Startup considerations for Planning a Cannabis based business.
1. Expect Scrutiny
Cannabis is a highly regulated industry, and therefore, startups in the industry must operate within a particular set of legislation. Add in tax regulations and things get even more complicated: Section 280E
📷 of the IRS tax code, for instance, prevents cannabis companies from taking general and administrative deductions that are standard for traditional startups. Whether your business actually touches the plant itself or provides ancillary services to the cannabis industry, expect regulatory and other constraints particular to operating in the cannabis industry.
Structure yourself to be legal and compliant
Unlike the majority of venture-backed startups that can form a Delaware corporation and run their entire business out of this one entity, a cannabis startup’s choices are more complicated because Cannabis is illegal in Delaware. For instance, companies cannot incorporate in Delaware and then apply for a cultivation permit in California using that same entity.
However, forming a holding company can be a workaround. For example, forming a holding company in Delaware allows a startup to raise money through the holding company while operating in California through a wholly-owned subsidiary. Even then, forming a Delaware holding company could still bring about concern due to the unknowns of how Delaware courts may treat a company that owns a subsidiary that is a cannabis business. As a result, some companies have chosen to form holding companies in states like Nevada where cannabis is legal and because it has corporate laws similar to that of Delaware.
While structural decisions like these can be nuanced, they’re important to get right. As Hua puts it, “It’s really important to get your company structure right. Otherwise, you may be at the finish line and unable to cross.”
Banking problems are not unusual
Since Cannabis is a Schedule I controlled substance, banks accepting money from cannabis businesses could be charged with money laundering. Some banks refuse to work with cannabis companies altogether, even if the company remains legally compliant and doesn’t actually touch the plant.
Some cannabis companies, however, can find a bank willing to work with them. But even then, a thumbs-up from a bank’s regulator is no guarantee. While being legally compliant is the best defense, many compliant cannabis companies have still found their accounts frozen or closed.
2. Keeping Tabs on Regulation
Cannabis companies that do not pay attention to pending legislation are risking the entire future of the company. This applies to more than just current laws—if you don’t understand legislation coming down the pike, you may wake up to find yourself in an obsolete business model.
Instead, successful cannabis companies will work to influence local legislation, track federal changes, and engage a legal team that stays on top of the ever-changing regulatory environment.
Influence local regulation
Since cannabis is such a nascent industry, regulatory areas are still being defined. Search for assistance helped lobby for delivery regulation, create trade groups, fight for licensing practices, and build a comprehensive software solution to allow both cannabis delivery and retail businesses to operate their core business functions compliantly.
Track federal regulations
Since federal changes can alter the whole nation in one fell swoop, they can be even more impactful than local laws. That makes monitoring them of the utmost importance.
In general, cannabis entrepreneurs must keep tabs on industry regulation, both current and future. It’s just part of the job.
Hire a good lawyer ASAP
Starting a cannabis business comes with a host of unique regulations, so a top-quality lawyer can be worth their weight in gold.
Given the industry’s specific requirements, finding the right fit can be tough, which makes starting the search early that much more valuable. Be sure to choose a lawyer with prior experience in cannabis law. While the importance of quality legal representation cannot be overstated, CEOs still need to keep in mind that lawyers are not entrepreneurs. Find a lawyer who will provide top-quality legal advice and still respect the business’s strategy.
3. How to Fundraise in the Cannabis Industry
Although cannabis is no doubt a rapidly growing industry, investors can be wary of its additional requirements. Here are three tips for finding the right investors and successfully fundraising:
i. Solve your structure and legal requirements before fundraising.
ii. Find investors that are comfortable with (or even well-educated in) the industry.
iii. Pitch your solution, not the space itself.
- Solve your structure and legal requirements before fundraising
No investor wants to invest in a company that might be regulated out of existence, so de-risking the investment is of paramount importance. That means you need the proper corporate structure as well as any relevant licenses.
While some cannabis companies have received VC funding before being licensed, not having this box checked can make many VCs hesitant.
If you are pre-license, it is generally really hard to raise money.
VCs are in an industry where a very high percentage of their investments fail, so lacking the proper structure simply makes it easier for them to pass on investing in you. It’s safest to take care of every structural danger before speaking to investors.
-Find the right investors
Some limited partners in venture funds prohibit these types of investments, which can make investing in a cannabis company a non-starter for their VCs (even if they like the industry and company). Still, however, some top VC firms are taking part. These are typically funds that recognize cannabis’s large potential upside and are willing to take a risk on the industry even though it lacks an established late-stage fundraising ecosystem.
Some investors may pass simply because they don’t like the industry. That’s okay—many others see cannabis’s value. Ultimately, just because an investor thinks that being in the cannabis industry means your company’s valuation receives a discount does not necessarily mean they are wrong. There are a lot of unknowns and investors that are comfortable with the regulatory complexities can be worth the price in order to have a quality adviser and partner in growing your business.
-Pitch your team and solution, not the space
While most VC pitches highlight market size, cannabis is different. Any cannabis investor already knows the impressive—and quickly crowding—market. Instead, cannabis entrepreneurs should focus more on their team, specific solution, and understanding of regulatory requirements.
The current regulatory climate means that most investors already recognize the value of the industry. Obtaining your temporary permits is just one hurdle most investors will require, but being able to convey an impactful pitch and that you have a team an investor is comfortable funding is more likely to land you the seed investment or Series A term sheet you’re looking for.
Every piece of advice for entrepreneurs navigating the cannabis industry stems from one fundamental fact: it is rapidly changing, be educated. Building properly, keeping a tab on the still-shifting regulations, and adjusting fundraising strategies are crucial tactics for companies taking root in the industry.