Photo of Vince Sliwoski

A well-rounded attorney with experience in areas such as music and trademark law, Vince heads up Harris Bricken's Portland office and is a leading practitioner in Oregon's ever-evolving cannabis industry.

Marijuana business valuations

In April of 2016, we covered the basics of marijuana business valuation. At that time, we were aware of just one accounting firm — or, more accurately, one accountant at one accounting firm — who claimed to have any interest in marijuana business appraisals. This was likely due to a couple of factors: 1) CPA firms were slower than attorneys to offer services to cannabis businesses, due mostly to complications with CPA ethics rules (there were no CPA firms in Oregon or Washington with cannabis clients when we started in  this  industry seven years ago), and 2) business valuation is a uniquely specialized and accredited field, even among accountants.

But things are changing fast. Recently, we were excited to see Cogence Group PC, one of Oregon’s best financial forensics and valuation firms, publish a no-paywall series of excellent articles on cannabis business valuation. The first article, “How to Perform a Business Valuation of a Marijuana Business,” gives a high-level overview of the three approaches appraisers commonly take: the asset approach, the market approach, and the income approach. Each of those approaches, in turn, comes with a dedicated article of its own. Those links are here, here and here.

In our 2016 blog post, we briefly described each of the three valuation approaches as follows:

  • 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?

The Cogence series expands on these descriptions with valuable insights and considerations for cannabis industry entrepreneurs and investors, who may take interest in this topic for any number of reasons, including: a pot business is making an allocation of intangible assets; the business is creating an employee stock ownership plan; the business is the subject of an ownership dispute, etc. Throughout the life cycle of a pot venture, as with any business, questions of value are common.

As cannabis business lawyers and litigators, we often work closely with CPAs, alongside our in-house tax attorney. Over the past year or two, we have been encouraged to see an influx of high-level professionals and blue-chip vendors beginning to serve the cannabis industry. These service providers include not just accountants and business appraisers, but also qualified lawyers, realtors, and others. The Cogence valuation series is a good example of the expanding pool of legitimate resources available to the cannabis industry. And it doesn’t hurt that it’s free.

Cannabis co-packing
(Your cannabis here)

Recently, we covered the basics of cannabis supply contracts here on this blog. Supply contracts are used when Party A is selling pot to Party B in a responsible way. Today’s post looks at another form of cannabis contract: the contract packager (“co-packer”) agreement. Co-packer agreements are used when Party A is working with Party B to produce a saleable cannabis product (also responsibly). Like supply contracts, we have seen a marked increase in co-packer agreements over the past year or so, and we expect that trend to continue.

Co-packers offer packaging equipment and expertise for hire, and may also provide services related to design, labeling, purchasing, and shipping logistics. Large numbers of companies exist solely to co-pack all around the world. In state-legal cannabis, co-packers tend to pack for themselves, as well: this probably stems from the value associated with holding a state marijuana license. In addition, most marijuana co-packer agreements are limited to packaging, labeling, and sometimes, sourcing of product. These services will likely expand as states refine their program rules and the industry continues to scale.

Co-packer agreements conform with the rules of most state cannabis programs when both parties have a marijuana license. When the non-packer party does not, however, the legitimacy of a co-packer agreement may be a much closer call– depending on the way the contract is written. In any case, when the non-packer lacks a license, that party will not be allowed to handle cannabis. At that point, the question becomes whether the state will allow the non-packer to delegate all cannabis purchasing, labeling, shipping and even sales of pot to the co-packer. If this is allowed, the non-packer can legitimately profit in a state-legal cannabis program, by virtue of its relationship with the licensed co-packer.

When the non-packer is allowed to profit without a license, a co-packer agreement can be a great fit. The model is attractive for start-ups that lack the interest or wherewithal to lock down their own premises and cannabis license. The model also works nicely for large, established cannabis companies looking to leverage a brand from one state to the next, without having to wade through a foreign licensure process. We have seen co-packer agreements deployed successfully in both scenarios.

Cannabis co-packer agreements tend to be accompanied by, or heavily weighted with, nondisclosure agreements and provisions. In the case of cannabis processing, the non-packer will provide its co-packer with recipes and formulas related to the final product. In the case of a grower or producer, the non-packer may not have these concerns but may bring other trade secrets to the table. In almost every arrangement, the non-packer will have a brand to protect, which means the agreement will carefully lay out control and licensing issues.

In most other respects, co-packer agreements cover many of the same topics as cannabis supply agreements, including terms like scope, title and tracking, invoicing, indemnity, representations and product recall. Co-packer agreements can be built off standard forms, but final documents will be unique to the parties at issue, and highly negotiable. If it is unclear whether a co-packer agreement or its terms will jibe with state program rules, our practice as cannabis business lawyers is to bring the issue to program administrators for review and consideration. Ultimately, if the parties are able to strike a deal, the co-packer agreement is a uniquely attractive option.

Get Legit.

In the old days, people rarely wrote things down when they sold cannabis. Selling the flower was risky, and leaving a paper trail riskier still. With the advent of medical marijuana programs, though, cannabis supply contracts became routine. Such agreements may be styled as “patient-caregiver agreements” or “patient-grower agreements,” and state agencies may even require their use. These limited scale agreements are often between two individuals for small sums of marijuana and cash. In the world of pot contracts, those deals are beta.

