As they say, knowledge is power. Social equity applicants for Cannabis licenses have a number of important things to stay on top of as they apply for licensing and work to raise capital. Among them are a great and grounded pitch deck, a well-thought-out capital and entity plan, a bullet proof financial model, appropriate entity and funding structure, and the right team, including a qualified CFO.
Whether you are a social equity applicant or want to help those who are seeking licensure in various states across the nation, five crucial keys are needed to maximize one’s chances of getting a legal Cannabis license. But before we delve in, take note of five common Cannabis license application pitfalls to avoid. Although such items may seem small, even the smallest of oversights can be the difference between winning that license and being sent to the back of the line.
Wouldn’t you know it, anyone who applies for a Cannabis license is going to have to go through an application process. While the questions and required documentation can vary from state to state, city to city, here are the most common application pitfalls. Make sure not to fall into one of them.
Check once, twice, and again. Once you’ve done that, have a trusted advisor check over your application again. You want to be 100% certain that your Cannabis license application is complete and that every requested form, copy, and document is included. This process will take much, much longer than originally anticipated, so start early to give yourself the time it will take to submit a complete application.
Most cities and counties who award legal Cannabis licenses stipulate that you must include the physical address where you plan to operate your licensed Cannabis business. Most say applicants cannot change their proposed business location during the application process, so get your location locked down prior to starting the application process.
Warning: It’s not as easy as picking a spot and opening up a coffee shop. The location selection process is incredibly involved, and most people underestimate how political, expensive, and time consuming this can be. Don’t get blindsided by it all. Start your research as soon as possible and start to identify areas that are Cannabis friendly. Although Cannabis may be legal in a certain state, not all jurisdictions will allow a business to operate, and if they do, there will be a whole lot of red tape to make it happen.
Think about it a bit and it makes sense that the city or county that processes your application is going to want to know that you have access to the capital you’re going to need to get that dispensary, cultivation site, or manufacturing plant up and running. Including the names of your investors and pertinent investor information will enable the persons processing your application to gain a better understanding of how prepared you are to get up and running as a legal Cannabis business.
If you have investors, make sure that they are prepared to provide a lot of information during the licensing process. Some cities look into where the investment money comes from and will dig deep to ensure that all involved are on the up and up.
Does a walkthrough inspection of the future dispensary location need to be included with the application? Does the exhaust system of the future grow site need to be inspected by an environmental health specialist? What city and/or county approvals do you need to have prior to submitting your application? Don’t be blindsided by all of the fees and timeline changes because you didn’t account for inspections and certifications that are required before you’re open for business.
Get clear on all of it by inquiring about the fees and requirements so that you can plan accordingly and avoid unnecessary delays.
Do you have a qualified Cannabis accountant or CFO on your team? Do you have investors? Have you had experienced professionals help you with your capital and entity plan, financial model, and entity and funding structures? If that’s all news to you, definitely read on! We’re about to get into all of it.
If you’re asking, “What’s a capital raise?” you’re hardly the first. As you know, “capital” is money and the “raise” is what you and the company you’re starting are doing when you go out to get those investors you need to get that Cannabis business off the ground. Gone are the days of “winging it” in Cannabis investing. Today’s players are super sharp, discerning, and very focused on making sure the business side of things are all up to snuff. Many have learned the hard way.
Early investors in Cannabis were less focused on transparency and accounting, and more concerned with funding what they assumed to be good products or good ideas. Sometimes companies with little more than a catchy idea got funded, launched, and died (i.e. MedMen). Today’s Cannabis business investors know better; they have to take a good hard look at the numbers.
What do they want to see? How about top-down corporate governance and internal controls, accounting policies, and carefully devised procedures set in place to protect their valuable investment. Among things they will expect are a Perpetual Data Room that is available and up to date all the time, board seats, and timely, accurate reporting conducted by a robust accounting team which includes Cannabis accounting and tax experts.
Understandably, investors are concerned about taxes being properly done. Doing so requires correct “GAAP” level cost accounting, something many accountants don’t understand how to do correctly. It makes sense that investors don’t want to risk fines, penalties, loss of licensure, and more, if the accounting is not done correctly. In the Cannabis industry, IRS audits are inevitable, and state audits will probably rise in coming years. Then there are compliance standards that need to be met for OSHA, USDA, FDA, and the respective state of operation.
