tenth-amendmentYesterday, we wrote about the various ways that enforcement of federal cannabis laws could ensue, if the current administration were bullheaded enough to attempt such a thing. The day before, we wrote about the Washington State Attorney General’s promise to fight any potential enforcement action. Today, we offer a brief primer on what rights the states may have to uphold their medical and recreational marijuana programs in the face of federal enforcement action. The answers may surprise you.

As a baseline matter, it is imperative to note that Article VI, Clause 2 of the U.S. Constitution declares that federal law is “the supreme law of the land,” preempting conflicting state laws. This means—and courts have confirmed—that if the federal government wants to enforce its draconian marijuana laws by targeting specific actors, it can, and states cannot stand in the way. However, if the federal government wants to force states to shut down their marijuana programs, or to use state resources to enforce federal law, it probably cannot.

The constitutional question that will determine the outcome of any lawsuit to invalidate state cannabis laws, whether for medical or recreational marijuana programs, is whether those state laws impermissibly conflict with the federal Controlled Substances Act (CSA). Another way of asking this would be: “Does the federal CSA ‘preempt’ state cannabis programs?” Given the plain language of the CSA, we think the answer is “no.”

Section 903 of the CSA includes express anti-preemption language:

No provision of this subchapter shall be construed as indicating an intent on the part of Congress to occupy the field in which that provision operates, including criminal penalties, to the exclusion of any State law on the same subject matter which would otherwise be within the authority of the State, unless there is a positive conflict between that provision of this subchapter and the State law so that the two cannot consistently stand together. (Our bold emphasis.)

What would a “positive conflict” with state law be? It may sound funny, but a positive conflict might consist of a state law requiring a citizen or state official to possess or distribute marijuana. Such a law would almost certainly violate the CSA. But, state marijuana programs that only permit individuals to traffic in federally controlled substances—because states do not proscribe them—make no such requirement. Think about it: anyone in Oregon, Washington, California, or any other state with a cannabis program, is free to ignore these state programs and follow federal law.

This begs the question as to whether the federal government could require states to shut down their programs, and assist in enforcing its horrible laws. Again, we think the answer is “no.” The Tenth Amendment to the Constitution serves as a constitutional check to the Supremacy Clause. The Tenth Amendment provides that the federal government cannot “commandeer” states by forcing them to enact laws in the federal interest, or to enforce federal laws whatsoever. In the context of cannabis, this means that neither Congress nor any federal actor can require states to enact or maintain laws prohibiting the cultivation, distribution or intra-state sale of pot.

The upshot here is that the Tenth Amendment, coupled with the express, anti-preemption language of the federal CSA, grants the states authority to run cannabis programs. This paradigm gives the states a strong argument in any potential lawsuit by the feds seeking to shutter those programs. Thus, the extremely tall and unpopular task of chasing state-approved pot merchants, would be left to the resource-poor federal government. And if the federal government really wants to go there, well, we’re in for another kind of fight.

Cannabis litigation lawyerThough we are hoping 2017 will bring you nothing but prosperity when it comes to your cannabis business. But if you are headed to court in 2017 or even if you are just just sensing a company dispute stirring, the following five tips will help you avoid or mitigate the negative impact of a business dispute.

  1. Make your business relationships crystal clear from the start. The days of handshake deals regarding ownership in a cannabis business are over. You should do no deals of any real size without first getting everything in writing. Operating agreements, bylaws, and shareholder agreements exist to ensure that your company structure and the relationship between its owners is abundantly clear. When starting a company together, you and your fellow owners should have at least some understanding on how your company will be operated and on how such things like equity versus debt, voting rights, sweat equity, preferred returns, owner employment will be navigated. Most of the ownership disputes our cannabis litigation lawyers have handled have been because of badly done initial company contracts and filings.
  2. Perform due diligence on your partners. If you want to increase your odds of avoiding a dispute with your cannabis business partners, the most important thing you can do is to choose your partners wisely. What never ceases to surprise us is how often we are told by a party locked in a life or death ownership dispute regarding a cannabis business is that they barely knew their business partner before they started the business with them. If you are going to start a cannabis business (or any business for that matter), the first thing you should do is find out as much as you can about your putative partner’s financial and business history. You should do this before you sign away your soul and money to joining with this person on a business project. It’s neither rude nor unexpected to ask your potential partners for documentation showing their financial and criminal history–the state licensing regulators will ask for this information anyway. It is even more important to conduct thorough due diligence if you are buying into an existing cannabis business. At minimum, this due diligence should include investigating and analyzing the assets and liabilities of the company and its current owners. Your due diligence should also include confirming the appropriate standing of the company with state and local government regulators, and determining that the company and its principals understand how to comply with state and local laws as well as the Cole Memo. This is routine in every other industry and it must become routine in the cannabis industry as well.
  3. Get your own attorney from the start to protect yourself. More often than not, the company has an attorney looking out for the company’s interests. But it is important to realize that the company attorney is not your personal lawyer and that lawyer will almost certainly be conflicted out of any dispute between you and your business partners and/or investors. For this reason (and many others) you need your own lawyer providing you with your own counsel and protection regarding your role in the company and your ownership rights. This lawyer should also make sure that the written agreements work for you and not against you. This lawyer will also be an asset for you personally if any dispute arises. For more on how to avoid a dispute relating to your cannabis business, check out Five Tips on How to Avoid Cannabis Litigation and How to Avoid Costly Marijuana Business Disputes. For more on how to choose the right lawyer for your cannabis business check out How To Choose Your Cannabis Business Lawyer.
  4. Know your dispute resolution options. Well drafted corporate documents and contracts should cover most possible breakdowns in the business or the relationship and set out the options for handling internal strife. If there is a fight or a tie on a vote, what happens? How are problems resolved and when? Who makes what decisions and how? What about liquidating the business? What about selling an ownership interest and for how much? Can you sell just your membership interest or shares without going through a vote of the members? Can you keep running the business free of your partners if there’s a fight? What about dissolving the company and winding down? What happens if there is a contract breach? All of these things can and usually should be covered in your corporate governing documents or in any other contract you sign, and by doing so, you greatly minimize your likelihood of destructive problems down the road. Your company documents and contracts should also make clear exactly how disputes are going to be handled. Are you going to want your dispute made public in a court, or kept quiet in an arbitration or mediation? It is a lot easier to reach agreement on such things when you are starting your business or your relationship than when you are already in the midst of a hard fought dispute with costly lawyers.
  5. Make sure your lawyer knows what he or she is doing. When hiring a lawyer to help protect you when getting into a cannabis business, you should be sure to hire a law firm with lawyers who know both business law and cannabis law. And when confronted with a dispute involving your cannabis business, you need to be sure to hire a law firm with lawyers experienced in civil litigation (criminal litigation experience does not count here) and cannabis law, if possible. For more on choosing your cannabis lawyer, check out How To Choose Your Cannabis Business Lawyer.

Be careful out there, and have a happy 2017.

Cannabis business lawyersWe’re in that time of year when at least some of the licensed cannabis producers in Washington tend struggle. A short-term glut of marijuana on the market makes it harder to stand out and make sales, and businesses that aren’t competitive on price or quality get left behind. I bring this up because it is also the time of year when financiers come to my firm’s cannabis business lawyers looking for a way out of deals they fear will never pay off.

“Financiers” in the Washington marijuana system generally refers to debt investors that get a set interest rate of return rather than a profit-interest in a business. Mark Cuban once said that only a moron would start a business on a loan, but the limitations on out-of-state equity ownership leave many newish cannabis businesses cash-strapped, so they turn to debt. We have also seen that many of the creditors involved in the local marijuana industry are not seasoned small-business investors. They are people looking to take advantage of an industry that seems to be printing money. Debt feels less risky than equity, so they throw some money into a cannabis business or two, believing they will be able to get 10%-20% interest annually.

Because so many of these investors are new to small business investing, many don’t protect themselves. Lenders have a lot of tools to make sure they get paid. Security interests in real, personal, and intangible property provide avenues for seizing assets. Marijuana inventory is complicated to secure, but most marijuana businesses have at least some high dollar capital equipment. Personal guarantees from major players put personal assets on the hook as well, and signed confessions of judgment make the process of obtaining a judgment on the debt significantly easier. Most loans do not involve all of these protections, but most smart lenders are not willing to provide completely unsecured capital to brand new businesses without any way to get a return if the business folds.

