As business and corporate cannabis lawyers, we have registered and structured a large and ever-expanding number of pot businesses up and down the west coast. Most of these businesses are corporations or LLCs, and most of the time, these businesses are incorporated in the state where they will obtain a license to trade in marijuana. Occasionally, though, someone will come to us with a company shell they have registered in a state like Delaware, South Dakota or Wyoming, or they will insist on incorporating their cannabis business there. The question becomes whether foreign registration is worthwhile? Most of the time, the answer turns out to be “no.”
As a preliminary matter, it is important to note that registering a cannabis business in a far-off state cannot insulate the owners from legal liability for violations of the federal Controlled Substances Act (CSA). That is true regardless of whether one is building out an LLC or a corporation, regardless of the tax election made, and regardless of whether the new business is nested within a holding company. The federal government is well within its rights to bring a claim against business owners and seize assets under the CSA, and company domestication or paperwork cannot serve as a shield.
Still, people have a fondness for foreign companies, and for Delaware companies in particular. People will say things like “half of all public companies are registered there,” or “my other company is a Delaware company,” or “Delaware has no state income tax.” Most of the time, none of these are great reasons to register a cannabis company in that state. This is because nearly all cannabis companies are small, privately held businesses that receive no tax benefits and no meaningful liability protection by registering in Delaware, or anywhere out-of-state.
Large, publicly traded companies, on the other hand, may prefer Delaware registration for various reasons, including: 1) Delaware law protects directors and officers from derivative liability (to shareholders and non-managing members); 2) Delaware has a unique “Court of Chancery” solely dedicated to corporate law disputes and significant business cases; 3) Delaware has no state corporate income tax; and 4) Delaware’s LLC Act and General Corporation Law are both perceived as cutting-edge, on topics from fiduciary requirements to series LLCs.
New marijuana businesses may see themselves as just a few years away from being large and even publicly traded, and they may hope to grow into the perceived benefits of a Delaware company. But in the short term, their primary goal should be asset protection, avoidance of unnecessary company paperwork, and sound tax strategy. If a privately held company is run correctly, the Delaware statutes are not likely to afford meaningful protection beyond local state statutes in any of these categories. In fact, out-of-state registration may cause complications that produce improper governance, defeating the purpose of out-of-state registration entirely.
As to specific factors that may weigh against a Delaware registration, it should be noted that: 1) filing in Delaware requires payment of Delaware franchise tax; 2) the home state will require “foreign” registration of the Delaware entity, often at fees that are double or triple that for a native company; 3) in addition to dual registration, both the home state and Delaware will require ongoing reporting; and 4) formation of the company out-of-state has no impact on where the owners pay income tax. If the company is operating in Oregon, for example, all of the activity will be taxable there.
None of this is to say that Delaware, Wyoming, South Dakota, or any other state are never worth a look when it comes to forming a cannabis company. A founder may have access to venture capital that insists on seeing a Delaware C-corp, or perhaps she is motivated to keep her name off formation documents at all costs, given the status of federal law. (Delaware allows this; certain states do not.) The bottom line is that forming a cannabis company, like any new venture, brings numerous considerations. But it’s important to actually consider them, not just default to Delaware.