Starting a company is intimidating for most, if not all, early stage entrepreneurs. Often founders are product-focused and put legal concerns on the back burner in hopes that they can get up and running before incurring legal expenses. Unfortunately, in the cannabis space especially, it’s important to have legal advice at the outset of the business to avoid later excess costs and burdensome reporting or restructuring challenges.
Since the regulatory landscape is multilayered and stringent at both the state and local jurisdictional levels when it comes to cannabis businesses, not only is it important for businesses to ensure they are cued up early on for facilitating the necessary licensing and permitting of their cannabis enterprise, but it’s important they devote early consideration to their desired long term corporate goals in terms of choice of entity type and general corporate structure. Changing the corporate structure of a cannabis company (e.g. changing entity type or ownership or control of an entity) after a business has applied for local and/or state permits or licenses can, depending on the circumstances and applicable jurisdictions, result in violations of regulatory requirements, license forfeiture or an imposition of confusing and burdensome reporting or other requirements and related processing issues and delays.
Since it isn’t always easy, or may even be prohibited, to change a corporate entity type or structure after an application or permitting process has commenced, choosing the right corporate entity type and structure is important for a lot of reasons at the outset. In making such decisions regarding electing a type of entity and determining the control and ownership of the entity, founders should consider multiple factors including the following:
- Which state should I incorporate in and why?
- How do I prefer my entity to be taxed?
- What is my risk for personal or other liability based on my entity type and/or ownership stake?
- What is the risk for not receiving approval of my cannabis applications or permits due to reporting requirements if I am subject to a background check and am considered an “owner” or “financial interest holder” of the cannabis entity under the applicable regulations at the state level and/or at the local level?
- Do I intend to raise funding for my cannabis entity, and if so, how does the investor prefer to structure their investment (keeping in mind that investment means investors become “financial interest holders” and often, “owners” under the state law subject to reporting requirements)?
- Should I create a separate holding company to hold real property, intellectual property or a holding company for investment or for some other purpose?
- Do I foresee partnering with one or more other companies in a way that will require shared ownership of certain assets or businesses?
- How can I form a business with someone who already holders a Conditional Use Permit or state license without putting them in jeopardy?
- Who will control the “vote” on big business decisions such as taking on debt or approving a liquidation event or exit for the company?
- How many directors should I have, who should they be, and why?
As stated above, these considerations are all important to ask at the outset of forming a cannabis entity and in connection with the regulatory framework applicable to cannabis companies since, once licensing and permitting applications are submitted, changing business structures can be cumbersome and expensive and sometimes can require a completely new application and fee depending on where in the process a cannabis business is with respect to its application for licensing.
Additionally, there are other reasons why upfront legal advice is important for early stage companies, including having a general understanding of how to proceed with onboarding employees, issuing initial equity awards, protecting the company’s intellectual property and confidential information (do take a look at our recent post about copyright protections) and putting in place the proper paperwork in connection therewith.
Securing a strong foundation of a startup is analogous to securing a strong foundation on real property. There is no question whether it’s important to build a solid foundation to a building, to lay the proper framing of the foundation so the building can be strong and for good and marketable title. It is no different with building a business. Often the foundation of the business is the most important in order to set the business on the right trajectory. Having early (but efficient) legal advice sets the groundwork for the company and can save significant costs on future cleanup. It also can avoid potential price reductions and pitfalls on a future exit transaction due to poor corporate record-keeping or lack of foresight.
At Rogoway Law Group we enjoy assisting early stage companies in considering these important compliance and corporate concerns and so that they can set the stage for a successful long-term business. You can contact us with any legal questions you have as an early stage cannabis entrepreneur.
