Cannabis Industry Investment Is Risky, Expensive, CPA tells GABB members
The cannabis industry might be one of the largest industries in the next decade, but right now, it’s risky, expensive and faces uncertain legal and tax hurdles, says an accountant who specializes in the cannabis industry.
Matthew Foster CPA, a partner with Frazier & Deeter, LLC and the firm’s National Practice Leader for the Cannabis Industry, spoke about accounting and the cannabis industry earlier this year at the Georgia Association of Business Brokers.
“This is not an industry for the faint of heart,” warned Foster. “If you have a very low risk tolerance, I would just advise you to stop right now and wait until the feds open it up in about five or six years, possibly longer.”
The biggest risk? The whole industry is illegal in the eyes of the federal government.
“From a federal perspective, every one of these companies that are in cannabis are lawless citizens of the U.S.,” said Foster. “They’re all breaking the law.” Federal officials could “come in at any moment and break them up if they wanted to.”
If the company is in one of the many states that has legalized cannabis, most assume that federal officials won’t intervene, “unless they do something really out of line,” Foster said.
Georgia’s Cannabis industry
Georgia’s cannabis industry is poised for growth because the state recently passed a law legalizing the production and manufacturing of low THC CBD oil, defined as anything with a THC content of 5% or less. That’s just strong enough for medicinal use, and not strong enough for intoxication. The new law allows up to six licenses for growing medical marijuana, plus licenses to the University of Georgia and Fort Valley State University for research.
Of the six private licenses, two will be for large productions, up to 100,000 square feet, and four for up to 50,000 square feet. There’s a $25,000 non-refundable application fee for a large license, along with an initial $200,000 licensing fee and $100,000 annual renewal fee. The smaller licenses carry a $5,000 non-refundable application fee, along with an initial $100,000 licensing fee and $50,000 annual renewal fee.
“So you need a lot of capital just to hold the license in Georgia,” Foster said. “That’s before you even start with the production and the costing and everything else.”
Recently Flourish, an Atlanta-based supply chain management startup that helps cannabis companies monitor logistics, raised $2.1 million in a seed round led by 7thirty Opportunity Fund, the Atlanta Business Chronicle reported.
Georgia has made cannabis companies ineligible for any state tax incentives. “You are going to pay tax on every single dollar that you make here in Georgia,” Foster said.
Bummer, right?
Which means that companies in the cannabis industry right now must be highly capitalized. “You have to have a lot of money at your disposal to weather the storm until the feds open it up,” said Foster.
Frazier & Deeter works with clients to set up inventory methodologies that will move as many expenses as they can under current tax law from their overhead into the cost of inventory.
Banking Obstacles
Another obstacle for the industry is banking. Under current laws, federally insured banks are not allowed to do business with cannabis companies.
“These companies can bank with state-sponsored banks, with credit unions, if those banks decide they want to work with this industry. But they can’t bank with FDIC-insured banking institutions, your Wells Fargo, your Bank of America, your Chase, because they are federally regulated,” Foster said.
Cannabis industry investors are lobbying legislators to pass a law that would make cannabis similar to hemp, which would open up a more traditional taxation and banking.
Foster predicted that Congress will act on banking before legalization because right now, the federal government is losing lots of potential tax revenue from the industry.
Cannabis VS Industrial Hemp
Cannabis and industrial hemp represent different segments of the market. For example, industrial hemp is becoming a very attractive option for people to invest in thanks to last November’s farm bill. The farm bill, in essence, descheduled industrial hemp, defined as a product with a less than 0.3% THC content per gram. Hemp fiber and oilseed can be used in variety of industrial and consumer products. What the bill did was deschedule hemp, meaning it’s still illegal at the federal level, unless you are producing and working in a state that has legalized industrial hemp.
Cannabis is still illegal from a federal standpoint, despite being legal for medicinal uses in 33 states and the District of Columbia, and in 11 states and D.C. for recreational uses. Because cannabis is included in Schedule I of the Controlled Substances Act, it falls under section 280E of the IRS code. “That means cannabis businesses cannot deduct any necessary or ordinary business expenses for federal income tax purposes, nor can they claim any Federal credits,” Foster said.
