Tips for Setting Up a Cannabis Business

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businessman contemplating fields of cannabis

There are so many things you need in order to start a business that it can seem a little daunting, especially if you want to start your own cannabis business. With all of the different regulations, restrictions, and laws out there, it is imperative that entrepreneurs do their research beforehand, and Leaf Retailer is here to help you with that process. 

Creating an Operating Agreement

According to Megan Dubatowka, a partner at Harris St. Laurent & Wechsler LLP law firm, the first step in starting a cannabis business is setting in place an operating agreement. This agreement is an explanation of how your organization will carry out its business. Questions that should be answered in this document include:

  • Who are the owners?
  • What is the percentage of each member’s ownership?
  • What is the division of responsibilities, rights, powers, and obligations of each member?
  • Where and when will meetings be held?
  • Where and when will meetings be held?

You will also need signatures of all members, which acts as a binding agreement. While this document is not always required, it is especially important when applying for cannabis permits to confirm what each party’s responsibilities are. It also clarifies your company’s structure for regulators when applying for permits. 

“It is important to think about the regulations and your application from the point of founding your company,” Dubatowka said. “If you are trying to go after the coveted social equity licenses, 51 percent of your company needs to be owned by someone who qualifies as your social equity person. If you are going to get the license, you will have to be very careful about how you set up the company from the start to ensure that you qualify.” 

woman burried in paperwork

Understand and Comply with Regulations

Even though there are still many question marks in the cannabis industry, entrepreneurs need to know and understand all of the regulations involved with owning and running a business, as well as with cannabis. According to Dubatowka, if you do not have a firm understanding, you will not be able to comply. This can be a struggle, particularly because the regulations are not always straightforward or clear, but you need to make sure you are creating and selling products in an ethically and compliant way. 

Harris St. Laurent & Wechsler LLP can help companies in a wide variety of ways with just getting started, including getting an understanding of what the regulations are beyond just the application process. They advise clients on regulatory compliance, and defend against regulatory investigations brought by the SEC, other federal agencies, state agencies, and self-regulatory organizations including FINRA and the NYSE. Dealing with cannabis brings about a whole new set of rules and regulations apart from just owning any business, so it is important to get involved with a company that can help you do everything correctly. 

It is also extremely important to make sure your employees know what is required of them. Have a structured setup so they fully understand what needs to be done and what regulators will be looking for. It is one thing to know the regulations yourself, but it is essential that knowledge is communicated to the employees on the ground so they stay compliant and understand how important it is for the business. 

Research Your Competition

Just like any other retail business you would want to get into, researching your competition is an important step to see other companies that sell the same products you are planning to sell. This will allow you to get an advantage over the other brands by seeing their product packaging, different popular flavors they offer, their policies, and more that can help put your company ahead of the competition. 

CannabizTeam advises cannabis entrepreneurs to start their research process by looking at the competition that has the most cannabis sales or biggest presence and work your way backward to analyze their brand identity. As you peruse their website and social media channels, analyze what pain points they address, the solutions they provide, and the personality of their brand. Get a sense of what you are up against, what they do well, and how you can set yourself apart from your cannabis industry competition and rise to the top. 

Get a Cannabis License

The next important step you will want to take in setting up your cannabis business is by getting a license to operate, which is not an easy or inexpensive thing to do. According to Leafly, there are different cannabis licenses depending on the type of cannabis business you are trying to open, including different options for:

  • Retail dispensaries
  • Delivery services
  • Cultivation (indoor and outdoor)
  • Manufacturing (for oral and edible products)
  • Distribution
  • Transportation
  • Cannabis testing facilities

Licensing laws vary from state to state, and you need to understand them thoroughly if you want to be successful. For example, in Massachusetts, you must get local approval to do business in your selected municipality before you can be granted a state license. Be sure to keep in mind that some states have multiple applications and that each state’s application process, including specific scoring criteria on the application, will vary. 

man burried in paperwork

Understanding Cannabis Business Taxes

Since cannabis remains federally illegal, cannabis companies face different taxation challenges from other industries. Most notorious of these challenges is the Internal Revenue Service’s Section 280E, which does not allow cannabis companies to deduct ordinary business expenses from their tax bills, according to JD Supra

By enacting section 280E, Congress sought to reverse a then-recent Tax Court decision: The 1981 landmark case of Edmondson v. Commissioner. In that case, the Tax Court allowed a trafficker of amphetamines, cocaine, and cannabis to deduct ordinary and necessary business expenses related to an illicit drug business. The expenses included rent, packaging, telephone, automobile expenses and the purchase of a small scale. In response, Congress enacted Section 280E, preventing businesses engaged in certain illegal activities from recovering costs related to controlled substances or claiming associated business deductions — that is, disallowing deductions that would otherwise be available under Section 162. 

