With the passing of the Farm Bill, a new market for hemp and CBD opened up as the once illegal crop became legal across the country, creating opportunities for growers, processors and retailers. Now, as these businesses just begin to establish themselves, and an increasing number of states move forward and legalize cannabis, these existing hemp businesses would appear particularly well poised to enter the cannabis market. Should they seize an opportunity to expand their business into a market where they may already have a head start?
While there may be some obvious advantages in the hands of existing hemp businesses, there are still many hurdles and complexities that require careful consideration when making this decision.
A key piece to this is the legal issues surrounding the different crops. The major factor being that hemp is legal on a Federal level, and cannabis is not. This single issue gives rise to many complexities for a business owner to consider if they are thinking of switching over to cannabis or incorporating it into existing operations. For example, there can be issues finding banking and financing services. Even if banking relationships are already established, entering into a business that is federally illegal could violate the terms of the banking relationship and existing financing. A business owner could also run into issues with the land or property that it uses for growing, processing or selling. Leased land or space might stipulate that it can’t be used for unlawful activities, and being involved with cannabis could violate the terms of the lease. Even if the land and property are owned out-right, this type of language can sometimes show up in deeds. While this is just a couple of examples of problems facing the cannabis industry, it is important to understand how a transition like this can impact all of the ancillary services that a business depends on to operate.
There are also Federal tax implications to consider as there are restrictions on the deductibility of expenses in connection with the illegal sale of drugs. Section 280E of the internal revenue code stipulates that only those expenses considered to be cost of goods sold are deductible for Federal income tax purposes. All general and administrative expenses are therefore not deductible against a cannabis businesses’ gross profits. This can lead to the recognition of income that far exceeds the actual profits made by the business, and result in burdensome tax liabilities.
While many states are legalizing cannabis, the illegal status of cannabis on a Federal level does carry with it the inability to cross state lines with the product, regardless of the legality in that state. Additionally, the license to grow or sell cannabis in legal states is only valid in that state. Therefore, the consumer or business to business market available to a cannabis business is only what lies within the borders of the state in which it operates. Expanding into other states would require separate operations and licensing in each state. The cost of setting up operations can obviously be significant, but some states also have substantial licensing fees, as well as different laws and standards surrounding growing, selling, and transporting cannabis. If the available market in a business’s current state is not significant enough to sustain operations, understanding all the implications of trying to expand into other states is crucial to success.
While it may seem like stepping into the cannabis industry has insurmountable obstacles, there is still a great opportunity here for success, and existing hemp businesses do have advantages in terms of growing operations, processing facilities, and established reputations, relationships and clientele. It is extremely important however, to understand the environment, the risks, and the complications, and to plan accordingly to ensure success in this exciting new industry.
For further questions on the Cannabis or Hemp Industries please visit our cannabis and hemp services page, or contact us today.