Choosing a Business Structure

Selecting the right legal structure for your cannabis venture is critical to your company’s success and ability to grow. Photo by Igor Lobzov

Picking the right legal structure for your company can minimize tax liability and protect assets

 

 Partnership? S Corporation? LLC?

Of the countless choices you will make as you expand your cannabis business, few decisions are more critical to your company’s financial future than the legal structure you select at the outset.

From taxes to raising money to your own personal liabilities as a founder, your company’s structure can make or break its chances for success.

“It’s a decision that’s full of twists and wrinkles, especially considering that regulations are still changing,” said Tatiana Logan, a corporate law attorney with the Harris Bricken law firm in Los Angeles.

For example, Logan said, the rules governing cannabis business licenses vary from state to state. In many states, those licenses cannot be transferred from one business entity to another.

“The biggest mistake I see is that folks don’t understand what rights they have on licenses,” she said. “People think they can treat their licenses like personal property and transfer or sell them. That is not the case in California.”

But a carefully crafted corporate structure, she said, can ensure that business entities remain intact, even if the founding members are ready to exit.

Benton Bodamer, a Columbus, Ohio-based attorney with the law firm Dickinson Wright, agreed.

“There are so many circumstances where people with access to financial resources will jump in headfirst with their business plan,” Bodamer said. “And while that is a very entrepreneurial thing to do, it’s a mindset that is often accompanied by a failure to bring the financial and legal opinions into the room as decisions are made. This is a process that comes with a labyrinth of complex issues.”

Here are tips for how to decide what corporate structure best suits your cannabis business and a look at the different options that are available.

Start With the Basics

In Logan’s law office, she begins with the basics as she walks cannabis clients through their options.

“We start with, ‘What is your business, and what do you want to do?’” she said. “At the end of the day, your corporate structure is very often dictated by two key considerations: your source of funding and tax efficiency.”

Tax liabilities, Logan and Bodamer emphasized, are a top consideration for cannabis firms given Section 280E of the federal tax code, which prevents cannabis companies from taking the same deductions that mainstream businesses do.

Organization Options

To help limit a firm’s tax burden, Logan advises her cannabis clients to consider building a corporate family of entities – in other words, creating a separate entity for each type of business activity the company might perform.

For example, if a marijuana company has cultivation and distribution operations, separating the two activities into their own business entities can limit tax liabilities and ensure that problems in one line of business don’t sink the company.

“This is a good way to ensure that a liability that threatens one business line doesn’t take down the entire operation,” Logan said. “If you had a harvest that somehow became contaminated, for example, and then patients began to file lawsuits, they would not be able to recover against the distribution side of the business, which could continue to operate.”

Other considerations:

Construct a separate business entity for your intellectual property. That IP can be licensed out to third parties and will serve as another line of business.

Certain equipment used in your operations can be placed into a holding company that charges your other operations rent for their use. “If you’re paying rent on equipment, it becomes a cost-of-goods-sold line item that you can fold into a business plan for tax-planning purposes,” Logan said.

Some businesses have even placed a company’s management operations into a separate entity – but Logan advised treading cautiously in this area. “If it is just a shell and not a substantive business entity, then regulators will prevent you from treating the operation as its own,” she said.

For those who recently launched a new cannabis enterprise or are advancing their venture to its next chapter, here is a brief overview of the most common business entities – and a few of the pros and cons to consider with each: