Guide to Starting a Cannabis-Industry Business

cannabis industry guideTable of Contents


Cannabis Industry Overview

The cannabis industry is one of opportunity, risk, red tape and stigma, although the latter is thankfully abating. Its consumer market is well established, but its regulation and legality remains subject to a patchwork of each state’s laws and the conflicting status of cannabis between state and federal law.

For many entrepreneurs, the opportunity – paired with a sense of optimism and a passion for the product – makes this the time to jump in and hope for the best. Still, even the most dynamic and experienced business owners are bound to face some challenges, and hope alone will not overcome them.  However, hope, an entrepreneurial mindset and a reasoned, thoroughly considered plan based in a granular assessment of the cannabis industry, its market, participants, and its regulation, have already led many founders to success in this space.

In this guide, we’ll look at what it takes to start a cannabis-industry business, including understanding the applicable laws, regulations and licensing requirements, creating a legal business, obtaining key business elements such as funding and real estate, and forming a smart business plan.

Each state determines how it will license, regulate and police the cannabis industry and its consumers within its borders, and so it is difficult to speak as if the industry were subject to a unified and consistent legal framework.  The law and regulation of the cannabis industry is a patchwork, but in this guide we attempt to deal with issues applicable to almost any, or at least a majority (potentially a plurality), of jurisdictions.


Barriers to Entry

It goes without saying that, at present, the cannabis industry is harder to break into than many others. This is due to a variety of challenges and roadblocks that must be addressed on the way to launching business operations.

Below, we discuss some of the most common issues to be aware of.

Legality

In 1937, the Marihuana Tax Act (as it was spelled at the time) was enacted by the U.S. Congress, effectively prohibiting possession and use of cannabis under federal law.

The law was replaced in 1970 by the Controlled Substances Act, following a Supreme Court decision that struck down the original act. Under the new law, cannabis was classified as a “Schedule I” drug, meaning it was determined to have “no currently accepted medical use and a high potential for abuse.”

In the 1990s, the support for medical marijuana use picked up and several states passed their own laws legalizing it to some degree. And in the 2010s, a similar movement for recreational use of marijuana gained traction. In 2014, Congress passed a measure that prohibited the federal government from preventing states from enacting their own medical marijuana laws.

In June of 2019, the House of Representatives passed a bill that would bar the Department of Justice from spending appropriated funds to prevent states and territories from implementing their own cannabis laws, including laws authorizing recreational use and the distribution, possession or cultivation of marijuana.  This bill had failed to pass both chambers of Congress in 2015, but the normalization of the cannabis industry since that time may lead to its passage and enactment. As Michael Collins, Director of National Affairs for the Drug Policy Alliance, stated in a Forbes article, “[t]he end of marijuana prohibition has never been closer.” 

The states of Colorado and Washington became the first to official legalize recreational marijuana in 2012, making national news and being the subject of much discussion, whether from the aspect of ethics or economics.

As of January 2020, 11 states have legalized recreational marijuana and 33 (including the previous 11) have legalized medical use.

Recreational use has been legalized in Alaska, California, Colorado, Illinois, Maine, Massachusetts, Michigan, Nevada, Oregon, Vermont and Washington state. It currently remains illegal under federal law.

All this is to say that entrepreneurs looking to enter the cannabis market first have to determine if their state will allow the business to operate legally. Even if the answer is “yes,” the fact that federal law still prohibits it may be a significant deterrent, even though most experts would suggest the risk of federal interference is low, as long as the operations (sales, distribution, etc.) do not cross state lines.

Licensing

Businesses of all sorts require licenses. This can include a basic business license obtained from the state (and in some cases a municipality as well) as well as licenses specific to an industry (for example, a Federal Firearms License) or other factors.

When states legalize medical and/or recreational marijuana use, the applications for licenses for these businesses tends to skyrocket. Likewise, general optimism of industry trends can increase demand where the business is already legal. This has led states to limit the licenses they allow on an annual basis. Economically speaking, this suppressed supply of licenses leads to an increased competition for them, which has resulted in issues of corruption for some states.

