Structuring Your Cannabis Empire

How to structure your cannabis empire
How to structure your cannabis empire

Market consolidation in the cannabis industry was always going to happen, and it is already starting to happen. States like Washington and California have or will have limits on the number of marijuana-licensed businesses that individuals can own, but those limits are likely to erode over time. The market simply puts too much value on the efficiencies that come with consolidation — more consistent retail and product experiences, lower prices, etc. There are negatives that come with market consolidation, especially if markets move past standard consolidation to anti-competitive consolidation. Market efficiency is good, but oligopolies are bad. For government regulators, the value in market consolidation is that companies that earn more money have more resources to put into compliance — enforcement is likely to be easier. But market consolidation also makes it easier for businesses to coalesce and participate politically, and business political power can come at the expense of regulatory political power. For a thoroughly enjoyable Ted Talk on “Big Marijuana,” I cannot recommend highly enough this talk given by Hilary Bricken, our lead cannabis business attorney in Los Angeles.

But we are still in the early stages and the possible negatives of market consolidation still appear to be a long way into the future. Acquisition and merger activity continues to be hot in the cannabis industry, as is organic growth and expansion. If you are one of those growing businesses, there are a ton of ways to put it all together. You can have a single corporation that holds everything. You can have a corporate holding company with multiple wholly-owned subsidiaries. Or you can have a number of parallel entities with common ownership but without a direct corporate relationship to one another. Here are a few considerations to keep in mind when putting it all together.

  1. Liability structuring: There are two schools of thought on how many entities to have for a business that has multiple locations and holdings. On the one hand, having multiple corporate entities is great for limiting liability. If you own five retail stores and have each of them in separate legal entities and one of them gets sued, the worst-case scenario is you totally lose one store and have to shut it down. If they are all owned in one large entity, all of the assets are at risk. On the other hand, properly managing many different companies can be a governance and accounting nightmare. The efficiency gains of internally consolidating as many things into single entities can be worth it regardless of the additional liability exposure.
  2. Investment: A cannabis business’s valuable assets can generally fit into the following categories: trademarks and other intellectual property; real and personal property and other physical assets, inventory, cash receivables and ongoing profit interest. When that business goes out to raise capital, a fundamental question to ask is whether the investor is buying into the whole pie, or if the return on investment is targeted. With a multi-entity structure, an investor can invest in Facility A, while having no stake in Facility B or IP Holding company C. But be warned — different ownership structures in related companies come with serious risks of conflicting interests for the management of those companies, and the business must adopt cross-company conflicts policies.
  3. Employees: Multi-company structures often involve employees providing services to multiple entities. This is especially true for internal marketing employees, bookkeepers, and anyone else involved in business strategy. But it can also be the case where employees at one entity are asked to cover a shift at a different location. This can be a major headache if the business doesn’t have clear employment policy. There are three main options. First, the companies can all maintain clear separation and treat the employee as separately employed by each company. This isn’t really a good plan, however, because for many government purposes, like the Family and Medical Leave Act, the Affordable Care Act, and overtime rules, the business entities will likely be treated as an integrated employer anyway. Another option is to use “paymaster” rules, where a single entity within the chain can pay the employees and be reimbursed by the other entities. Finally, an affiliated entity within the business structure can serve as a professional employer organization and be licensed to formally provide paid employment services to the various entities within the business empire.
  4. Company Separation: No matter how closely aligned, different legal entities should not commingle their funds. Work done by third parties should be invoiced to the recipient of that work, and transactions within the business empire need to be invoiced and paid at reasonable market rates. Without following clear structures and formalities, there could be tremendous tax and liability consequences — the liability shield that exists between entities can be pierced if the companies don’t act as if they are truly separate.

As cannabis businesses grow, the time and money spent on internal compliance and good governance processes needs to grow as well. Policies and procedures that work for a single location company don’t work when that company outgrows its original home and multiplies.