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The Problem with Marijuana Industry Startups
By Brett Melson Monday, January 9, 2017

marijuana industry startups

The cannabis industry is one of the nation's fastest growing industries and is generating enormous interest from entrepreneurs, investors and, of course, regulators and tax authorities. 


Twenty-eight states and the District of Columbia have legalized medical marijuana, with fourteen states authorizing the sale and use of medical marijuana just within the last five years. 


Eight states and the District of Columbia have gone further and passed laws permitting the recreational use of cannabis and cannabis products.


Despite the impediments the industry faces from practical and regulatory obstacles, the legal cannabis market is presently valued at $2.7 billion dollars annually; in Colorado alone, cannabis sales reached $1 billion within the first ten months of 2016.  


Since Delaware is known as the Incorporation Capital of the world, we have also seen a large number of startup companies that are operating in the medicinal or recreational marijuana industry.   


The easiest part of opening a business in the cannabis industry is the formation of the company. While Delaware allows the formation of companies in the marijuana industry, it will not allow the use of the word “marijuana” or any similar terms in a company’s formation documents.


Stocks associated with corporations in the industry that are listed on the publicly traded markets have seen tremendous gains in the last year. However, despite the growth and potential of the cannabis industry, there are a number of difficulties for those operating in the space, primarily due to the treatment of cannabis under federal law. 


Marijuana remains illegal under federal law. It is a Schedule 1 controlled substance. Even in the jurisdictions that have legalized medical and/or recreational use of marijuana at the state level, the cultivation, sale and possession of marijuana remains a violation of federal law.

medical marijuana industry

Per a Supreme Court precedent, federal law criminalizing the use of marijuana trumps any state laws that legalize its use.


The Obama administration has adopted a policy allowing states to implement marijuana legalization laws; under this administration, federal agencies have not sought to prosecute those operating in accordance with applicable state laws. 


Since marijuana remains illegal under federal law, most federally chartered banks and financial services companies will not open accounts for, or process transactions with, businesses operating in the cannabis industry. 


Proceeds from the production and sale of cannabis products are currently considered drug proceeds under federal law; as a result, banks that deal with cannabis companies risk potential seizures and/or enforcement activities by federal agencies. 


Although some smaller banks are willing to assume a greater risk in dealing with cannabis companies, most large banks simply find the emerging cannabis industry too risky from a regulatory perspective.  As a result, many cannabis companies cannot open or maintain bank accounts or process credit card transactions.


Due to these banking complications, cannabis companies cannot use traditional banks or other financial services, so they often operate as cash businesses and thus have difficulty documenting the source and movement of funds for tax filings.


Holding significant cash not only raises security issues (robberies of cannabis companies are a very real problem), but it also brings intense scrutiny from the IRS, state tax agencies and the Treasury Department, which polices money laundering.  


Cannabis companies are a frequent target of IRS audits, state tax agency investigations and Treasury Department inquiries.


In addition to the operational difficulties related to the inability to access banking and financial services, cannabis companies are often unable to obtain bank loans or even mortgages on properties that will be used in the operation of a cannabis business. 

cannabis startups

Other market participants, such as commercial landlords and insurers, are also hesitant to do business with cannabis companies. Many commercial leases contain provisions that prohibit use of a leased property for activities that are illegal under federal law. 


As a result of these issues, cannabis companies generally pay far higher rates of interest on lending from alternative capital providers; pay higher rents from landlords willing to lease these businesses space; and are forced to forego insurance that any business would otherwise obtain.


Even if the federal government were to soften its stance toward cannabis, it is likely that the Food and Drug Administration will move to regulate cannabis. Such FDA regulation, among many other potential sources of regulation, could prove to be highly burdensome. 


Thus legalization may not cure the marijuana industry's regulatory woes and may, in fact, increase them. However, there is a growing number of enterprising startups that are trying to solve these problems, such as Tokken, which aims to help marijuana dispensaries manage their huge influx of cash.


It is unclear how state and federal laws and policies will evolve, although many people feel complete legalization is inevitable.


Until then, participants may see the cannabis industry as a tremendous opportunity and a new gold rush (or green rush), but they will need to overcome a number of practical and regulatory obstacles and deal with significant operational headaches until cannabis has become more widely accepted by government agencies, traditional financial services institutions and the market as a whole.


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EIN vs ITIN: What's the Difference?
By Brett Melson Tuesday, December 13, 2016

ein vs itinThere are many numbers that are used to identify ourselves and our corporations or LLCs, such as a Social Security number, driver's license number, passport number, DUNS number and EIN (Employer Identification Number).


Many business owners and employees wonder about the differences between the Federal Employer Tax ID number (EIN) and the individual taxpayer identification number (ITIN).


The Federal Tax ID Number, known as an EIN, is an identification number used by the IRS to administer tax laws. The Federal Tax ID Number is used to identify an entity to the IRS, banks and other businesses.