For example, in Maryland (where medical marijuana is legal), contenders for cannabis licenses were ranking by Towson University’s Regional Economic Studies Institute, which was hired by the State to review and rank license applications and applicants based on specific criteria. After the Institute Released its rankings after many months of review and consideration, the Maryland Medical Cannabis Commission, the government body charged with officially approving applicants for licenses, revised the rankings over the course of two days, inexplicably disregarding their own rules and stated ranking criteria amid allegations of corruption and back-door deals with, and investments in lower-ranked applicants by, Maryland legislators and other officials. The State ultimately issued additional licenses that had been originally authorized by the Legislature to end a lawsuit brought by applicants bumped off the highest spots by the Commission, leaving Maryland’s licensing process as one of the more farcical so far conducted, and an example to avoid for later states.

States generally use various criteria to award licenses. This may include business experience, credit scores, proximity to areas the licensing body wants businesses to operate, security measures, and many more. Your state’s criteria should be available publicly – check with the licensing board if you can’t locate them.

One factor that some states will weigh quite heavily is the quality of a business’s supply chain. In other words, the licensing board may not want to see only your own credentials, but also those you will be using as suppliers, vendors, distributors, and/or partners. In particular, your grower's track record the quality of their facility may be of extra importance. Be judicial in choosing who you enter into agreements with! 

Another thing to consider with limited license availability: it can create monopoly issues, as many dispensaries, growers, processors, etc. have exclusive relationships with each other. Thus, an independent dispensary may have a shortage of product relative to a dispensary already affiliated with a grower, especially because licenses for growers are often in extremely short supply. 

Racial Disparity

Related to licensing, the issue of racial disparity plays a role in access to the cannabis industry as well. In Maryland’s case, as well as in other states, there have been accusations of discrimination and underrepresentation of racial minorities in the licensing process.

Part of this reflects a deeper issue. States generally will not issue licenses or permit cannabis-related operations to people with drug-related criminal records. As ACLU statistics show, African Americans are 3.7 times more likely to have a criminal record for marijuana possession than white Americans – despite much more similar rates of use – thereby precluding many from the industry from square one. 

On the other hand, the industry at large is eager to increase its diversity. A 2017 study found that over 80% of the industry’s business owners are Caucasian. A diverse ownership base in a cannabis startup, including owners, directors, key employees, and even stockholders, can be an important factor in the licensing process.

Bank Accounts

It's not surprising that banks are much less likely to open a business account for a cannabis company than for other companies. Banks are notorious for avoiding risky clients, and illegality of possession, distribution, and sale of cannabis under federal law is enough risk for them to generally say no to these businesses. Banks are concerned that contact with the proceeds of state marijuana operations would still, under federal law and regulation, constitute money laundering, among other offenses.   

These regulations affect not only cannabis grow operations, processors, and dispensaries, but can also extend to companies providing the cannabis industry with goods and services, but which never “touch the plant” as it is called in the industry.

Generally speaking, business owners will have more luck trying local banks with state (not federal) charters. However, they should still expect to pay higher, sometimes exorbitant, fees as a matter of extra risk and compliance on the bank’s part. These banks also tend to favor businesses that “don’t touch the plant.”

The Treasury Department and banking regulators have issued policy statements attempting to ease banks’ minds to some extent, but it will take federal legislation to fully give banks comfort.  Those banks that do accept cannabis industry clients are often very quiet about it, and where a bank suddenly changes its policy on cannabis companies or if it becomes wary of a customer that operates in the cannabis industry, it can simply terminate the customer’s bank account very promptly, without any significant notice or means to assist a company with a transition to a new bank or other service provider.

To shed a little optimism on the banking situation, see the SAFE Banking Act currently (as of 2019) under consideration in Congress. Many in the industry see this as a promising development.

