California Nonprofit Marijuana Business Transitions

California Marijuana Businesses

There are a bunch of marijuana businesses in California, the vast majority of which are organized as state nonprofit mutual benefit corporations (NBMCs). Under current California law, there is no strong argument that marijuana sales by for profit companies are legal and S.B. 420 specifically states that it does not authorize “any individual or group to cultivate or distribute marijuana for profit,” which is why we have so many nonprofits there. This is true in many other states too. Cannabis possession by medical patients was legalized, but businesses were not, so different forms of nonprofit cannabis clubs developed.

It is also important to note that while many marijuana businesses are formed as nonprofits under state law, they operate as not for profit entities which are distinguishable from true nonprofits that are tax exempt at the federal and state levels.  Thus, while these businesses technically cannot earn profit, they still must pay tax on any revenue generated minus expenses (though not all business expenses are eligible under section 280E).

As states like California go legal, with regard to both medical and recreational use, many businesses that got started under an older legal regime will want to transition into whatever new licensing system is in place. And many businesses that originally organized as nonprofits will want to transition. In addition to getting licensed to operate in the new system, the directors and officers of these not for profits will often want to attempt to restructure into for profit corporations and LLCs, if such transitions are feasible. This is doubly true when medical businesses get priority in new licensing regimes, as those with priority will be the first targets for purchase or investment by newcomers to the industry. Can a nonprofit restructure in that way?

Not all nonprofits are the same, and not all state nonprofit laws are the same. Most states have a basic entity called a “nonprofit corporation,” and the limits on those businesses are pretty severe. A nonprofit corporation has no owners, but it does have officers and directors. No one has the right to receive distributions of cash or property from the nonprofit. On dissolution and liquidation of the nonprofit, any remaining assets are distributed as the articles of incorporation may govern, but generally officers, directors, and other insiders are not able to receive any types of asset distributions.

California’s nonprofit mutual benefit corporations, though, aren’t quite as limited as some other states’ general nonprofit corporations. Similar to other types of nonprofits, distributions of corporate assets is not allowed during the life of the corporation. If a nonprofit member, director, or officer wants to get money out of the nonprofit while it exists, they have to receive that money as either salary or as repayment of debt. Mutual benefit corporations diverge from some other types of nonprofits here. On dissolution — when the business shuts down — it can freely distribute its assets to its members. And these corporations can admit any individual to membership. This means that the directors and officers can also be members, and they can draft corporate bylaws to allow full asset distribution to members on dissolution.

But distributions on dissolution only get you so far. What if we want to keep the entity alive, so that it can rely on its business track record and reputation to receive a new marijuana business license, but then we simply want to restructure it afterward? Again, most general state nonprofits don’t really allow that type of transition, but mutual benefit corporations may be able to, using a merger. California allows mutual benefit corporations to merge with for profit corporations. So, if I wanted to restructure my California nonprofit mutual benefit corporation into a regular for profit corporation so that I could issue stock to new investors, I could form a new for profit corporation, execute a merger with the mutual benefit corporation, and then walk away with the new for profit company as the surviving entity. It’s a little more complicated than that, but it’s possible.

A nonprofit mutual benefit corporation in California can also convert to a for profit entity by amending its articles of incorporation and filing the amendment with the Secretary of State. The amendment will require approval from the state and may also require approval by its members.

That doesn’t mean that California businesses will necessarily be able to take advantage of this merger or conversion ability, however. First, we don’t really know what types of limitations the state of California will put on medical marijuana businesses. California may still mandate that they remain nonprofits as new regulations emerge. Even if it doesn’t, the state may give itself approval power over any merger or conversion involving a licensed cannabis business. Cannabis businesses operating in California as a nonprofit now should keep close watch on the situation and keep its options open as the state unveils its new systems.