Think of this number as the social security number for a business. This number is typically needed to operate your business in the United States, do banking in the United States, hire employees and file taxes with the IRS.


The individual taxpayer identification number (ITIN) is a tax number only available to certain non-U.S. residents and resident aliens and their spouses and dependents who are not able to obtain a social security number (SSN). ITINs always start with a "9" and are typically formatted like a Social Security number: 9xx-xx-xxxx.


The ITIN is needed by many non-U.S. residents who form a Delaware corporation or LLC. If there is a tax filing requirement with the IRS, an ITIN is needed.


For example, if a company has U.S. source income and profits or losses that flow through to the member or shareholder, owners typically need to obtain an ITIN in order to complete a tax filing with the IRS.


ITINs are issued regardless of immigration status because both resident and non-resident aliens may have a U.S. filing or reporting requirement under the Internal Revenue Code.


We are able to form a new Delaware entity and obtain a Tax ID number for both U.S. and non-U.S. clients quickly and easily.


We are unfortunately unable to obtain an ITIN for you. However, we are happy to refer you to Seaford Management LLC, which is a Certifying Acceptance Agent with the IRS. They can file your application to obtain in ITIN number.


If you have any quesitons about obtaining an ITIN, or if you would like to get an ITIN, you can email Seaford Management LLC or call them at (302) 990-9003. They offer services in both English and Spanish.


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The Delaware Series LLC Operating Agreement & Structure
By Brett Melson Tuesday, November 15, 2016

delaware series llcUnder Delaware law, a series LLC (limited liability company) may be composed of individual series of membership interests. This type of entity is referred to as a Delaware series LLC. 


Each series is effectively treated as a separate entity, meaning the debts, liabilities, obligations and expenses of one series cannot be enforced against another series of the LLC, or against the LLC as a whole.



Each series can hold its own assets, have its own members, conduct its own operations and pursue different business objectives, but each series remains insulated from claims of members, creditors or litigants pursuing the assets of or asserting claims against another series. 


The structure of the series LLC, which is often likened to a piece of honeycomb, is Delaware’s version of the "segregated portfolio companies" which are widely used (under various names) in the Cayman Islands, British Virgin Islands and other non-U.S. jurisdictions.


The Delaware series LLC reduces the fees incurred in creating and maintaining separate business entities for different ventures or investments. Only one filing fee is required to form a Delaware series LLC, regardless of the number of series it contains.


In addition, this type of LLC is treated as one entity for Franchise Tax and Registered Agent Fee and service purposes, meaning it is assigned one Registered Agent Fee and one $300 annual Franchise Tax, rather than the separate taxes and fees that would otherwise be applied, individually, to separate LLCs.


The Series LLC Operating Agreement


The Delaware series LLC Operating Agreement (which is not required to be publicly filed) may provide for any number of series. The Certificate of Formation for a Delaware series LLC must specifically note, however, that the LLC is divided into distinct series and the assets and obligations of a series are attributable only to that series.


Additional series can be added, or series can be terminated, at any time by an amendment of the series LLC Operating Agreement. In order to maintain the legal distinction among the series, a series LLC must maintain records documenting the assets and liabilities of each series; however, from a practical perspective, records should be kept as though each series is a separate entity.


Although series LLCs have become increasingly popular, there is a certain degree of uncertainty surrounding the Delaware series LLC. For example, the legal separation of the assets and liabilities of each series has not been tested in court.


Although Delaware law clearly provides for legal separation of each series, it is unclear whether courts in other states and/or jurisdictions would recognize a legal separation of assets and liabilities within what is, technically, a single entity. 


Therefore, even if a Delaware series LLC were properly structured and operated, with distinct records relating to the assets and liabilities of each series, a court in another jurisdiction could decide not to recognize the legal separation afforded under Delaware law.


Additionally, the United States federal tax treatment afforded to individual series is not certain.


In January 2008, the Internal Revenue Service held that the distinct series within a Delaware series LLC will generally be taxed as separate entities for federal income tax purposes; however, many states have not provided concrete guidance on the effect of the series distinction for state tax purposes.


We have been creating Delaware series LLCs for the last 10 years, and possesses the experience to allow you to take advantage of this flexible and efficient business formation. If you think the Delaware series LLC may be right for you, please call 800-345-2677 or email us for more details.


We can also offer guidance if you need help creating a series LLC Operating Agreement. We also offer a series LLC Operating Agreement template. 


For more information on the Delaware series LLC, please read these helpful articles:

The Delaware Series LLC: Advantages and Disadvantages

The Delaware Series LLC

Proposed Regulations on the Series LLC

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The Court of Chancery: Part of the Delaware Advantage
By Paul Sponaugle Tuesday, November 8, 2016

court of chancery delaware

Delaware’s reign as the nation’s number one place to incorporate is no secret, but what remains a secret to so many is the reason why it is number one.