Some business owners may choose (or are forced by necessity) to operate as a cash business and avoid the banking issue altogether.  However, this does not make up for the inability to obtain bank loans and other features of a bank that are unavailable to cannabis companies.  While operating as a cash business is technically an acceptable way of doing business, it presents two major issues:

  1. The IRS is more likely to audit cash-based businesses than others. Not only is the audit process nightmarish for any company, but the IRS being a federal agency once again invites the risk of federal law into the equation.
  2. Being a cash-only business means you’ll always have a significant amount of cash on-premises. It goes without saying that the presence of both cash and marijuana inventory presents a less-than-optimal security situation.  Many states include physical security of the business location and any satellite offices as a factor in issuing licenses, not wanting to bring unwanted criminal activity to an area (which already may be displeased with the presence of a new cannabis dispensary in the neighborhood).

Trademarks, Patents and Copyrights

Once again touching on federal law, since the U.S. Patent and Trademark Office is a federal body, it will not accept applications related to federally illegal activities or business. Therefore, cannabis companies typically cannot gain a federal Trademark or Patent for their intellectual properties, making them more susceptible to copycats, knockoffs and other regulated forms of competition.

Copyrights, which are awarded by the Library of Congress, can be obtained for a cannabis business’s assets. However, in the event of litigation, the enforceability of such copyrights may be questioned due to the illegality of the business.

In many states, state law automatically provides common law trademark protections for marks used within a geographical area within the State. These rights are limited in geographic scope, however, and can be confined only to the area where the company asserting rights over the mark operates. Cannabis companies can attempt to register trademarks with state authorities, but the primary benefit this confers is treble damages upon a finding of willful misuse of a protected trademark. The best option, and one which provides nation-wide protection, would be federal trademark protections. As we note, however, the Patent and Trademark Office generally will not issue federal registration protections to cannabis-related marks.

Finding a Location

Whether you’re planning to grow, process (in the case of edibles, tinctures or other mediums), distribute, or sell cannabis products, finding a location in which to conduct your business can be a unique and frustrating challenge if you do not own the property yourself.

For starters, you’ll have all the considerations that any other business owner would have: size, proximity to customers and a workforce, rent and lease terms, and so on. On top of that comes another level of difficulty that could significantly shrink the number of possible spaces available to you.

It boils down to one primary issue: due to the evolving and unpredictable nature of the legalization trend, property owners and landlords see cannabis-related business as riskier tenants than most other business types. This can lead to any of three troublesome scenarios:

  1. The landlord will automatically deny leasing to the cannabis company.
  2. The landlord will charge substantially higher rents to the cannabis company than they would to other tenants.
  3. The landlord will use a loophole in the leasing terms to void the contract if they become too uncomfortable with the tenant’s business and/or activities.

This last scenario is based on common leasing language that states, in some way, that the tenant may not break the law on the premises or in their business activities. Even though a state and municipality may provide for the business to operate legally, it is still technically a crime at the federal level. Landlords could cite this technicality as an escape from the terms of the lease.  Counsel familiar with this issue often strike this provision from the lease or attempt to carve out the cannabis industry legal under state law from the impermissible types of criminal activity under the lease.

If you do enter into a lease with a landlord for your cannabis business, it is generally recommended to work with an attorney to ensure all applicable language around this topic explicitly defines the meaning of “legal” business to limit your risk of this situation occurring.

Notably, the location of a grow operation, processing location, or dispensary is often a key part of its licensing application, as legislators and regulators are very careful in how cannabis industry businesses which “touch the plant” are dispersed.  Losing a lease, therefore, can have significant consequences, up to and including loss of a license.