Long story short—get in the know and surround yourself with a team of professionals with expertise. There’s just too much to handle to go it alone.
Your pitch deck is a succinct, grounded summary of what you want to do, how you want to do it, and how the next one to five years will play out, based on the data which includes “worst case” and “best case scenarios.” Investors may like your passion but they love a good deck that does everything it's supposed to do.
Many companies looking to raise capital have decks that are missing key components, lack realistic figures, and here’s a very big one—they don't agree with their financial model. Many decks only include the “best case scenario.” Now when is the last time you saw a best case scenario actually come to fruition?
A good deck will contain ALL of the following components:
A management team that shows proven prior success, including a qualified accountant and a CEO who is not “just a grower.”
A good story depicted by answering these questions: What is the background? Why now? How did you get here? What’s the key problem your company addresses, and what’s the solution you provide?
A solid board and advisors. The more robust your team, the better.
Market analysis, which is an accurate look at TAM (total addressable market) and determines what your share will be from year three to five.
Unit economics (unit revenues and costs), your business model, and investor metrics and ROI
An actual well thought out offer and company valuation
Any many more items
Your capital and entity plan shows investors how you plan to raise capital and the entity structures you will use to do so. The plan you put in place matters greatly, so once you have familiarized yourself with the various entity structures and have a ballpark figure of the amount of equity you need to raise, get a corporate attorney involved to help ensure things are set up correctly. That being said, your role during the drafting process should not be a passive one. You likely have a particular vision for the Cannabis business you are working to create, so get in there and learn all you can so that you can make informed decisions that align with your goals and make sense for you and your financial needs and concerns.
Consider the following:
Many startups will issue convertible notes (debt that can convert to equity later) or SAFE Agreements (Simple Agreement for Equity). If you go with a C corp entity structure, shares can be sold to raise capital. If you go with LLC, member interest and ownership is exchanged to raise capital.
Two of the most common legal entity structures for Cannabis companies are LLCs and C Corps. When it comes to raising capital, most investors prefer the C corp entity structure, although specific partnerships or arrangements may be better suited for LLC or multiple entity structure. We’ll have more on that in Key #5.
A good financial model contains simple, easy-to-read, accurate information that agrees with your pitch deck. It includes your financial statements, key assumptions, and summary.
Your financial statements should include all of the below, followed by separate tabs for key assumptions and your Investor Summary:
For all of the three above listed items, your model needs to show financial projections spanning from year one through to year five. You may also choose to add a tab, broken down by month, to show your projected P&L for Year One. Remember, your model must agree with your pitch deck. Hence, it should be prepared and reviewed by a world class CFO.
Next, comes your “key assumptions tab” which is just what it sounds like. Again, being grounded is the name of the game, so make sure all of your assumptions are #1 - shown and #2 - reasonable. Consider every variable that applies to your Cannabis business. If you are going to be a grower or cultivator, getting clear on how much each plant will yield is important, as is determining how much a pound of product will sell for in the current market.
Your summary tab should include key metrics, expected returns, and financial ratios, as well as investor capital, Internal Rate of Return (IRR) at Year Five exit under various valuations, and the overall return of investment (ROI to investors). Be sure to show your “best case” and “worst case” scenarios, so that an investor can see what happens if your predictions are off by 50% or more. Having a deck and financial model that shows integrity, that it’s built on real considerations and reasonable assumptions is far better than pie-in-the-sky figures and predictions.
Selecting the right entity and funding structure matters greatly. Most investors prefer the C corporation entity structure far more than the LLC entity structure, while many accountants and lawyers tend to prefer LLC, largely due to the fact that they’re much easier to maintain. From the outset know this: if you select LLC or something other than C corp, that could limit your number of potential investors.
The major advantages of choosing a C corporation entity structure for one's Cannabis business are its attractiveness to investors, and the personal asset protection it gives them. If a Cannabis company that’s set up as a C corp gets audited by the IRS, the shareholders are protected from having their own personal assets dragged into the mix, since under this structure auditors can solely audit the business.
It’s understandable that Cannabis business investors, shareholders, and founders, want the level of security and peace of mind the C corp structure provides, saving them from worrying about having their personal assets tied up or seized in an audit. Under this structure, shareholders also have the potential of having their capital gains excluded from taxation. A quick and by-no-means-final list of the requirements shareholders need to qualify for the 1202 capital gain exclusion include the following:
Learn more about the 1202 capital gain exclusion at IRS.gov.