If you are one of those unsecured investors and the cannabis company to whom you loaned money defaults on your loan, what can you do? If you want any chance of recouping your investment, you really only have two options. First, you can renegotiate the debt. In most well-drafted promissory notes, an uncured event of default causes the debt to accelerate and mature. This means that if your cannabis borrower misses a payment and doesn’t make a late payment by the cure date, its entire debt becomes due. Once this happens, it is just a matter of negotiating an extension on the note. During that extension, you as the creditor have significant leverage to extract concessions from your cannabis borrower, such as personal guarantees, security interests, or even pledges of ownership interest in the cannabis company. The reason you as the creditor have leverage is because your only other viable option would be to obtain a judgment against the borrowing company and that judgment will likely be a nightmare for your borrower. If you are wiling to brave the legal fees and get a judgment against your borrower, you can then use that judgment to begin levying on the cannabis business’s assets as though you had a security interest in the property to begin with. In most states, once you get the judgment, at least some of what you spend collecting on it, including your attorneys’ fees, will be collectable as well.

Companies that owe debts to third parties and realize that they are about to go under sometimes look for ways to avoid paying the debt. This is a good time to bring up fraudulent transfers. As defined in most states, a fraudulent transfer occurs in a few different ways, the most common of which is when an insolvent debtor transfers property without receiving a reasonably equivalent value in the exchange. If an “insider” — someone connected to the company like a director or a director’s spouse — is involved in the transaction, showing fraudulent transfers becomes far easier. For example, if a debtor  company has a bunch of equipment and transfers it to the company owner’s brother, that is potentially a fraudulent transfer, and the property can be clawed back for creditors.

The stickiest situations come when there are multiple debts. A company is not necessarily breaking any laws if it chooses to pay one creditor before it pays other creditors. Unless the creditor is an “insider,” the company can generally choose which of its debts to pay unless it is in a formal bankruptcy (probably not available to marijuana businesses) or a state receivership proceeding. In certain circumstances, multiple debt investors have signed promissory notes in which the company promises not to pay the notes proportionally and not to provide any payment preference. If the debtor company does pay one holder disproportionately to the others in that circumstance, the creditor left-behind may be entitled to a clawback of the payment.

These collections matters don’t usually end with either side truly happy. Attorneys make some money, and investors can often recoup a portion of their investments, but debt litigation against a business is an unpleasant affair. If you are looking to lend to a cannabis company, make sure you know what your plan is if things turn south. It’s better to have a security interest up front than it is to fight the company and other creditors in court to get the right to levy.

RRLast week, the Oregon Land Use Board of Appeals (LUBA) ruled against a certain cross section of pot growers in the state. The Petitioners at issue wanted to grow medical marijuana on land covered by a “rural residential” zoning designation. When Jackson County adopted a zoning ordinance prohibiting such activity, the growers sued. Because LUBA sided with the County, medical marijuana grows in that jurisdiction will be limited to land zoned exclusively for farm (EFU), forest or industrial use. In that sense, the ruling is fairly narrow, although it could discourage prospective litigants in other counties on similar appeals.

As covered in the LUBA decision itself, the zoning change was consistent with Jackson County’s Comprehensive Plan and ORS 475B.500, which allows cities and counties to adopt “reasonable regulations on the operation of marijuana grow sites.” The Board found that a county keeping medical marijuana grows off rural residential land is “reasonable” for a couple of reasons, including that there are over one million acres of land in Jackson County that remain suitable for marijuana cultivation under the new ordinance.

The growers took an interesting approach to the “reasonable regulations” issue; they first argued that marijuana production is an exercise in free speech under the First Amendment of the Constitution. Due to this broad protection, the growers argued, the County’s zoning amendments would have to serve a “significant government interest” to withstand scrutiny. As you might expect, LUBA dismissed that argument quickly. More compellingly, the growers also argued that marijuana is now a “crop” under Oregon statutes, and the County did not prohibit other “crops” from being grown on rural residential land. In response, LUBA pointed to the large amount of land still  available for medical marijuana grows even outside the rural residential context.