Changes to Federal Policy

As we’ve referenced in multiple places already, the status and enforcement of federal policy regarding cannabis-related commerce remains uncertain. During the Obama administration, the Department of Justice issued a memo (referred to as the Cole Memorandum) which directed the agency’s policy on enforcement of federal cannabis laws.  Generally, the memo stated that the agency would not enforce federal cannabis prohibitions in states that legalized marijuana in some form and implemented regulatory and enforcement systems to govern the legalized cannabis industry in that state. In 2018, Jeff Sessions, famously known for stating that “good people don’t smoke marijuana” and equating the harms of cannabis with those of heroin, released a memo that some felt muddied the waters on federal policy.  Although the Department of Justice has not acted in contravention of the Cole Memorandum, Sessions’ memo was seen as a retreat from the position in the Cole Memorandum.

It is unclear what federal policies will be adopted in the future, but as the cannabis industry grows nationwide and becomes a multi-billion dollar industry, it becomes more difficult for the federal government to contravene state regulatory regimes and state-level legalization.

Given the money pouring into the industry and the overall state trend toward cannabis legalization (to varying extents), it is somewhat unlikely that enforcement of federal law would increase, but it is still a tenuous matter and risk factor. In fact, it may be more likely that the federal government legalizes cannabis, rather than trying to regulate further.

Health Concerns and Health-Related Litigation

Putting aside any issues related to the legality of marijuana itself, companies offering the drug must also consider the possibility of legal issues related to health effects stemming from its consumption.

Tobacco – most notably cigarettes – represents one of the most heavily regulated consumer products in the country. Since the 1980s, smoking has been increasingly linked to cancer, emphysema, and other illnesses and conditions, banned from most public and private buildings, and tested extensively in the legal system regarding the responsibility and liability of the companies that sell it.

As marijuana is most frequently consumed via smoking, companies in this space should be prepared to face similar issues, whether in the form of a lawsuit against a specific company or as further legislative changes to the industry.

On a related note, the recent explosive growth of vaping has generated a whole new set of concerns about health, public nuisance, and marketing toward minors. Although these issues are largely centered around tobacco and nicotine products, its overlap with cannabis consumption makes it a highly relevant topic to monitor.


Opportunities in “Cannabiz”

Given the significance of the barriers to entry, why is cannabis such a popular and growing industry? Simply put, the opportunities are abundant and demand for the product, which was high before legalizations began, is only expected to grow.

“This Bud’s for You”

cannabis industry guideIn fact, many in the industry see cannabis as the next “craft” sensation. For decades, the beer industry was dominated by a small number of mega-brands, many of them offering a similar product (low-alcohol pilsners and lagers). If you’ve been to any U.S. city or suburb since about 2010, chances are you’ve noticed the massive swing toward smaller, local breweries and an exponentially greater number of brands and styles of beer available.

The presence of so many new magazines, blogs, newsletters, brand apparel, and advocacy groups suggest that, similar to trends in cannabis, beer businesses extend well beyond the actual producers and retailers.

What’s even more interesting in the beer industry is that this rise of microbreweries has not been a death knell for Budweiser, Coors, et al. Rather, demand for those brands is still strong; much of the “craft beer” demand comes from creating new beer drinkers, not stealing the existing ones. 

Purveyors of marijuana see a similar opportunity. There is room and opportunity for both lower-end, “generic” product and higher-end, specialized product. Already, employees that help you select product at dispensaries are being referred to as “bud-tenders.”  They talk about sourcing, floral notes and other sensory properties of the specific strains of the plant.

Expected Cannabis Industry Trends

If you’re looking for a more quantifiable measure, a 2019 study by research firm New Frontier Data suggests, “Total legal sales of cannabis in current legal states are projected to grow at a compound annual growth rate (CAGR) of 14% over the next six years, to reach nearly $30 billion by 2025.”

That figure doesn’t include sales from states that are yet to legalize (or fully legalize) recreational marijuana. By 2025, it is very likely that a number of states will enact such new legislation.

And when it comes to the industry expanding in other terms – variety, investment, infrastructure – there is plenty to be optimistic about there as well.

