One of the most important decisions a new cannabis company can make is the form of entity it will use. In fact, one of the first questions companies ask is whether the right entity for a cannabis business is a limited liability company (LLC), corporation, or something else. Like any other legal analysis, the answer depends on a lot of business-specific factors. In this series, I break down some of the key points to consider the right type of entity for a cannabis business. In my last two posts in this series, I looked at companies And the A limited liability company. In this third and final post in this series, I’ll look at some of the types of alternative work we’ve seen or heard about.
A note on limited liability
For those of you who haven’t read my other posts in this series, I want to define the concept of limited liability. Limited liability is an essential feature of certain types of businesses. If a person owns a LLC, the person will generally not be personally liable for the company’s debts, obligations, etc. Except for a few limited scenarios, if the company is sued and loses, the owner has nothing to lose – except for his investment in the company at most. But as this has been pointed out, not all companies have limited liability by definition. I will discuss those below.
In my previous posts I covered general tax principles applicable to corporations and LLCs. The company is subject to tax on its income. Then, if the company issues a dividend to shareholders (after paying taxes on its income), the shareholders are taxed individually. This is usually called “double taxation” and the corporate structure is called a C corporation. On the other hand, LLCs and partnerships have pass-through taxes, the corporation model is essentially ignored (I’m oversimplifying) and business profits and losses are passed directly to the owners for purposes tax . There are advantages and disadvantages to each structure, which I reviewed before. But taxes are another key area for choosing the right entity for your cannabis business.
a Sole Proprietorship It is an unregistered one-person company. There is no legal distinction between the owner and the business. Even if a jurisdiction allows individual owners to obtain cannabis licenses, this is not the right entity for a cannabis business. It’s a poor choice for any business, really, because there is no limited liability. Limited liability is crucial and is something you get by default in a corporation, LLC, or other limited liability entity. While forming a company requires some expenses (registration fees, drafting legal documents, company taxes), which generally pale in comparison to the liabilities that can personally accrue when someone’s home, cars or other personal property is at stake.
Generally, a partnership exists when two or more people cooperate to carry out a business for profit. If the persons are cooperating to form a partnership without forming an entity then this is called a ‘general partnership’. Like a sole proprietorship, general partnerships have no limited liability, and therefore are not the right entity for a cannabis business.
Most states allow partners to form limited liability partnerships by making certain filings with the state and by observing certain formal procedures for governance. Like I said above, this is really a subtle question when considering the drawbacks of not having limited liability. There are also entities called limited partnerships with limited and general partners. I might talk about limited partnerships in a different post, as they can get a little complicated.
Partnerships, like LLCs, are taxed on a pass-by basis. People looking for C corporation taxes in a partnership type form choose LLCs instead. With a few exceptions (LLPs for law or accounting firms and limited trust partnerships), partnerships of any kind are very rare for cannabis firms.
DAO is an acronym for Decentralized Autonomous Organizations. This is a new entity type that is beginning to emerge in the Web3, NFT, and blockchain technology spaces. We have written about it at length over here And the over here So I won’t repeat everything, but here’s a teaser that might help explain:
DAOs allow organizations to be created on a collaborative and decentralized basis that can then achieve the common goals of their members. Smart contracts form the basis of DAO operations by executing transactions between counterparties that automatically handle administrative duties and make relevant decisions made by humans in managerial roles. Governance is then decentralized when control of smart contracts is transferred from DAO developers to DAO members.
At the moment, I am not aware of anything licensed The cannabis business is regulated as a DAO although it is likely to be permitted under state laws that broadly allow almost any type of entity to apply for a license. The problem with DAOs is that they are largely based on smart contracts. This may help with simple organizations, but cannabis business is often more complex to run. So at the moment, the DAO is probably not the right entity for the cannabis trade.
Funds and real estate funds
A trust is a legal relationship in which one party (known as a “trustee”, “grantor” or “settlor”) entrusts another party (“the trustee”) possession of property for the benefit of a third party (the beneficiary). Chests are creatures of state law. State law on trusts varies widely – in terms of the types of trusts, whether the trustee can also be a beneficiary, and whether the trust is treated as a separate legal entity.
Personally, I have never seen a box that has a cannabis license. Instead, individuals often own cannabis businesses via trusts. This can become thorny for a family trust with beneficiaries under the age of 21, as most states have age requirements for cannabis business ownership. But nevertheless, confidence in owning shares in the cannabis trade is very common.
REIT is an acronym for Real Estate Investment Trust. REITs are generally created to raise money from third parties, often in public markets (yes, even in hemp space). Their plans run the entire gamut of investment – from development through operation and sale of cannabis-related properties.
REITs are not subject to federal income tax. Instead, they are allowed to deduct dividends distributed to investors. They must have at least 100 shareholders and be suitable only for large-scale real estate investments. So again, it’s not the type of entity you see owning a cannabis license even though we see them investing in cannabis properties all the time.
There are different types of business entities in the United States and abroad. Depending on the state, there are limited — and in some cases no — restrictions on the type of entity that can be used in the cannabis business. This does not mean that opting out of the corporate model is a good idea. There is a reason why the majority of companies in the space are corporations and LLCs. However, whether an alternative business type is the right entity for the cannabis business depends on a number of business-specific factors, rather than on some analysis in the vacuum.