Operating A Cannabis Business: Common Problems You Will Face

Certain cannabis industry problems repeat themselves, state by state.
Certain cannabis industry problems repeat themselves, state by state.

When a state legalizes marijuana, it sees a multitude of benefits, including increases in tax revenue, new job creation, and a less burdened police force. It sure beats prohibition.

But operating a cannabis business in a recently legalized state is no easy task. Our cannabis attorneys have seen business owners face similar challenges in every state that has legalized cannabis, whether for medical or recreational consumption. This industry is brand new and expanding rapidly, and growing pains are to be expected. Below are some of the most common problems we see in the industry state after state.

Common Problems When Operating a Cannabis Business

Raising Capital.

Just about anyone involved in the cannabis industry could conceivably be criminally charged with aiding and abetting and/or conspiracy. The federal prohibition against marijuana tends to cause traditional financial institutions and investors to refuse to participate in the cannabis industry. This greatly reduces access to capital and to banking. Raising capital is also restricted by states with residency requirements, that limit investments to only those who have lived within the state for a requisite period of time. Many new businesses require start-up capital and marijuana businesses are no exception.

We have seen businesses borrow money from less-than-ideal sources. We have seen founding members use their own personal capital to lend the business money and this can complicate the distinction between the person and the entity. We have also seen business owners borrow from friends or family, on behalf of the business, far too often without the sort of legal documents that help in such transactions. We also see loan sharks and hard money lenders lending money at high interest rates or for too much of a stake in the company.

Consumer Liability Issues.

The media has recently taken to zealously covering stories on the lack of regulations on pesticides in the cannabis industry. Pesticide use is only one potential consumer protection issue. As a plant, cannabis is also susceptible to mold and mildew. Processing, cannabis products can add additional risk for consumers because of the chemicals used to create things like oils. Cannabis companies are at risk of serious liability if a consumer is injured as a result of using a product. This also applies to products ancillary to the cannabis industry. For example, new technology such as vape pens may pose as yet unknown health risks.

Marketing and Advertising Restrictions.

In an effort to comply with federal dictates most legalized states have enacted onerous advertising restrictions for marijuana businesses. For example, the Colorado Department of Revenue prohibits “advertising that is visible to members of the public from any street, sidewalk, park or other public place.” Such rules prevents local operators from advertising on billboards or bus benches. These heavy handed advertising strictures have produced a halo effect that has led to media self-censorship. For example, in both Colorado and Oregon, television stations have refused to run marijuana company ads, citing regulatory uncertainty and liability concerns. This advertising blockages limits the opportunity for cannabis businesses to reach new markets.

Regulatory Compliance.

Compliance with state and local laws should be a top concern of anyone in this industry. State and local regulations typically cover everything from security and safety protocol to inventory management. States also expect companies to be transparent and they often require regular reports or inspections. Some counties or cities in states with legalization prohibit cannabis outright while some opt to regulate it. Nothing can be more frustrating to an entrepreneur than finding out that a city has banned cannabis after he or she has purchased or leased land in that area. Our cannabis litigation lawyers have handled many lawsuits against cities and counties and each battle has been different, depending mostly on the local laws in play. Complying with state and local cannabis regulations can be a full time job.

Real Estate.

Finding a suitable and state-and-local-law-compliant location for a marijuana business can be difficult. Add in the need to find a willing landlord, and the task can sometimes seem impossible. Most states, cities, and counties limit where marijuana businesses can physically operate.For instance, it is not uncommon for a state or city to require cannabis businesses be at least 1,000 feet away from schools and parks. Why? Because federal criminal law sentencing guidelines tack on extra time at sentencing for cultivating, processing, and distributing marijuana within 1,000 feet of the same. Zoning laws can also significantly restrict location options and typically vary greatly from local government to local government.

Operating a Marijuana BusinessIt can also be difficult to find commercial landlords willing to lease space to a cannabis business because of the risk of federal asset forfeiture of the building. Because cannabis remains illegal under federal law, landlords can face arrest for violating the federal Controlled Substances Act or, more realistically, losing their property via a civil asset forfeiture.  For more on cannabis leaseholds and why they’re unique and need to be handled with great care, check out Why Your Marijuana Leasehold is Key.

Oppressive Federal Taxes.

In 1982, Congress enacted Section 280E of the Tax Code to punish traffickers of illegal controlled substances. This provision disallows all deductions or credits for business expenses related to trafficking of most illegal drugs, including cannabis. In 2007, the US tax court ruled that Section 280E applies to cannabis businesses even where the business activities are legal under state law, and 280E has hurt the finances of state-legal cannabis businesses ever since. There are no signs that the IRS is going to change its attitude about marijuana and 280e anytime soon.

Steep Barriers to Intellectual Property Protection for Marijuana.

The United States Patent and Trademark Office (USPTO) typically will not register cannabis product trademarks due to the federal illegality of marijuana (although products related to a marijuana business, such as the logo for a vapor pen, may receive protection from the USPTO). Many state governments will register trademarks for cannabis products, but they do not offer the same protections as the federal system which are far greater. For example, state registrations only provide protection within an individual state and only when you can prove use in commerce first. Additionally, the lack of access to federal trademarks makes it difficult to determine whether another company has already registered a trademark for a given product, which increases a company’s chances of inadvertent infringement. In addition to searching the federal registry, cannabis businesses should also search the registry of individual states to make sure they’re not infringing on existing, protected marks. For more information on cannabis trademarks and on how to protect your cannabis brand, check out How to Protect Your Cannabis Brand Part One, Part Two, and Part Three.

Lack of Access to Bankruptcy Relief.

When businesses go (or are near to going) under, they often file for bankruptcy in a federal court to re-organize the business and to liquidate assets to satisfy their creditors. Bankruptcy ultimately allows debtors to keep their necessary assets and property for day-to-day operations, and it also involves an asset distribution plan that keeps creditors from suing the business and, most importantly, keeps the business alive. To date, however, federal courts have generally refused to allow cannabis businesses to proceed with bankruptcy filings due to cannabis’s illegal status under federal law.  Bankruptcy is in the exclusive jurisdiction of federal courts, and though state receivership process can offer some relief to debtors, they do not offer the full slate of benefits that federal bankruptcy provides. This lack of federal bankruptcy protection is another reason why lenders and creditors hesitate to lend to the marijuana industry.

There is an implicit gamble that anyone who invests time and money into a cannabis business makes — the bet that financial returns will more than outweigh the costs of these myriad challenges. And for many, that bet is paying off. Not all businesspeople are willing to forge ahead given the tax, banking, IP, and other difficulties that plague the industry. But for anyone that does jump in, it’s vital to have the plan to deal with all of these potential pitfalls.