Types of Cannabis Businesses

If you were to say, “I own a cannabis business,” there’s a good chance the average person would assume you meant some sort of dispensary or retail establishment, where clients (or patients) obtain their marijuana, edibles and/or other products. And that sort of business is certainly growing as entrepreneurs in post-legalization states look to capitalize on the excitement of the local population to partake in the newly-decriminalized activity.

Of course, there are a number of different ways to get into the industry. Here are some of the more prevalent ones:

Growing stage:

  • Breeding – How different strains of cannabis and marijuana are developed. Cannabis has an interesting breeding process which you can read about here.
    • Genetics is a growing sub-field of breeding, where scientists are using expertise and complex equipment to alter and crossbreed cannabis plants. Unfortunately, new strains cannot be patented under current federal law.
  • Cultivation – Growing the plants themselves, usually for commercial use. A cultivator typically obtains the desired types of plants from a trusted breeder.
  • Extraction – The process of extracting compounds (generally THC) from the marijuana plants. This could be done by the cultivator, or the plants could be sent to a separate facility/business for extraction.
    • Generally, you will want to make sure your product does not cross state lines, even at this stage, or you could face serious legal issues.

Distribution Stage:

  • Retail/dispensary – Storefront facilities that receive the processed marijuana product and distribute it to consumers. For medical marijuana dispensaries, this business is similar to a standard pharmacy.
  • Edibles manufacturers – Recreational marijuana legalization has given rise to an industry niche that has existed alongside illegal use for decades – using marijuana as an ingredient in prepared foods and drinks. Baked goods, gummies, and both alcoholic and non-alcoholic drinks are among the most popular varieties being commercially produced.

Ancillary Businesses:

  • Growing systems – Irrigation systems, hydroponics, lighting systems, greenhouses –  these products are all being used with greater frequency to offer growers top-notch quality and consistency in their product.
  • Complementary products – There is a wide range of products used as vehicles for or complements to marijuana use. Rolling papers, hand pipes, and water pipes are the most ubiquitous, but other products and devices for ingesting, inhaling, topically applying, or otherwise consuming marijuana are becoming more popular.
  • Financial Resources – With traditional banking a difficult avenue for cannabis companies (see “Roadblocks” above), some investment firms and financial service providers have taken to targeting the cannabis industry specifically, giving business owners a facilitated process for banking, loans, venture capital, and more.
  • Marketing agencies, research, and analytics – These are examples of vendors used by all sorts of businesses and industries. With cannabis growing as quickly as it is and with the lack of public data and information due to past illegality, some entrepreneurs have found success specializing in this space and working with multiple cannabis-related clients.

This is not an exhaustive list of cannabis companies, and surely there will be new types of businesses that develop as the market expands.

One thing to be aware of is that businesses that “touch the plant” – that is, actually handle the cannabis or its derivatives themselves – are typically subject to much stricter regulations than those that do not.


Business Plan

Almost every successful business starts with a business plan, whether it’s a professional looking document or just scribbled on the back of a napkin (we recommend the first option).

A business in the cannabis industry should be no different. You’ll want to consider your strategy, available market, competitors, external opportunities and risks, financial projections, and more. Because cannabis involves some unique parameters, your business plan should take these into account in ways a more generic business plan might not.

One area where you might want to give additional focus is your “team,” which can include yourself, your own employees, contract workers, vendors, and anyone else in your supply chain. Refer to the “Licensing” section above to understand why the people involved in your company can have a significant impact for a cannabis company.

You may also want to spend some extra time considering contingencies for legislative changes. What happens if your state makes more progress with legalization? What if it regresses? What if the federal government decriminalizes it altogether? Think about how these very realistic possibilities could affect your business for better or worse, and what you would do to maximize your position in those circumstances.

Here are a few external resources for assisting with creating a cannabis business plan:


How to Start Your Cannabis Business

Choosing a State for Your Company

When you start your cannabis company, you’ll generally want to create a legal business entity, such as a corporation or LLC. The right choice will depend on your specific business model and growth strategy, among other factors.

