Risk Mitigation and Planning for Success in the New Phase of Cannabis

The cannabis industry is difficult to thrive in, whether you are a new business on a shoestring budget or a large private or public company with a capital stack. In addition to widespread market and transaction inefficiency, there is an inordinate amount of regulation and compliance requirements, as well as non-business-friendly tax regimes that make it hard to grow and sustain a profitable business.

These laws, regulations, and tax structures often fail to understand the business, professional or commercial realities of the industry. The media sensationalized the green rush on the covers of magazines and nightly news stories, but with the market corrections that have been occurring it is clear that the bales of cash never came off the money trees.

To be candid –  cannabis is a risky business. However, cannabis is here to stay.

We’ve entered a new phase in the story of cannabis. Gone are the days of through-the-roof valuations and endless funding supply. Now are the days of sensible economics and informed, pragmatic business decisions.

There will be many successful businesses that emerge from this new phase of the industry, however the ones that are successful will need to get back to the basics – which means executing sound business fundamentals and creating true commercial value. The basic foundation of this is strong legal and corporate governance structures.

Thus, it is time for the cannabis industry to better use and leverage trusted professional advisors and counsel to minimize, mitigate or otherwise manage risk.

There are obvious risks that affect cannabis businesses. Cannabis is illegal on a federal level, and the banking, tax and trademark laws offer little to no benefit or protection to cannabis businesses. On the state level, even in states where cannabis is legal, cannabis is highly regulated.

There are also less obvious risks that affect cannabis businesses. These less obvious risks are the same as those that have traditionally affected businesses, markets and industries generally.

The purpose of this blog is to function as an overall survey of what any business (and especially cannabis businesses) need to have in place from inception to have a strong foundation. If a business is already operating and does not have the proper legal and governance structures, there is no better time to close the gaps than now – problems that are not solved today have a higher propensity to become big issues later down the road.

  • Corporate/Legal Risks: It is important that cannabis businesses make sure their corporate and legal documentation and filings are prepared, filed, executed and maintained accurately.  Doing this helps mitigate any founder, legacy or other ownership, management or governance items, and promotes reliability, stability and trust both inside and outside the company.
    • Organization Documentation
      • Articles of Incorporation or similar documents and filings
      • Federal and state identification numbers (EINs, etc.)
      • Foreign Qualifications
      • Applicable written consents, resolutions, etc.
    • Governance, Management and Organization Documents
      • Bylaws
        • Procedures for corporate matters and processes
        • Rules applicable to directors
        • Rules applicable to officers
        • Other general rules for the company
      • Partnership, Shareholder or Operating Agreements
        • Management matters
        • Contributions of Owners
        • Rights/Preferences/Privileges of Owners
        • Duties/Obligations of Owners
        • Voting of Owners
    • Founders Documents
      • Founders Agreements
        • Vesting
      • Tax Forms (83(b)) election
  • Commercial Transactions: As the cannabis industry starts to mature and integrate with more traditional agricultural, consumer packaged goods (CPG), manufacturing and distribution industries, understanding, negotiating and closing solid commercial deals that make business sense are increasingly more critical.
    • Forecasts and Minimum inventories
    • Minimum purchase requirements
    • Title and risk of loss
    • Indemnification
    • Limitations of Liability
    • Quality Controls
    • Recordkeeping and Bookkeeping
    • Inspections and Audits
  • Tax Matters: Tax matters that affect all businesses are also starting to influence cannabis businesses. In addition to looking at 280E matters more strategically, cannabis founders should look to start protecting themselves financially with making timely tax filings, and using estate planning strategies. On a larger scale, it’s critical to make sure that the business is structured in a tax efficient and tax friendly manner (especially important to help avoid tax issues when the company is being sold and there is an exit event).
      • 280E strategic analysis and structuring
      • 83(b) elections
      • Trust and estate structuring

Accountants that understand cannabis businesses and the tax code can develop thoughtful tax structures for favorable tax treatment.

  • Intellectual Property: Intellectual property rights and protections become more important, as strong brands become more valuable in a consolidating cannabis marketplace. This is certainly a valuation driver in the cannabis industry.
    • Trademark protections for cannabis business, under non-specific cannabis classes such as smokers’ articles, clothing, merchandise and website information; processes and trade secrets.
    • Trade Secrets

Lawyers experienced in intellectual property matters  can provide effective trademark strategies or precise regulation compliance programs.

  • Insurance and Liabilities: Cannabis businesses are susceptible to liability in terms of their products.  Now is a great time to understand the liabilities that exist and structures that help mitigate, such as contractual indemnification and limitations on liability, and insurance plans and policies.

Lawyers, insurance brokers and other professionals can offer products and services to help manage product and other liability risk.

Addressing these issues now is critical.

As the cannabis industry continues to mature in its next growth phase, it is likely that laws and regulations will continue their evolution towards creating a more favorable business climate for the cannabis industry. This means that now is the time to use and leverage of business professionals from traditional markets and industries.

Union Cannabis Group is available to discuss your cannabis business gaps, risks, and opportuntities.

Eli Korer

Eli Korer is the Chief Legal Officer of Union Cannabis Group.  In addition to managing the company’s legal matters, he also contributes to the company’s business and commercial activities.