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How to Start a Cannabis Business, Part 2

What are the legal and regulatory issues you might face as a Marijuana company?

The marijuana plant is, of course, simply another variety of Cannabis Sativa L, but it is a variety that produces high THC levels and, usually, low CBD levels. That means it’s a federally scheduled drug, which has many ramifications.

In our last post, we discussed some of the many business issues related to starting a cannabis business. In this post, we will cover some of the legal and regulatory matters.

How to Start a Cannabis Business, Part 1

The Regulatory Environment

For marijuana, it’s a plate of spaghetti.  Not only is there federal regulation, but each state regulates marijuana, too. In fact, each county and city can, as well.

Internationally, in October 2017, Canada became the first G7 country to fully legalize recreational marijuana. In late 2019, the Senate of Mexico legalized recreational marijuana, with the House of Representatives in Mexico set to confirm in Q1 2021, creating the world’s largest legal market. Medical Marijuana (“MMJ”) has been legal in Mexico since 2017.

While the circumstances are evolving with incredible speed (and is not always uniformly reported), the US situation for marijuana as of this writing is approximately this:

  • Still federally illegal as a Schedule 1 drug, which bars interstate commerce. This status impedes FDIC insurance for many financial institutions, requiring cannabis businesses to deal in cash. This status also eliminates many standard federal tax deductions for marijuana companies.
  • As of February 27, 2021, 16 states (AK, AZ, CA, CO, IL, MA, ME, MT, NJ, NV, OR, MI, SD, VA, VT, and WA) and the District of Columbia allow (or will soon allow, e.g., VA in 2024) recreational marijuana with THC.
  • Post 2020-election, 36 states (and DC) allow the distribution of medical marijuana with THC (VA is just getting organized on MMJ).
  • Post 2020-election, another 13 states allow medicinal CBD oil with limited THC.
  • As of Q1 2021 (and noting recent medical legality), marijuana remains fully illegal in only 6 states (AL, ID, KS, SC, TN, and WY) and decriminalized in NC and NE. In contrast, CBD from marijuana or hemp is still fully illegal in only 2 states (ID and NE).

And then… there are so many state-by-state regulatory oddities. For example:

  • Georgia has now legalized low-THC marijuana oil but only authorized 6 licenses (+ 2 universities) across the entire state (with multi-million dollar bond and working capital requirements).
  • Maine legalized recreational marijuana in 2016 but only started recreational sales four years later in 2020.
  • Montana authorized recreational licenses in 2020, but for the 1st year, it is limiting them to existing MMJ licensees.
  • In late February 2021, Virginia became the 16th state to legalize recreational marijuana, but legal possession sales won’t start until 2024.

What fun. On balance, it’s all good news for cannabis startups… it’s just… specific to where the business wants to operate.

Better news?  Federal de-scheduling of marijuana is probably not far off. State options abound, and the inevitable federal delisting of marijuana from Schedule 1 will soon precipitate something resembling the Wild West, the 1849 California gold rush, Silicon Valley dot-coms in the ‘90s, and a deluge of US investment opportunities with potent IRR, MOIC, stability, hard asset-contra-cyclical collateralization, and predictable taxation scenarios.

Are there other issues?

Yep.  Let’s start with taxation.

  • In a nutshell, the IRS (IRC 280E) bars the federal deduction of ordinary business expenses for “hot” (e.g., marijuana) companies, but states like California and Montana do not.
  • As a result, Cannabis companies tend to opt for “smart business structuring.” That is, the business is often divided into two separate entities for tax purposes.
  • Moreover, each state, county, or municipality can also impose various taxes on cultivation, sales, business operations, etc.

Ah, man. Is there more?  Yep.

  • Interstate Commerce: The federal illegality of marijuana is still, far and away, the most significant impediment to rampant cannabis industry growth in the US. For example, federal law prohibits interstate shipments.
  • Financial Institutions: Banks and other financial institutions are still keeping a wary eye on cannabis companies, pending the future enactment of the Secure And Fair Enforcement (SAFE) Banking Act of 2019 that prohibits federal banking regulators from penalizing banks that offer financial services to cannabis-related businesses.
  • Black Market: While not a barrier to legal sales, the illegal black market remains much larger than the legal marijuana market in North America.
  • Myths: Some media reports about potency and chemical content claim that marijuana is 30 times more potent today than during the 1970s. This is misleading and fuels opposition.
  • Health Issues: Like the use of alcohol, there are some limited medical concerns – particularly in connection with young and/or daily users of THC – which can include mental health, memory, and dependency issues for excessive users.
  • Fragmentation: The US cannabis industry is fragmented, disorganized, antiquated, and beset by one-off, inefficient processes that can require reinventing the wheel on each new issue.

This is a complex and rapidly evolving market. If all of this seems overwhelming and you need help, tap the Contact Us Now button at the top of the page, and we can help you work through the issues and prepare your business plan.

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Lee is a Principal Consultant at Cayenne Consulting. Lee brings to Cayenne clients over 30 years of experience from his prior roles as a law partner in entertainment law, securities licensee, real estate broker, and multiple positions as a CEO/COO of early-stage media companies. Lee received his JD from the UCLA School of Law. View details.

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