You will also have to choose which state you want as your “home” state. This doesn’t mean you’ll have to live or have a physical location there; rather, you can often choose any state you wish and still live and operate elsewhere. In some instances, states may require that you form your cannabis company there if you wish to operate it there, but this is not typically a requirement.

Harvard Business Services’ General Counsel, Jarrod Melson, worked with some cannabis companies prior to joining the Harvard team. One strategy he employed for companies with operations in multiple states was utilizing a multiple-company structure.

“I would create a few financing entities intended only to hold capital and invest it to an affiliate that engaged in business.  We created a separate entity for each state, all under a parent entity, and divvied up returns into some investors tied to certain state revenues and others entitled to distributions from general, all states revenue,” Jarrod explains.

Harvard Business Services is a Delaware formations specialist and we cover the benefits of Delaware incorporation in depth on this site. Let’s take a look at some aspects of starting your cannabis business as a Delaware company.

Is a Marijuana Company Legal in Delaware?

At the time of this writing, Delaware does not permit recreational marijuana use or sales within state borders. Medical marijuana is legal and it is possible (though not easy) to operate a dispensary or related cannabis business.

Assuming your business will not physically be located or operating in Delaware, these regulations do not significantly impact your business; you should focus more on the laws of the state in which the business will operate.

Still, there are some considerations with registering your cannabis company in Delaware. For example, you’ll need to be careful with your company name. Delaware does not allow the use of certain terms in a company’s name when they imply something that is illegal, vulgar, or otherwise against state policy.

Although this can be somewhat subjective, the state has made public statements about what they will and won’t approve. Generally, the words “cannabis” and “marijuana,” as well as close variations, slang uses such as “weed,” and any other obvious references (such as “420”) to the drug will not be approved.

There may be restrictions on individuals who want to start a cannabis company. Most states, including Delaware, typically prohibit persons with a felony record from working in the cannabis industry, including as a business owner or as an employee. In addition, Delaware prohibits those with misdemeanor drug offenses within the prior five years from working in the industry (see subsection 4918A of Delaware’s Health and Safety statutes). Other states’ rules on this issue can vary.

How to File a Delaware Cannabis Company

The procedure for forming a cannabis or marijuana-related company is the same as any other type from the perspective of the necessary forms, fees, and information.

Once you have a company name and know what type of business entity you want to form, you can work with an incorporator such as Harvard Business Services to complete the filing with the State of Delaware. Our Learning Center provides information on various company types, and you should not hesitate to seek legal counsel or a tax professional (we are neither) if you are unsure of which entity type is right for you.

When you are ready to proceed, here’s what you’ll need to do:

  1. File your company by providing your incorporator with basic company information, such as the company name, entity type, name and Communications Contact person, and, if forming a corporation, information on initial director(s).
  2. Obtain an EIN (Employer Identification Number), which is a federal tax ID. This is generally required for operating a U.S. business. The number is assigned by the IRS.
  3. File for Foreign Qualification in the state(s) in which you will operate.
  4. Obtain the proper business licenses and permits for your local jurisdiction.

Once everything is approved and obtained, you’ll be on your way to operating your business. You’ll still have to consider many other aspects of your business (as we’ve discussed above), but at least you’ll have a formal business entity with which to proceed.

If you would like to form your company with Harvard Business Services, our services start at $179 and we can obtain the EIN for you at an additional fee. We can also assist with Foreign Qualification and can refer you to a partner of ours to help with business licenses.


Established Companies in the Cannabis Industry

In the coming years, the list of top cannabis companies will surely fluctuate. Here’s a video from Quartz News from 2019 about the biggest names in the space at the time:

These sites also provide information on some of the top cannabis companies:


Cannabis Business Resources:

Vendors and Suppliers

Product Knowledge

Finance and Investment Capital

Incubators