Though not mentioned in the opinion itself, LUBA surely took note of how Jackson County entertained significant public input before adopting the zoning regulations. Local jurisdictions tend to do this ahead of controversial decisions. In theory, the jurisdictions want to gain as much public input as possible before making impactful decisions; but cynics argue that this process affords only the veneer of democracy, designed to insulate government from criticism and lawsuits. In our experience, early advocacy may be fruitful, if the approach is correct.

As further background to this case, LUBA also surely understood that farmers who had been on rural residential land prior to the ordinance can still “grandfather in” as a non-conforming use under Jackson County Code. We have worked on this issue with growers all around the state, as most local land use codes contain a section on non-conforming uses and vested rights. These concepts allow people to continue to operate as they had operated before a zoning change, even after the change occurs. As such, the only people that should be effected by this decision are those who will resist paying the fee to grandfather in, and those who had not yet begun to operate on rural residential land when the ordinance passed.

The growers in this case have vowed to fight on, which means a date in the Court of Appeals. They will argue, as they did in the press last week, that “it is hard to understand how an ordinance that stops 3,500 farmers from producing medicine for their patients is a reasonable regulation.” It is possible, but unlikely, that they will win. Meanwhile, prospective litigants around the state will have some food for thought when it comes to challenging local land use regulations.

Fortunately, there will be opportunities to distinguish the claims brought by the Jackson County growers, which are limited to a certain class of land in a certain county. This adverse decision should have only minimal impact on the Oregon cannabis industry’s momentum overall.

 

 

GraphicEmployees in wrongful termination lawsuits have faired poorly when the grounds for termination involve marijuana use. We have written about these frustrating cases time and again (and again). Courts have sided with employers even where the terminated employee is a sympathetic party who suffers from a debilitating medical condition, confines his use to off-hours, observes state law to a T, has a stellar employment history… and pretty much everything else you might want to see in a plaintiff. Truly, it’s been tough. Continue Reading Oregon Arbitrator Sides with Employee in Marijuana Termination Case

Cannabis litigationLately, our cannabis litigation team has seen a massive spike in cannabis businesses owners suing their fellow owners within the same cannabis business. Whether you’re already headed to court or you’re just sensing a company mutiny brewing on the horizon, the five tips in this blog post will help you prevent an ownership dispute and best resolve one if one should occur.

  1. Perform due diligence on your co-owners. If you want to increase your odds of avoiding a dispute with your cannabis business co-owner, the most important thing you can do is to choose that co-owner wisely. What really kills me is how often I have been told by a party locked in a life or death ownership dispute that they barely knew their business partner before they jumped into business with them. If you are going to start a cannabis business, the first thing you do is find out as much as you can about your putative partner’s financial and business history. You should do this before you sign away your soul and money to joining with this person on a business project. It’s neither rude nor unexpected to ask your potential co-owner for documentation showing his or her financial and criminal history. It is even more important to conduct thorough due diligence if you are buying into an existing cannabis business. At minimum, your due diligence should include an investigation and analysis of the assets and liabilities of the company and its current owners. Your due diligence should also include confirming the appropriate standing of the company with state and local government regulators, and determining that the company and its principals understand how to comply with state and local laws as well as the Cole Memo.
  2. Make your business relationship with your partner as clear as possible. The days of handshake deals regarding ownership in a cannabis business should be history; you should do no such deal without first getting everything in writing. Operating agreements, bylaws, and shareholder agreements exist to ensure that the company structure and the relationship between its owners is clear. When starting a company together you and your fellow owners should have at least some understanding regarding how the company will be operated and how such things as equity versus debt, voting rights, sweat equity, preferred returns, owner employment, will be handled. Most of the ownership disputes we have handled have arisen either due to no or bad initial paperwork.
  3. Know your options and consider alternative dispute resolution. Well drafted corporate documents should cover most possible breakdowns in the business and set out the options for handling internal strife. If there is a fight or deadlock, what happens? How are problems resolved? Who makes what decisions? What about selling the business? What about selling an ownership interest and for how much? Can you sell just your membership interest or shares? Can you keep running the business free of your partner? What about dissolving the company and winding down? All of these thing can and usually should be covered in your corporate governing documents, and by doing so, you greatly minimize your likelihood of insurmountable problems later. Your company documents should also make clear how disputes are going to be handled. Are you going to want your dispute made public in a court, or kept quiet in an arbitration? It is a lot easier to reach agreement on such things when you are starting your business rather than in the midst of a hard fought dispute.
  4. Get your own attorney from the start. More often than not, the company has an attorney looking out for its interests. But it is important to realize that the company attorney is not your personal lawyer and that lawyer will almost certainly be conflicted out of any dispute between you and your business partner and/or investor. For this reason, and many others, it almost always pays for you to have your own lawyer providing you with your own counsel regarding your role in the company and your ownership rights. This lawyer should also make sure that the written agreements work for you and not against you. This lawyer will also be an asset for you if any dispute arises. For more on how to avoid a dispute relating to your cannabis business, check out Five Tips on How to Avoid Cannabis Litigation and How to Avoid Costly Marijuana Business Disputes.
  5. Make sure your lawyer knows what he or she is doing. When hiring a lawyer to help protect you when getting into a cannabis business, you should be sure to hire a law firm with lawyers who know both business law and cannabis law. And when confronted with a dispute involving your cannabis business, you need to be sure to hire a law firm with lawyers experienced in civil litigation (criminal litigation experience does not count here) and cannabis law, if possible. For more on choosing your cannabis lawyer, check out How To Choose Your Cannabis Business Lawyer.