The major cons of the C corp entity structure are they’re harder to set up (requiring many legal docs), cost more to maintain, and are generally taxed twice. Taxation happens the first time the company files its income tax return. The second time taxes get paid happens when company profits are dispersed as dividends.
Other cons are the gamut of aforementioned legal docs (including ongoing board meeting minutes, ongoing shareholder meeting minutes) and the need to maintain a current capitalization table that lists all of the shareholders and the amount of equity owned by each.
Nevertheless, if a social equity applicant is planning on raising capital from investors, choosing the C corp structure might be their most advantageous option. Learn more about the required documentation for C corporations.
Compared to C corps, setting up an LLC (Limited Liability Corporation) is a breeze, taking as little as a day of paperwork and a day of handling the various filings to set up. When establishing an LLC, little more is needed than the Articles of Organization/Incorporation, statement of information, operating agreement, paying the annual franchise tax, and filing for the EIN (Employer Identification Number). The fees are modest, costing less than $200 to file in most states, and less than $1000 to maintain per year. When it comes to taxation, unlike the C corp, tax is paid only once, not twice.
Depending on the amount of qualified business income (QBI), LLC shareholders may be eligible for the IRC 199A deduction of as much as 20% of QBI but there are thresholds and a number of variables to consider, so definitely consult a Cannabis accountant or CFO if you’re considering setting up as an LLC.
The biggest con of the LLC structure is the limited liability protection it provides for all of its shareholders. Consider the following scenario: you’re the founder of a Cannabis dispensary and have a rich uncle who wants to invest in your business. If the dispensary undergoes an audit and your assets are minimal, your uncle’s assets may be subject to recovery i.e. being seized by the IRS.
In situations where there are one or two capital investors who provide the majority of the capital, their prevailing interest is, understandably, protecting their personal assets. The owner/operator may, however, find the lower taxation of the LLC structure more appealing than personal asset protection. Hence, a balancing of all of the stakeholders needs and interests should be fully considered prior to forming an LLC. Another thing to consider is IRC 1202, the capital gain exclusion. In an LLC, 1202 does not apply.
Want the best of both worlds? Consider multiple entity structures. One option would be to set up a C corporation as the holding company for a number of LLCs. Doing so could enable the owners and investors to get certain benefits, like the personal asset protection of the C corp structure, while also minimizing tax liabilities. Entity structures alone will not lower your 280E exposure. If you plan on your business having non-Cannabis divisions, you can allow for various investors to buy shares of those non-Cannabis LLCs, open bank accounts for those non-Cannabis LLCs, and take advantage of a broader array of options for raising capital and expanding the business.
Setting up as a multiple entity structure, especially if it consists of a C corp, will require a lot of paperwork. And while it can provide a greater amount of asset protection, bear in mind that each and every separate entity must maintain its own books and hold them (or copies of them) at the business location. Those items include: ongoing board meeting minutes, ongoing shareholder meeting minutes, list of all shareholders and their home addresses, operating agreement(s), Articles of Incorporation, federal tax returns for the past six years, etcetera.
A word of caution—do not select a multiple entity structure as a means to get around 280E. It will not work. There must be a real, legitimate business purpose for the erection of each entity.
If you’re feeling just a little overwhelmed after reading this article, take a deep breath. One word of advice: embrace the challenge ahead of you. Doing so enables you to get aligned with the hefty amount of work that goes into gaining licensure and starting that Cannabis business.
You do not have to go it alone. There are qualified, knowledgeable professionals, including DOPE CFO VIP Members (make sure they are an official member of the Dope CFO VIP network as evidenced by their digital badge), who can help you with navigating the social equity licensing process, as well as setting up your funding and entity structures, creating a winning pitch deck, and more. Do not let a few terms of art (jargon) and a fair bit of work stand in the way of realizing the opportunities you have in front of you.
Getting the right accounting professional on your team matters greatly. Select an accounting professional who knows Cannabis accounting and who is experienced in helping entrepreneurs get their pitch decks, financials, and documentation in order. If you can do so, get a Chief Financial Officer (CFO) who is well-versed in financial models, raising capital, and who knows what it takes to appeal to the right investors, and who knows what to steer clear of.
We’re rooting for you!
For more information on navigating the Cannabis business licensing process, check out the FREE replay of our webinar 5 Crucial Tips for Social Equity Cannabis License Applicants.