Actually, Delaware’s “corporate crown” can be credited in large part to a court system whose roots reach back to feudal England.


In its infancy the Court of Chancery was set up by the King of England to hear matters where no law was in existence to settle some disputes.


Thus the King’s Chancellor was to hear the case and consider the fairness of the matter. This type of court does not exist in other legal systems and only three U.S. States have such a court.


A court of equity differs from a court of law; matters before the Court of Chancery are heard as bench trials meaning that they are tried before a judge, alone. Without juries, judges are left to make rulings considering all issues of fact and law.


For more than 200 years, the Delaware Court of Chancery has exercised exclusive jurisdiction over all matters and causes in equity in the State of Delaware.


The Court is comprised of one chancellor and four vice chancellors, all of whom are nominated by the Governor and confirmed for 12 year terms by the Senate. The five chancellors must all be well versed in law and must be Delaware citizens. The Delaware Court of Chancery has jurisdiction over a number of matters including commercial proceedings, real property, guardianship, and civil matters.


The majority of the litigation heard in today’s Delaware Court of Chancery consists of corporate, trust and estate matters.  The most notable power of the Court is its ability to issue injunctions and temporary restraining orders, and is most frequently exercised in corporate differences over mergers or acquisitions.


A typical merger dispute will see a plaintiff seek temporary relief to preserve the status quo until a trial can occur. If the need should arise, the Court of Chancery may order issues of fact to be tried by a jury in the Supreme Court of Delaware.


With more than 200 years of judicial precedent, the Delaware Court of Chancery is hailed as the nation’s leading forum for settling corporate disputes, and is one of the most important reasons why Delaware is the most favorable environment for the world’s commercial affairs.

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101: Delaware Blank Check Preferred Stock
By Rick Bell Tuesday, September 27, 2016

The Directors’ Trump Card For Attracting Early Investors, Maintaining or Gaining Control, Rewarding Key Participants, Going Public And Avoiding Bankruptcy


Every Delaware General Corporation must have one class of common stock, but it can also have a second class of stock (or more) with customized terms for the different classes. The most popular second class of stock is called preferred stock because it can contain terms, negotiated between the Board of Directors and the recipient, that are preferred over the rights of common stockholders.


Delaware’s brand of preferred stock is so powerful and flexible as a business tool that the top U.S. and international corporate lawyers refer to it as Delaware blank check preferred stock.


If you’re thinking of starting a business, raising capital and going public, or if your company is ready to go public, you should be aware of the power this type of stock offers.


delaware blank check preferred stock

Why would anyone want more than one class of stock in a Delaware corporation?


Common stock has two fundamental characteristics that are written in the Delaware General Corporation Law, and they are mandatory.


The first is that every share of common stock carries one vote. If you own 100 shares, you have 100 votes to cast on all matters presented for votes at stockholder meetings.


The second is the right to your pro-rata share of any dividends issued by the Directors to the common stockholders. If the total dividend is $1,000,000 and you own ten percent of the total outstanding shares of common stock, you’re entitled to 10% of the $1,000,000. You cannot get cheated on those two issues.


After all, common stockholders own the company. They have invested their money in the company and they have a keen interest in their share of the profit. If the company does not profit, the shareholders receive nothing. If the company does profit, the Board of Directors decides where the profit is to be spent, invested and/or distributed.


A stockholder's dividend is a distribution of profits. If the Board of Directors saves and/or invests all the profit with the best of intentions, and does not regularly declare a dividend, the stockholder has little recourse.


If the Board of Directors decides not to declare a dividend, the shareholders do not get a share of the profit. In the case of Apple, until recently, shareholders did not get a dividend but they did get an extreme increase in the valuation of their stock, so everyone was happy.


In other cases, like Wal-Mart, the shareholders have been given a distribution of profit in the form of a dividend for many consecutive years, and that dividend has increased every year. Neither of these examples is more right or wrong than the other; it’s just how it works. The same is true for any Delaware General Corporation.


All entrepreneurs admit there are extreme challenges that can occur in the life of a company, and often it is wise to make deals with new investors, the founder or creditors that are made on better terms than those that the common stockholders typically get. Delaware blank check preferred stock can do all this and more.


In fact, owners of Delaware blank check preferred stock can get dividends before common shareholders and, unlike common shareholders, can be guaranteed a security interest in the company’s assets, equipment and Intellectual Property. If properly stated, they can even be guaranteed a percentage of gross sales before any money is directed towards paying bills or paying dividends to common shareholders. (ergo the subtitle: The Trump card)


blank check preferred stock



How does an inspired entrepreneur obtain this silver sword?