Be careful out there.

 

cannabis arbitrationOne of the questions that needs to be answered in every state with marijuana legalization is whether marijuana contracts be enforceable in state court. If an activity is legal under state law but illegal under federal law, courts need to determine whether contracts involving the activity are for an “illegal” purpose and thus void under standard contract law. Courts in Colorado and California have come down on both sides of the issue, and each state’s court system will need to grapple with this issue. Arbitration may be a workaround for cannabis businesses.

Last week the 2nd Circuit Court of Appeals in New York, upheld Tom Brady’s four game suspension given to him by the NFL commissioner who was acting as an arbitrator. Because the NFL and the NFL Players Union have a collective bargaining agreement, the arbitration is governed by the federal Labor Management Relations Act. In its ruling, the 2nd Circuit held that arbitration awards under the LRMA cannot be overturned because the arbitrator made mistakes of fact or even of law. The only way arbitration awards could be vacated or overturned is if the arbitrator didn’t act within the scope of the collective bargaining agreement.

Even when you don’t have a collective bargaining agreement, the Federal Arbitration Act gives courts very limited rights in overturning or vacating arbitral awards. In Hall Street Associates v. Mattel, the Supreme Court ruled in 2008 that the only allowable reasons to overturn an arbitration judgment were those listed in the Federal Arbitration Act, 9 U.S.C. §§ 10 and 11. After the Hall Street Associates decision, for example, the 8th Circuit Court of Appeals held that a lower court could not overturn an arbitration decision even where the arbitrator’s decision exhibited “manifest disregard for the law.”

So the question isn’t necessarily whether state law, as determined by the highest court in a state, determines if marijuana contracts should or should not be enforced. The question may be whether the contracts are going to be enforced by arbitration, assuming the contracts call for arbitration. Because in that circumstance, even if state law says otherwise, courts are very likely to uphold and enforce arbitral awards.

Contracts that use arbitration as their dispute resolution mechanism usually will select an arbitration association to administer arbitration or will say that the parties have to agree on one to three arbitrators. The chances that an arbitration association would determine that a contract is wholly unenforceable in arbitration because marijuana is illegal is a lot lower than a state court making that call, if only because the arbitration association wants the business.

Our cannabis business lawyers have met with many arbitrators and at least one arbitration society looking to market their services as arbitrators for cannabis industry disputes. Of course these individuals and associations are not going to toss out all marijuana contracts — they’d be out of business. If you’re a cannabis business representative, you have to strongly consider arbitration — it may be the safest way to ensure your contract is enforced. And if you write in your agreement that your arbitration should be kept confidential, it can also be a great way to keep your disputes private as well.

