation challenges that others do not. Most notorious of these taxation challenges is the Internal Revenue Service’s (IRS) Section 280E, which does not allow cannabis companies to deduct ‘ordinary business expenses” from their tax bills. Section 280E indicates that any expenses related to the “trafficking of controlled substances” shall not be eligible for deductions or credits.
The result of this law is that cannabis businesses are forced to pay larger amounts in taxes than they would if they were selling a federally legalized product. The businesses must pay taxes based on gross income, rather than their income minus cost of goods sold. This creates an average effective tax rate of over 50% on cannabis businesses, whereas the average effective rate on similarly situated non-cannabis companies is closer to 30%. Also, don’t forget about your individual State’s taxation plans, including excise taxes on all sales. Your tax obligations in the cannabis industry are significant and oftentimes comlex, so be sure to work with experienced individuals who have a firm grasp on the implications of taxation on your company.
Most Importantly: Hire The Right Staff for Your Cannabis Business
Obtaining the best people on your business team will help ensure the lasting success of business in the industry. In the case of the cannabis industry, staffing decisions can be uniquely challenging due to the fact that the field is relatively new. This leads to high demand and a low supply of quality candidates at all recruitment levels. Additionally, because this industry is still considered a regulatory gray zone, your business may be at a higher risk of lawsuits and financial loss resulting from poor staffing decisions. As has been reiterated throughout this article, make sure you know your State’s cannabis laws and licensing rules. These will often have specific requirements for staffing and recruitment issues.
Further Information on Cannabis
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