“You can deduct your cost of goods sold, but everything else in your return is non-deductible,” Foster said. “You can’t have R&D credits, you can’t have business credits, and you can’t have jobs credits. Take your revenues, deduct your cost of goods sold, get your gross profit, and that’s your taxable income: your gross profit.”
But companies with shrewd accountants can take advantage of certain sections of the IRS code that allow companies to capitalize their overhead, which would allow them to deduct some of the expenses for rents, utilities, property taxes, salaries, depreciation, etc.
Managing Cannabis Finances
Foster recommends that their traditional cannabis clients do full financial statement audits which allows for an opinion on what’s capitalized into the cost of inventory and what’s being deducted as cost of goods sold. If the IRS does come in and audit, “we have a lot of support for the position that we have taken.”
Cannabis companies should NOT use the name of the plant in their company name, Foster recommended, to try to minimize the red flags that the IRS will see on these companies.
“First and foremost, the words cannabis, hemp, and marijuana should not appear on your tax return, anywhere,” said Foster.
Also, these companies should not get creative in taking deductions, Foster said. If you go that way, “start putting money aside because you’re going to get audited.”
He also recommends that anybody in this space should operate as a C Corp, mainly because it’s the lowest tax rate that you can find on federal level right now. Also a C Corp allows a company to “put up a corporate wall around your investors.”
If the IRS starts attacking the company, the investors are only out what they put into the company. It won’t be able to go after their personal assets. He also recommends portioning off different sections of the business into separate entities for real estate, equipment or intellectual property.
Potential Profits Huge
Returns on investment are a mystifying 10 to 30 multiples on revenue streams in the industry. “I haven’t quite figured out what’s going on in this space,” Foster said. “This must be Toad’s Wild Ride for investors.” But last year, a lot of people made a lot of money.
“So, it depends on when you get in, what you get in to, and how long you’re willing to ride this roller coaster,” Foster said.
Big U.S. companies are awaiting new banking regulations that will ease investment into this industry. Foster said “They’re either waiting to go public, or they’re waiting for big pharma, big tobacco, or big alcohol to come in and buy them up.”
Read MoreBusiness Buyers Can Leverage SBA Lending
Finding the money to start your own small business can be a challenge. Over the decades, countless people have turned to the Small Business Administration (SBA) for help. A recent Inc. Magazine article, “Kickstart Your Business Dreams with SBA Lending,” by BizBuySell President, Bob House, explored how SBA lending can be used to the buyer’s advantage.
The article covers the basics of an SBA loan and who should try to get one. House notes that the SBA doesn’t provide loans itself, but instead facilitates lending and even micro-lending with a range of partners. The loans are backed by the government, which means that lenders are more willing to offer a loan to an entrepreneur who might not typically qualify for one. The fact is that the SBA will cover 75% of a lender’s loss if the loan goes into default.
Entrepreneurs can benefit tremendously from this program. In some cases, an SBA loan even means skipping the need for collateral. SBA loans can be used for those looking to open a business, expand their existing business or open a franchise.
House points out that getting an SBA loan has much in common with receiving other types of loans. For example, it is necessary to be “bank ready.” By “bank ready,” House means that all of your financial documentation should be organized, clear to understand and ready to go.
Next, a buyer would need to check that he or she qualifies, find a lender and fill out the necessary SBA forms. In order to be eligible for an SBA loan, it is necessary that the business is a for-profit venture and that it will do business in the United States. Once the necessary forms have been submitted, it can take between 2 to 3 months for an application to be processed and potentially approved.
The simple fact is that the SBA helps thousands of people every year. If you are looking to buy a business or expand your current business, then working with the SBA could be exactly what you need. Of course, business brokers are experts on what it takes to buy. Working with a broker stands as one of the single best ways to turn the dream of owning a business into a reality.
Copyright: Business Brokerage Press, Inc.
Powered by WPeMatico
Read MoreHow Employees Factor into the Success of Your Business
Quality employees are essential for the long-term success and growth of any business. Many entrepreneurs learn this simple fact far too late. Regardless of what kind of business you own, a handful of key employees can either make or break you. Sadly, businesses have been destroyed by employees that don’t care, or even worse, are actually working to undermine the business that employs them. In short, the more you evaluate your employees, the better off you and your business will be.
