Starting a cannabis business legally under state law requires owners to consider a wide range of possible challenges. Some of the major considerations include possible federal enforcement issues if the DEA changes its stance regarding the Cole Memo; concerns with banking because many FDIC-insured banks do not want to handle cannabis business accounts; potentially limited growth options since businesses cannot move product across state lines; and personal financial and safety concerns related to being in a cash industry.
These are just a few issues to consider before entering the cannabis industry, but there are countless more.
One significant issue that many entrepreneurs may fail to consider and could have huge implications on both the business and its owner is bankruptcy. Entrepreneurs and business owners rarely think about the possibility of failure when starting a new venture, but this is something that needs to be discussed, particularly in the cannabis industry.
Compare the following two stories:
First, we have a business person looking to open a restaurant. The owner finds a location and uses a small business loan to renovate the building, buy new kitchen equipment, hire qualified personnel and then opens the doors for business. As is the case in most industries, the owner is paying for rent, utilities, payroll and products, which leads to a fairly sizable operating budget on top of paying down the small business loan.
Next, we have an entrepreneur looking to start a cannabis business — in this case, let’s say a retail store. The owner needs to find a location, pay for build-out, security systems, licensing fees, operating costs, etc.
Both businesses aim to make enough income to cover the owners’ personal needs outside of work, but after a few months, it becomes clear that neither business is generating enough revenue to cover costs and make a profit. The restaurant owner can file for bankruptcy. In this setting, the owner has the chance to be relieved of the outstanding debts and liabilities and live to fight another day. However, bankruptcy is off the table for cannabis businesses.
Federal bankruptcy courts in both Arizona and Colorado have recently made the decision to deny bankruptcy protection for cannabis businesses and their owners, and these rulings have been affirmed by the 9th and 10th Circuit courts. As long as cannabis remains illegal at the federal level, cannabis entrepreneurs will be unable to file for bankruptcy. Debtors going into bankruptcy cannot receive relief if they are considered to have “unclean hands,” meaning they are involved in illegal activity. However, there are a number of steps owners and cannabis businesses can still take to mitigate against this fate.
First , make sure the business is a properly registered corporate entity (limited liability company, S corporation, C corporation). The structure may be different given the preferences of the owners.
Second, maintain all the corporate formalities necessary for the entity structure chosen. This means holding annual corporate meetings as required by law in the state governing the business, accurately keeping books and records for the business, voting on major decisions, taking minutes for the meetings at which votes take place and otherwise following the rules and requirements of the LLC agreement, operating agreement, shareholder’s agreement, etc., as is applicable to the business. If the business is properly maintained, it will assist in protecting the personal assets of the owner from future creditors.
Third, while some construction is necessary for nearly every cannabis business, it is important to keep initial startup costs low. Many cannabis businesses start out expecting that having a license to operate is enough to guarantee a profitable business. This assumption has proven repeatedly to be incorrect. Keeping expenses low will go a long way to preventing a business from ever needing bankruptcy protection.
Fourth, do not overextend yourself personally in an effort to fund the business. A cannabis business will not be entitled to bankruptcy relief and neither will an individual owner with debts and liabilities associated with that company. This means liens against personal property, additional mortgages, credit card debt and any other form of liability incurred to fund the business may remain enforceable.
These steps will not allow you to enter bankruptcy, but they may help avoid the need to file for it. There is a misconception that cannabis businesses are “printing money” with people across the country believing an investment in cannabis equals big returns. In reality, excessive taxes, tough competition and growing uncertainty with the federal government make this a risky bet and such risks should not be taken lightly, especially in a business without bankruptcy protection.
Matthew Cleary is an attorney at Van Kampen & Crowe PLLC (www.vkclaw.com), practicing business and transaction law with an emphasis on the cannabis industry. He has represented cannabis businesses from highly trafficked retail stores to large producer operations and everything in between. Before practicing law, he was an enforcement officer for the Washington State Liquor and Cannabis Board.
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