How to Win in Cannabis in 2019

cannabis accounting Jul 26, 2019

Learn How to Maximize Your Efforts

My goal with this blog is to explain how to win in cannabis in 2019 as an accounting professional. We get countless emails from people that want to try to do it the hard way, and that’s fine. But if you really want to maximize your efforts, you’re going to want to pay attention. As you may know, we provide cannabis accounting training to professionals all over the United States. This knowledge is unique in the cannabis industry right now, and is a way to add REAL VALUE (listen up all of you not knowing how to express value for fees to CEOS) to Cannabis CEOs, and add 10x to your fees to those that listen.

In most of the feedback that we receive, and among many of our students, I still see that most accounting professionals are “missing the boat” around 280e. The goal is simply to do it right, pay the tax, and not “beat” it (that is the losing strategy).

The advice attached is CONTRARY to what many accountants/attorneys are telling cannabis clients. If a CEO listens to the bad advice, and misapplies it (as many do) they could likely be sitting on a big hidden liability.

What You Don’t Know CAN Hurt You

I’ve been in this industry for quite a while, and I have already seen a few big winners (large public and small private entities), but many, many more big losers in this space. There is a way to win big in cannabis (few will follow this), but it’s a much easier path to lose big as the costs and taxes are so large. Thousands and thousands of cannabis companies exist in the US today, and the industry is expanding quickly. However, almost nobody in this niche is trying to build a company to “leave to their grandkids.” Everyone is thinking about exit on day one, and about how they are going to get there successfully.

The quote, “Like picking up pennies in front of a steam roller,” (Nassim Taleb) makes me think of the strategy that has been pitched by cannabis accountants and attorneys since Colorado legalized; a strategy sought after and followed by likely 90% of cannabis CEOs, a strategy still being pitched today at events, blogs, and meetings all over the US, yet a strategy that simply doesn’t work.

My mission right now, and that of DOPE CFO, is to “fix” this massive problem in the industry, to educate accountants, CEOs, and investors about why this is the wrong strategy, and what exactly to do about it. 

The Best Way to Lose in Cannabis

Assuming that cannabis companies are being founded primarily for a large exit, it’s interesting to me that so many are focused on the extreme short term and the incorrect strategy of trying to beat the IRS and 280e.  

This strategy has been pitched by many for nearly 10 years now, and in all its forms it comes down to three primary strategies for overcoming the punitive 280e provision (that says you can’t take any deduction or credit if you traffic Schedule 1 drugs):

  1. Complex entity structure and cost movement,
  2. Non-Cannabis divisions, and
  3. Maximizing Cost of Goods Sold (COGS)

Since CHAMPS, the IRS is winning case after case because of the incorrect use of these three strategies. Yes, there are ways to do each of these correctly (it’s impossible if you don’t have world class accounting professionals and processes), but my contention is that this is like “picking up pennies in front of a steamroller.” I speak with CEOs and speakers all over the US, and all the talk is around these strategies and NOT about what really matters: Helping set up a world class valuation, and ultimately exit, for the cannabis company.

First of all, I have never seen a cannabis company implement these three strategies correctly (and I’ve reviewed hundreds of books/returns), and so the IRS, which is FULLY aware of all three of these games, is having a field day as they audit these companies. We are seeing the IRS winning many cases (Altermeds, Harborside, Alternative, etc), and I expect the win rate will accelerate rapidly for them as more companies are audited in 2019.

Second, even if done right, yes, you will pick up some “pennies,” but the more important decision is to make sure that the cannabis accounting is done right, and that each strategy has a legitimate business purpose and is executed flawlessly. That said, this strategy only earns you a little bit along the way to exit if done right, but if done wrong (as most do) it will succeed in lowering your exit valuation, plus you will likely be assessed fines, penalties, interest, jail time, and/or risk being shut down.

With so little reward, and such high risk, why are there so many companies following these aggressive strategies that have very little “substance” behind them? That’s an answer I don’t know, other than possibly just misguided short-term thinking.  Better to scale back the risk level, have cash flow DECREASE just a little in the interim, then have EXIT Values increase substantially.

So What is the Secret to Succeed in Cannabis?

It’s actually very simple, and if followed, I can help lead to a successful exit:

  •  Be well capitalized!!! Having funding to survive while cannabis is subject to 280e, including difficult commodity state pricing environments, is critical. Many are failing, as they don’t have the funding to survive to exit. 
  •  Have a world-class team, which means not just a motivated CEO/COO, but also a  QUALIFIED cannabis CFO and accounting department, as well as a compliance function (CCO) that can monitor and report on state, county, OSHA, and FDA rules.
  • Focus less on “beating 280e” and MORE on building your brand, growing revenues and market share, and location (if it is a dispensary). Exits are happening right now based on these metrics, and NOT EBITDA or Net Income. These multiples will rise significantly when federal legalization happens.
  • Vertical integration can add value to the enterprise, as well as improve cash flow and control over the supply chain.
  • Have rock solid accounting (perpetual data room, auditable books including correct cost accounting, Accounting Policies & Procedures, and internal controls, and someone trained in cannabis accounting).

Want an example? Check out Tilray and the first US canna billionaire CEO: they get the process, accounting, brand, market share growth, and ALSO that there’s no need for net income during this “land grab” stage (huge net losses, but super high valuation). 

Or, read what Harvest CEO says about their 850 Million buy in the space HERE

But, it’s not just the big guys. Even in a state like Oregon, where we have a 6 year supply of weed sitting in vaults going stale, we are seeing nice prices for a good brand or location.

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