California CannabisFirst came the Ogden memo in 2009, which announced to federal prosecutors in the Department of Justice (DOJ) not to focus its limited investigative and prosecutorial resources on individuals whose actions are in clear and unambiguous compliance with state medical marijuana laws. Then in 2014, Congress passed the Rohrabacher-Farr amendment, which prohibited the DOJ from using federal funds to prevent states from implementing their own medical marijuana laws.

The amendment was the basis behind a federal judge’s ruling last October that the DOJ could not enforce injunctions against a California dispensary that was in compliance with the state’s medical marijuana laws. During the case, the DOJ argued that prosecuting and shutting down medical marijuana dispensaries does not prevent states from implementing their laws. Judge Breyer did not respond well to this argument, instead saying that the DOJ’s interpretation “tortures” the meaning of the law and “defies language and logic.”

The DOJ appealed the district court’s ruling to California’s Ninth Circuit court, but in a surprising turn of events, the DOJ dropped its appeal earlier this week by filing a motion to dismiss its own case. If the DOJ had proceeded with the appeal and lost again in the Ninth Circuit, the ruling would have set an even greater precedent for California courts. This is a big win for those of us who believe that marijuana businesses operating in compliance with state and local laws should be treated the same as any other legally compliant business. As long as Congress continues to renew the amendment each year, marijuana business owners in legal states can sleep more soundly knowing they will not be woken up by DOJ boots kicking down their doors, and that even if this does happen, they could have the courts on their side.

Still, both the Ogden memo and the district court’s ruling highlight an important element of the federal government’s current position on marijuana enforcement. The feds will not interfere if, and only if, states have clear and robust marijuana regulations in place. For states like California, which only recently passed statewide regulation and is still in the midst of its rule-making process, there is an urgent need to get that robust regulation in place so cannabis businesses can enjoy the fruits of these policies against federal interference.

Cannabis business lawyers
By Mahons at http://bit.ly/22nx5mL

Washington tends to be pretty strict regarding the flow of money into and out of the cannabis industry. To date, it still allows marijuana businesses to be financed only by state residents (soon to be relaxed), and it only allows state residents to exert any control over licensed businesses and/or to share in the profits of licensed businesses. Even if you are a state resident, a licensee faces major risks if it shares profits with you without having declared you as a true party of interest and having received approval from the Washington State Liquor and Cannabis Board (“LCB”) before sharing any profits with you.

As many licensees know, however, where the rules are vague or ambiguous, it is generally the first impulse of the LCB (like most regulators), to say that the most conservative, restrictive answer is the correct one. And though listening to your regulators and complying with their wishes is usually your best and least expensive option (See How To Deal With Your State Marijuana Regulators: Fess Up), it sometimes pays off to push back, at least a little.

I and some of the other cannabis business lawyers at my firm recently wrapped up a Washington case dealing with the “profit issue.” Our client was a licensed processor based in eastern Washington that client had contracted with an independent sales company to sell its product primarily in Western Washington for a 7.5% commission. A licensed retailer complained about this arrangement and the LCB sent an enforcement officer to interview the processor. The processor confirmed the basic agreement and the LCB then turned around and tried to cancel its cannabis processing license. Despite our client being a first time “offender,” the LCB had no interest in offering a monetary penalty, a suspension, or any alternatives; it wanted only to cancel the processor’s license.

When we took on the case, our first goal was to achieve a reasonable settlement with the LCB. Few people that have been through litigation, including administrative litigation, would ever describe it as a fun or rewarding or inexpensive experience. Even when you have a good case — which we did – it often makes financial sense to pay a settlement than to pay your attorneys to fight. We tried to get the LCB to agree to a lesser penalty, but it was just not willing to budge, so we went through the administrative hearing process. The administrative judge listened to both sides and let us know about 45 days later that we had won. The judge ruled that under WAC 314-55-035 someone who receives a commission on a specific sale is not receiving “a percentage of the gross or net profit from the licensed business during any full or partial calendar year” and therefore does not have to go through the LCB approval process for true parties of interest.