The result is that cannabis businesses pay a larger amount in taxes than they would if they sold a federally legal product. Cannabis companies must pay taxes based on their gross income, rather than their income minus cost of goods sold. The result is an average effective tax rate of 55 percent on cannabis businesses, compared with an average effective rate of 30 percent on similarly situated non-cannabis companies, according to Business.com

Register Your Business Name and Entity

Since national prohibitions prevent the interstate sale of cannabis and there are many different regulations across the states, you will likely create a business on a smaller scale, but this still means that you will need to choose a business entity that is right for you. According to NerdWallet, the business entity you choose will affect the taxes you pay and the level of risk you are exposed to. You might be leaning toward opening your business as a limited liability company, also called an LLC, or maybe a corporation. Both entities can shield owners from personal liability, but there are some key differences when it comes to an LLC vs. corporation.

Then you need to choose a name for your cannabis business. This process is specific to each state, so always make sure to check your local area, but generally, you will need to conduct a search to ensure the name you want is available, and then there will also be a small fee associated with reserving your name for a set amount a time, according to NerdWallet. 

Open Up a Business Bank Account

Despite all of the regulations surrounding cannabis, you can still open up a bank account with participating banks for your business. Even dispensaries can have bank accounts — they can deposit money in the bank and pay bills electronically. It just looks a bit differently than other industries. According to Flowhub, the federal government treats cannabis similarly to other high-risk industries — gambling, firearms, and adult entertainment.

If you do not set up a bank account, cannabis business owners are more susceptible to theft, higher costs for arranging security on site, less operational efficiency since you cannot pay bills electronically, the inability to accept non-cash payments, and it makes future planning for your company more difficult. Since no major banking system will service the marijuana industry, Flowhub advises getting an account from a smaller institution, like a community bank or credit union

Get Business Insurance

Even though insurance is something that all business owners must get, it is very difficult for cannabis companies to obtain reliable insurance coverage due to the state and federal laws governing the sale of these products. According to HUB, cannabis insurance is available in Canada and all U.S. states where medical and recreational cannabis is legal. There are specific insurance agencies that will cover cannabis, you just need to seek them out. Different agencies include HUB, Cannasure, Admiral, and Cannabis Insurance Company, just to name a few.

Given that the legal cannabis industry faces a unique set of challenges and risks, it is crucial for cannabis businesses to have insurance. Some states require specific coverage, so be sure to check your local laws. CannaCon offers a breakdown of a few coverage options that cannabis businesses need, in addition to general liability:

  • Crop Coverage
  • Equipment Coverage
  • Product Liability
  • Technology Errors & Omissions Coverage
  • Property Insurance
  • Cyber Liability
  • Inland Marine

Having adequate coverage is essential, as is handling the process in a savvy manner when issues arise. CannaCon advises business owners to maintain files with photos and documentation. Then, after loss has occurred, document every possible affected element and immediately review insurance coverage. Request assistance from your insurance broker, if need be. Remember that insurance companies are for-profit businesses, designed to make money by collecting more in premiums than they pay out in claims. If a claim is denied at first, keep trying. Overall, patience is a must, as insurance dealings are notoriously slow, regardless of the industry.

Fund Your Business

If you have no money to start a business, you can reach out to investors for financing help. It costs a lot of money to start and run a company, so how you choose to finance can affect the future of your brand. First, the Small Business Administration advises entrepreneurs to figure out how much funding you need. Once you find that out, you can either self-fund or reach out to different investors. 

Dubatowka warns business owners to be careful when dealing with investors: “As you are talking with investors, they will want a share of the company. If you have someone who wants to invest heavily, they are going to want a large piece of control over your business. You need each party’s roles documented to help avoid potentially devastating disputes farther down the road,” she said. This is where operating agreements really come in handy. 

There is so much that goes into starting and running a business, but these tips are some great beginner points before you build your website, hire employees, and find a storefront if you wish to sell at a brick-and-mortar location. “Everyone is very excited to get going and will sometimes overlook the less-fun or exciting parts of the business, such as insurance, making sure your agreements are documented, and setting your foundation. It is important to pause and be thoughtful about key decisions early on,” advises Dubatowka.  

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