Handling related-party transactions and third-party contracts
As discussed in the January 2019 issue of Marijuana Venture, there are likely multiple legal entities involved in your dispensary operations and by now you should understand the importance of accounting for each in its own QuickBooks file.
The activities and transactions of each legal entity are separate and distinct transactions applicable to that and only that legal entity.
Your management and real estate companies exist to provide a service to your dispensary entity and therefore, the facts and circumstances surrounding these services need to be documented and signed.
Pro Tip #5: Document the services and transactions in place between all your dispensary-related entities.
The staffing, management and real estate companies provide important services to your dispensary, and the terms and conditions of these services need to be in a contract between the applicable parties. As soon as possible, put in place a management services agreement and/or a lease agreement between your dispensary and your management and real estate companies, respectively.
These contracts should include all the applicable terms and conditions as if between non-related parties. Most importantly, they should define the scope of the services and the fees/rents charged. When setting the fees and rents, do not give your related dispensary entity a discount or below-market rent. Remember, your goal is to operate all your related entities as if they are completely independent and separate. If you were to consider selling your management entity, a potential buyer will want to know the company’s effective profitability.
With your management entity in a separate QuickBooks file and arms-length contracts in place (and followed; see next tip), you will be able to answer this question at any time. When drafting these agreements and leases, consult with a knowledgeable cannabis attorney and accountant to make sure you do not run afoul of the licensing rules and that your plan is tax efficient.
Pro Tip #6: Follow the contracts and invoice and pay/record the intercompany bills monthly.
It sounds obvious, but of all the tips included in this article, this is the area where most dispensary owners fall short, resulting in costly year-end reconciliations, true-ups and even audit restatements and/or tax return amendments. Monthly, the management, staffing and real estate entities should invoice the dispensary for all services rendered and full reimbursement of expenses incurred on behalf of the dispensary.
Fees and rents for services rendered should be billed in accordance with the terms of the underlying contracts between the parties.
DO NOT arbitrarily transfer money out of the dispensary to the management, staffing or real estate entities. In Arizona, for example, this is a violation of the state’s medical marijuana regulations. In addition, the service entities need to bill the dispensary monthly regardless of the dispensary’s ability to pay. If dispensary cash flow is tight, the dispensary should record a payable to the related service/real estate entities every month.
Contracts with Third Parties
A growing trend in the industry is to contract with third-party management companies to staff and operate the dispensary’s off-site cultivation facility. This may be in the form of a sub-contract where the head management company contracts with a sub-management company (usually a third party).
The terms and conditions of these sub-management contacts are very important to understand and follow.
At all times, remember that you as the dispensary owner are fully responsible for everything that goes on in that facility. Therefore, ensure that proper management and oversight of the facility is in place. Be on-site at each state inspection and inspect and monitor the facility operations regularly. Walk the facility regularly and unannounced. Look for anything suspicious or out of the ordinary. You have worked too long and hard for the right to operate only to have a reckless sub-contractor ruin it.
Pro Tip 7: Ensure the inventory at all of your operating locations is on your balance sheet at each reporting period.
This should be obvious for the locations operated internally, but what about the locations operated by a third party? Should the inventory, including plants, bagged flower, trim, etc., at a cultivation facility operated by a third-party sub-management company be included on your dispensary balance sheet? Yes! If you understate your balance sheet by excluding potentially material amounts of inventory, you risk costly restatements of your financial statements and serious issues with regulatory compliance.
In Arizona, the dispensary must maintain ownership of the crop from seed to sale. Remember that the name of the company on the wall at each location is your company and therefore the cannabis product at each location is yours, regardless of who is operating the location. This may not be intuitive to the non-accountant, but the solution is simple: Require the sub management company to provide you a detailed listing of inventory and sales at the end of each month.
This will allow your accounting team to add the inventory to the balance sheet and to perform certain sales analytics as part of your ongoing monitoring and oversight of the sub management company.
John Terry is a certified public accountant in Arizona who spent the first 14 years of his career as an auditor with “Big 4” type firms. In those roles, he had multiple national responsibilities in the areas of learning and education, technical accounting and audit methodology. He also served as the first corporate controller for a national media company during its $3.5-billion-plus market cap NYSE IPO. Since late 2016, he has consulted with several marijuana-related businesses and served as the interim controller for one of the largest multi-state dispensary operators in the U.S. He can be reached at John.Terry@MarijuanaVenture.com.