If there is any industry where you want to make sure you have extra layers of protection for your business and personal assets, it’s the cannabis (CBD oil) industry.
The U.S. is the land of opportunity and also the land of lawsuits. We have more lawsuits than any other country in the world. Selling products have an inherently higher risk of liability.
Anytime you are involved in a fast-growing industry with new regulations, it’s a recipe for a huge spike in litigation. This is the case with the fast-growing Cannabis industry, which was worth $8-billion in 2018 and is expected to grow by 5 times, to $41-Billion by 2025! (see
Several aspects of the cannabis industry lead to huge opportunities, and several aspects that will lead to a massive litigation increase.
Areas of Cannabis Litigation:
- Legal agreements with partners and investors
- Product liability class action lawsuits
- Patent or trademark infringement
- Deceptive trade practices
- The actual amount in at least one of those products was far less than stated, which lead to litigation.
- False claims and FDA issues (including all-natural and health benefits)
- The FDA warned that the product did not meet the definition of a dietary supplement and said the company could face its supply seizure.
- State liens and seizures because of past due sales tax or licensing issues.
There are several keys when it comes to protecting your current and future assets as you enter the cannabis business, even as an investor. With investment capital ranging from $500k to $1.5-million at a minimum, this is not an area to set up a $99 LLC online; you must start with a complete formation.
Basic and Advanced Asset Protection Steps for the Cannabis Industry:
- Use a separate, clean entity for your cannabis business. Do not use an entity from the past, especially one with past partners. You do not want mistakes from the past to come back to haunt you in the future.
- Work with a securities attorney for investors. It’s essential to have the proper security agreements in place. There are specific rules about investors living in the states that have legalized marijuana.
- Ownership Structure. As the owner or an investor, you will need to determine how you want to maintain your relationship with the operating cannabis company. Is that going to be you, as an individual or another separate legal entity, holding the safe asset or investment in the operating company? How does it impact your licensing requirements when the owner is not an individual? If you bring an investor on later, membership in an LLC or stock ownership in a corporation will need to be updated. Will you create a taxable event upon capitalization for the non-investor partner? This is where a CPA firm is required.
- Protect your Trade Secrets. Get a non-disclosure/non-compete/non-circumvention agreement (NNN Agreement) in place before you reveal too much to a potential investor.
- Proper 280E Analysis. Ensure your investors understand the IRC 280E analysis from an accounting point of view, which prevents a cannabis business from claiming business deductions (payment, rent, marketing… other than the cost of goods sold. Removing business deductions will increase profits and also increase the amount of taxes to be paid. The states may take a different position than the federal government, so proper planning is required. Here is a video overview from a top cannabis CPA firm on this subject. We recommend an expert familiar with the cannabis industry if you are looking to increase your cost of goods sold related directly to your cannabis product. You cannot deduct your payroll, office, supplies, or anything not directly related to the product’s product or cost. You may be exposing your cannabis to an IRS audit (which they are 10X more likely to be audited than a regular business).
- Protect Intellectual Property. It is essential you trademark your business and product names properly. You will want to make sure your name and packaging are not infringing upon any existing trademarks. You don’t want to be on the wrong side of a class-action lawsuit. A qualified trademark and patent attorney with experience are recommended. We can recommend one as needed when you work with NCP.
- Proper licensing. It’s especially critical that you have all the licenses for your cannabis business in place, including sales tax registrations. If you are selling to other states where it is legal, you will want to track your sales and transactions to determine if you have created economic nexus and are required to collect and remit taxes in that state. Sales tax laws have changed dramatically since the 2018 U.S. Supreme Court Case, Wayfair vs. South Dakota. If you sell on a marketplace facilitator, such as Amazon, they will be responsible for collecting and remitting sales tax in most states (currently 34 of them).
- Banking Control Over Funds. If it is just you in your cannabis business, you have 100% control over your funds. If you have a partner involved in day-to-day operations, you will want to require both signatures for checks or money wired out of the bank account, if over a certain amount. That may be $5K + or whatever number you feel comfortable with. You will also need to consider investor control over your money for distributions or expenditures if they exist.
- Insurance. The basics include adequate fire insurance for a cultivation facility and business liability insurance for your business operation.
Advanced Asset Protection for the Cannabis Industry:
- Establish a Complete Formation with Your Operating LLC or Corporation. Most will go online and only file articles, get a registered agent and obtain an EIN, which provides ZERO liability protection. You must have the correct operating agreement, which matches an LLCs taxation type and number of members if a corporation is bylaws, minutes & meetings, and resolutions for a corporation AND LLC (based upon court cases of piercing the entity veil). You must properly issue membership interests or stock and avoid commingling of funds. You have liability protection the day you form an LLC or Corporation, but beyond that, you must operate it as a separate legal entity. If you are forming an S or C corporation form an LLC, you must file the proper tax forms with the IRS promptly, form 2553 or 8832.
- Set up a Nevada Asset Protection Trust (NAPT) for your cannabis business operating entity’s ownership interest. This same trust maybe your other entities’ owner, which may own your intellectual property or cash investments (safe assets). The benefit is after the ownership is transferred to the NAPT, and two years go by, no creditors may touch your ownership within the trust. You do not want to put a risk asset, like real estate, within the trust because that will bring risk to your cannabis ownership. Learn more from an interview on this important advanced strategy with attorney Robert L Bolick. https://vimeo.com/314354874. You will want to watch until the end of the Q & A section, which is most important, and the option to schedule a free consultation with Rob.
- Establish Business Credit with Dun & Bradstreet. Capital is important to any cannabis business, and making sure your business does not look financially naked to investors or vendors is important. This process does not happen automatically, and you must work with a company that knows how to help you develop an 80+ business credit score with D & B.
Proper policy and procedures for your entire cannabis operation (especially for checking proper ID for individual sales), HR, and payroll support are critical to reducing your liability. If you have personal assets, such as real estate (outside of your primary residence), you want to get those out of your own name and into separate LLCs. There are multiple steps involved, including a possible increase in property taxes, insurance issues, and transfer tax…but as you clarify these points, you will be much better protected if your cannabis business creates an unforeseen liability to your personal wealth.
If you need support with asset protection for the cannabis industry, reach out to our team at support@launchwithconfidence.com, and we will follow up with our current strategy session rates.