Forbes’ article “Identifying Key Employees When Buying a Business,” from Richard Parker does a fine job in encouraging entrepreneurs to think more about how their employees impact their businesses and the importance of factoring in employees when considering the purchase of a business.
As Parker states, “One of the most important components when evaluating a business for sale is investigating its employees.” This statement does not only apply to buyers. Of course, with this fact in mind, sellers should take every step possible to build a great team long before a business is placed on the market.
There are many variables to consider when evaluating employees. It is critical, as Parker points out, to determine exactly how much of the work burden the owner of the business is shouldering. If an owner is trying to “do it all, all the time” then buyers must determine who can help shoulder some of the responsibility, as this is key for growth.
In Parker’s view, one of the first steps in the buyer’s due diligence process is to identify key employees. Parker strongly encourages buyers to determine how the business will fare if these employees were to leave or cross over to a competitor. Assessing if an employee is valuable involves more than simply evaluating an employee’s current benefit. Their future value and potential damage they could cause upon leaving are all factors that must be weighed. Wisely, Parker recommends having a test period where you can evaluate employees and the business before entering into a formal agreement.
It is key to never forget that your employees help you build your business. The importance of specific employees to any given business varies widely. But sellers should understand what employees are key and why. Additionally, sellers should be able to articulate how key employees can be replaced and even have a plan for doing so. Since, savvy buyers will understand the importance of key employees and evaluate them, it is essential that sellers are prepared to have their employees placed under the microscope along with the rest of their business.
Copyright: Business Brokerage Press, Inc.
Powered by WPeMatico
Read MoreBusiness Buying Scams to Avoid
1. They want you to hold money in your escrow account (usually a large dollar amount so the deal is attractive). The risk is that the deal or client requires you to transfer some or all of the money out of your account before you bank has time to verify the funds are legit and can cover the transfer. This actually happened to a Georgia attorney awhile back and it was in the AJC. Talk about bad publicity for the attorney who got suckered; he was very embarrassed.
2. The transaction involves an overseas or out-of-state company wanting to do a deal with either an individual or a business in located Georgia, and they need a Georgia attorney or other professional to represent them.
GABB To Unveil New Website at July 30 Meeting
- Private chat area for member brokers to ask questions and confidentially share information.
- A new and improved broker search tool that will enable visitors to search for member brokers by radius, specialty, and other filters.
- GABB members will be posting our listings to our own webpage, this will give us the ability to post more photos and info about our listings, it will also help with our longer-term goal of improving the SEO of our website among other benefits. We are working on methods to share those listings to BizBuySell and other websites.
- Visitors to our site will be able to find what they are looking for faster.
- The new design will be less labor intensive for GABB’s administrator and for each member to manage profiles and listings.
- Sponsors and affiliates will have better visibility in the new design.
Members will be able to view the proposed new website and ask questions of the website developer, Ron West, of Business Brokerage Press, who also hosts the GABB website. Ron will join us remotely.
Business Brokerage Press is the publisher of the text for Business Broker University Training, The Complete Guide To Business Brokerage and the industry standard guidebook for valuing businesses, the annual Business Reference Guide. BBP, through Ron’s knowledge and leadership in technology, also hosts and consults with many business broker Websites and IBBA Affiliate Websites through the DealStudio brand.
The GABB will meet at the Georgia Association of Realtors at 6065 Barfield Road, Sandy Springs, GA, 30328. The meeting will start at 10:30 a.m. preceded at 9:45 a.m. by a networking breakfast. The GAR headquarters building is a two-story building located in Sandy Springs near the intersection of Hammond Drive and Barfield Road.
The GABB is the state’s largest and oldest association of professionals who specialize in brokering the purchase and sale of businesses and franchises. Broker members help owners determine the asking price of their business, create marketing plans and strategies for selling their business, identify and qualify buyers, and have the knowledge, experience and skills needed to help maintain the confidential nature of the process. Affiliate members include bankers, lawyers, appraisers, insurers and other professionals who work closely with brokers to help owners and buyers get to the closing table.
For more information about GABB, please contact GABB President Dean Burnette at 912-247-3209 or dean@b3brokers.com, or GABB Executive Director Diane Loupe at diane@gabb.org or 404-374-3990.