There are three situations to consider:


  1. If you have not yet formed a Delaware corporation to pursue your vision, be sure to specify it when you initially form your company. This is the time when it’s least expensive to obtain. You don’t need to outline the specific terms of the preferred stock when you form the company, just the number of shares and a nominal par value. You will specify the terms for each series of your blank checks as you use them. You just want to declare the Preferred Stock in the beginning so you can utilize it later.
  2. If you already own a Delaware General Corporation with only one class of stock, then your Board of Directors, with shareholder approval, can authorize a second class of preferred stock. If you can’t get your Board to approve it, or if you can’t get your stockholders to approve it, you’re effectively blocked and powerless. Once the shareholders approve the authorization of the stock, the Board is free to negotiate the terms to attract capital, to inspire top people or to create strategic alliances using the blank check preferred stock as a form of currency.
  3. If you own a corporation in any state other than Delaware, you may want to consider forming a Delaware General Corporation, authorizing both common and blank check preferred stock and then merging your current company into your new Delaware General Corporation. It’s a little expensive, but it could still be worth it if your vision is long-term.


Now here’s the best part: the total number of shares of preferred stock that your Certificate of Incorporation authorizes may be split into any number of different series of the preferred stock, with each series having its own separate terms.


For example, let’s say the company has 1,000,000 shares of common stock and 100,000 shares of preferred stock. The Board can designate that the preferred stock be split into any number of distinct series, giving you, literally, not just one blank check but as many as you want, numbered one through whatever number you choose.


How do I use these blank checks?


I’m going to enumerate some specific examples of how Delaware blank check preferred stock has been used to attract investors, maintain or gain control, reward key participants, go public and avoid bankruptcy, as they relate to the rights of each series of preferred stock, but first, some general legal knowledge is appropriate.


Stock ownership comes with certain rights. You can’t avoid giving common shareholders the two basic rights I described above. At the same time, you cannot give common shareholders any special rights like a guaranteed dividend, a guaranteed percentage of the profit or a security interest in the company’s assets. The Delaware law guarantees them two particular rights and doesn’t leave a lot of room for changing those rights.


The rights of a preferred stockholder, on the other hand, can be negotiated before the stock is issued. These are the three most notable rights that are important in the negotiations:


  • Voting rights: Common shareholders get one vote per share, but the Board can give one or more series of the preferred stock super voting power, such as two votes per share, or ten or 100 or 1,000 votes per share. Why do this?

Let’s say the company is trying to attract more capital from a key shareholder who already owns a big percentage of the common stock and the Board doesn’t want him to take control. The Board can create a series of preferred stock with no voting rights but a guaranteed 10% dividend paid quarterly. Your investor might be enticed to invest more money but give up any increased voting rights in order to get a guaranteed return on his investment.

Or let’s say you are raising capital and you’ve sold 45% of your stock. Once you sell more than 50% of the company, you lose control. So what do you do? Bring out a series of preferred stock designated as Founder’s Stock, in which the 10,000 shares have 100 votes per share. Have the Board of Directors issue the whole 10,000 shares to you. Now you can sell more of the common stock to investors and still keep control of the company.

These maneuvers are sophisticated tricks and should be undertaken with the assistance of a very good corporate lawyer.


  • Dividend Rights: Common stockholders have the right to a share of the profits only if the company has profits and if the Board of Directors declares a dividend. Preferred stockholders, however, can be guaranteed a certain dividend per share ($1.00 per share, for example) or a dividend based on a business calculation that suits the deal (x% of increase in net profits, for example).

These dividends can be guaranteed, cumulative and convertible to common stock if the deal makers agree and a good lawyer drafts it correctly. If properly stated, preferred dividends can be paid before the common stockholders see any return.


  • Security Rights: Preferred stockholders can hold a security interest in a company-owned asset. This can include a patent, real estate, a major piece of equipment, the company’s website or any other company asset.

In a typical example, the company is desperate for an influx of cash. Bankruptcy is the next step if a deal isn’t put together in time to save the company. No one will buy the common stock if they fear a company is going out of business.

However, someone might invest if you gave him/her a security interest in the assets that will revert to him/her if the company declares bankruptcy. I hope you never need to use this technique, but if you find yourself in that position, you’ll be glad you have a Delaware corporation with blank check preferred stock.


If you’re about to form your Delaware General Corporation and expect to sell stock in the company to raise money, it would be a good idea to consider getting the preferred stock right from the start by including it in the Certificate of Incorporation. This way, you won’t need the shareholders' approval to authorize it when you need it.


The Directors will be able to issue the stock in the best interests of the company without the necessity of shareholder approval. If you already run a Delaware General Corporation, you will need shareholder approval to amend the Certificate of Incorporation, authorizing the preferred shares.


If you control the Board and the common stock now, you might be well-advised to consider authorizing a preferred class of stock at your next shareholder meeting so when you need it, it will be there.

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