Don’t wait until adult-use regulations are passed
It is no secret that New York and New Jersey — two of the nation’s most populous states — are racing to legalize adult-use cannabis in 2019, and experts predict that Illinois, Connecticut, New Hampshire, New Mexico, Rhode Island and Minnesota are strong 2019 contenders as well. While prospective operators await the enactment of regulations and issuance of applications, there are steps they may take now to prepare.
First, form a new business entity. A separate legal entity will have the power to enter into contracts and provide its owners with limited liability (to protect them and their other entities from incurring individual liability for business debts). Typically, cannabis entities select either an LLC or a C corporation. While owners of both structures enjoy limited liability, there are significant state-specific differences between LLCs and C corps with respect to, among other things, taxation, who may be shareholders, the manner by which corporate responsibility may be allocated among owners and managers, and the scope of fiduciary responsibilities that owners and managers owe to each other and the respective shareholders. Once a cannabis business is formed as a distinct legal entity, prospective operators should apply through the IRS for a corporate employer identification number (EIN) and endeavor to open a bank account.
Second, secure real property. In every state in which adult-use cannabis has been legalized, licenses have been location-specific. In some existing adult-use programs, including Massachusetts and California, priority licensing may be given to prospective operators who identify locations as in-need of economic development, or in an area largely populated by socio-economically disadvantaged members of society or those disproportionately impacted by the failed War on Drugs. New York and New Jersey are signaling a similar intent.
While it may seem counterintuitive to invest in real estate before a license to operate is awarded, it is advisable to scope prospective properties, minding zoning requirements (such as farm or agriculture for cultivation uses; manufacturing for processing uses; and retail for dispensing uses) and prospective distance requirements (typically a 1,000-foot buffer between the cannabis business and a school, playground, daycare or other facility where children may congregate). In densely populated areas like New York City, such locations may be difficult to find. Once a site has been identified, work with the landlord or seller to enter into an arrangement that is contingent upon regulations and/or licensing. And it’s important to develop positive relationships with prospective neighbors. A cannabis business is infinitely more valuable and successful when it is viewed to be a job-generating value-add to the neighborhood, as opposed to an entity likely to attract crime.
Third, raise capital and solidify your team. While barriers to entry in adult-use markets tend to be dramatically lower than in highly restrictive medical markets, the successful buildout of a cannabis operation still requires a significant investment in capital — both financial and human. And in this stage of the game, many well-capitalized, multi-state operators are already positioned to deploy funds quickly and employ experienced talent. Prepare a business plan, identify how much capital and talent is needed and obtain commitments using letters of intent and term sheets that have regulatory and licensing contingencies.
When raising capital, operators need to decide whether they are seeking a buy-in from prospective equity investors (a private placement or simple agreement for future equity), to take on debt (a loan/promissory note) or a combination thereof (such as a convertible note or a loan with warrants). Conduct background checks of prospective partners and investors, as those with certain types of felony offenses — including financial crimes and, perhaps, certain types of drug trafficking offenses — may be excluded from ownership or from controlling operations. Also, assure that each team member is deeply committed to regulatory compliance. A team is only as strong as its weakest link, and one weak link could result in the loss of the entire license.
Fourth, develop and protect intellectual property. Emerging markets, particularly in New York and New Jersey, are going to be competitive. Intellectual property assets, such as patents and branding, are likely to set prospective operators apart from one another. Further, investors prefer to visualize something tangible. That could mean patents pending, a well-developed brand identity or a well-defined ethos, backed by a relationship with a qualified and respected brand developer who has been retained to design the vision. Speak with a patent attorney to understand if any assets are sufficiently unique and useful to qualify for patent protection.
Anyone seeking to be first to the table to produce and sell adult-use cannabis in an emerging market should not wait until regulations are issued and applications are posted. It is never too early to consult with legal and accounting advisers in order to develop a sound game plan. Preparedness will be the key to early success.
Lauren Rudick represents investors and startup organizations in all aspects of business and intellectual property law, specializing in cannabis, media and technology. Her law firm, Hiller, PC (www.hillerpc.com), is a white-shoe boutique firm with a track record for success and handling sophisticated legal matters that include business and corporate law.