State agencies get to write the rules they enforce so long as they go through the standard rule-making process — proposed rule, comment period, then final rule. Even if they don’t go through that process, they still get quite a bit of leeway when it comes to interpreting ambiguous rules. But once a rule is written, a state agency is not supposed to expand its scope beyond its text without first going through the rule-making process. When they do act without going through the required rule-making process and then refuse to back down, it is important to use the legal system to push back.

Nonetheless, it is always important you “pick your battles” and know when you are doing something that may cause trouble. In this case, the client probably would have liked to go back in time and not have paid the commission, as that would have meant it could have avoided having to fight the state at all. Regulated businesses need to make decisions using a green light, yellow light, red light approach. Green light decisions are clearly allowed and red light decisions are clearly rules violations. Yellow light decisions are the trickiest, as those are the ones that could go either way based on rules interpretations. For these decisions, it’s all about deciding whether the risk of losing a legal fight against the regulator is worth the potential reward of making the decision.

Most of the time, you will want to be cautious, but every now and then the fight is worth it.

From http://bit.ly/1WqdVNG
From http://bit.ly/1WqdVNG

So you went and started a cannabis business. Congratulations! Now, here’s a question for you: what’s it worth? And if you don’t mind us asking: how did you make that determination? Is it supportable?

Recently, we have written about the future of cannabis funding and the basics of investment rounds. The valuation question looms large when capital is injected into a cannabis venture in exchange for ownership, as it would in any other industry. The valuation question may also come up at other points in the lifecycle of a cannabis business, including for tax reporting (c-to-s conversions, charitable conversions (now available in Oregon)); financial reporting (purchase price allocation, portfolio valuations); and litigation (shareholder disputes, damages, fraud). If you are like me, you have even hired, examined and cross-examined professional appraisers on valuation issues in arbitration and in court.

Of course, valuation of a “going” cannabis concern is different than valuation of any other type of business. This is largely due to federal prohibition, which results in heavy taxation of pot operators and highly differentiated local markets. A license in New York State or Hawaii, for example, may have a much higher value than a license in Oregon or Washington, because of the exclusivity involved. However, legislation in an “open market” state may be much more favorable, and every business has its own characteristics, like location, lease and allowed activities.

One common characteristic across the board with cannabis companies is risk. Arguably, risk assessment may be the biggest challenge within the cannabis sector. Federal prohibition aside, state regulation is so new that pot firms face an ever-changing regulatory landscape. Another substantial challenge for any pot business appraisal is the lack of operating history, both for the individual business and for the industry as a whole. Appraisers like to use comparables, but in legal marijuana markets, those are hard to come by.

Despite these challenges, pot businesses sometimes must be appraised or valued, and appraisers need to work with what is available. As in other industries, there are three general approaches to valuation of a pot business: the asset-based approach, the market approach and the income approach. Each approach carries a unique methodology and, depending on the situation, one approach may be preferable to another. For example, an asset approach would probably not be helpful with a start-up enterprise, and an income approach would not be availing in a shareholder dispute. To understand why, here is a very brief overview of each.

  • The asset approach looks at the business as a sum of assets and liabilities used to determine its value. This approach asks “what would the cost be to create another business that would produce similar economic output?”
  • The market approach looks at similar businesses, and asks “what are other, similar businesses worth?”
  • The income approach considers the expectations of someone participating in the business. This approach asks, “what economic benefit will an investor of time or money receive?”

Within each approach, discounts to the business’ ultimate value may be applied for lack of control, lack of marketability or other factors. Capitalization rates may vary. And ultimately, the answer to the seemingly simple question “what is this business worth?” may come out differently, depending on the approach as well as appraisal objectives.

Hiring a valuation expert may hard to avoid in certain situations, like taxation or shareholder disputes. But for other purposes, like funding a cannabis start-up, an expert opinion may not be required. Still, anyone seeking money from third parties must be able to state and support what a cannabis venture is worth. No savvy investor will believe your cannabis venture is worth $5 million, for example, if you cannot show them why. As attorneys who regularly deal with funding new marijuana businesses, we are often able to help with this.

Today, marijuana industry appraisals are more speculative than in other areas. This will change as markets mature and it will change dramatically when federal prohibition ends. For now, anyone raising money in this industry should understand basic principles of valuation. An accurate assessment up front may even help avoid disputes in the long run.