Today, four states have scaled adult-use (“recreational”) cannabis programs (Washington, Oregon, Colorado and Alaska), with four others close behind (California, Nevada, Massachusetts, Maine). In these states, trading in cannabis is no longer limited to patient-caregiver transactions. Instead, it involves licensed agribusinesses bringing statutorily designated “crops” to increasingly differentiated markets. For this reason, cannabis distribution agreements have become a key contract for many of our clients.

Below are ten critical terms in any cannabis distribution agreement. This list is by no means exhaustive, but is curated to show how unique these agreements are and should be:

  1. Distribution Grant. This term covers the territory in which the cannabis can be distributed by the purchaser, as well as other items, like whether sub-distributors are allowed and what their roles may be. The key consideration here is ensuring that cannabis is kept within state borders, pursuant to whatever tracking system may be required.
  2. Term and Termination. Terms tend to be short in cannabis distribution agreements and with multiple renewal options, to account for price fluctuation and general market dynamism. Termination may be allowed for a variety of specific reasons, or for no reason at all. Specific reasons may include cessation of business operations, contract breach, business impracticability, regulatory violations, etc.
  3. Testing Obligations. States with robust regulatory systems require cannabis be tested for pesticides and other contaminants. Therefore, the distribution agreement should designate which party is responsible for testing and its associated costs, and what happens in the event of a failed test.
  4. Inspection.  Marijuana is a perishable and essentially fungible commodity, and the purchaser will want a right to inspect upon delivery, and sometimes for a window of time thereafter. Sellers will want to limit this right as much as possible because once the marijuana is out of sight, the seller has no control over the care and treatment of the product.
  5. Purchase Orders and Payment. Your standard cannabis distribution agreement will detail the method a purchaser must use to communicate its product needs to the seller, how invoices are presented, and at what point payment must be made. Sometimes, the agreement will contain a requirement for one party to notify the other of market changes; i.e. of the wholesale market rate per pound of marijuana.
  6. Sales and Marketing. Sellers will want purchasers to comply with all advertising and sale regulations and make good faith efforts to market the sellers’ marijuana among shelves of competing products. In many cases, trademarks will be in play, and sellers will have specific parameters around how a name and logo may be used in association with these efforts.
  7. Representations and Warranties. Distribution agreements in all industries are chock full of representations and warranties, but cannabis agreements take this concept to the next level. In a cannabis distribution deal, warranties will cover everything from program compliance concepts to product safety.
  8. Confidential information. Because cannabis companies have fewer options to protect intellectual property through formal registrations than companies in other industries, the industry relies heavily on non-disclosure and trade secrets.  When one party is selling cannabis to another, the parties are bound to learn a bit about each other, especially where site visits are involved. In many cases, the distribution agreement itself may even be designated as confidential.
  9. Limitation of Liability. This section is often heavily negotiated, as the parties attempt to carve out who would be responsible for what unfortunate event, and to what degree. It takes little imagination to dream up things that could go wrong in a cannabis distribution deal, from product recalls to intellectual property infringement. Here, each party will seek indemnification for anything beyond its control.
  10. Federal Law Concepts. Federal illegality will flow through nearly every section of the pot distribution agreement, from licensing to termination to dispute resolution protocols. When reading through each contract term, both lawyer and client should ask “how might federal illegality affect this provision?”

At the end of the day, like all cannabis industry contracts, agreements for the distribution and sale of pot are unique. Generic distribution agreements may do more harm than good when trading in cannabis, and although courts may recognize the existence of oral contracts, no legitimate business will move its goods without a tailored, written agreement.

In that sense, the old days are gone. It’s time for a new approach.

Where to incorporate your cannabis business?

As business and corporate cannabis lawyers, we have registered and structured a large and ever-expanding number of pot businesses up and down the west coast. Most of these businesses are corporations or LLCs, and most of the time, these businesses are incorporated in the state where they will obtain a license to trade in marijuana. Occasionally, though, someone will come to us with a company shell they have registered in a state like Delaware, South Dakota or Wyoming, or they will insist on incorporating their cannabis business there. The question becomes whether foreign registration is worthwhile? Most of the time, the answer turns out to be “no.”

As a preliminary matter, it is important to note that registering a cannabis business in a far-off state cannot insulate the owners from legal liability for violations of the federal Controlled Substances Act (CSA). That is true regardless of whether one is building out an LLC or a corporation, regardless of the tax election made, and regardless of whether the new business is nested within a holding company. The federal government is well within its rights to bring a claim against business owners and seize assets under the CSA, and company domestication or paperwork cannot serve as a shield.

Still, people have a fondness for foreign companies, and for Delaware companies in particular. People will say things like “half of all public companies are registered there,” or “my other company is a Delaware company,” or “Delaware has no state income tax.” Most of the time, none of these are great reasons to register a cannabis company in that state. This is because nearly all cannabis companies are small, privately held businesses that receive no tax benefits and no meaningful liability protection by registering in Delaware, or anywhere out-of-state.

Large, publicly traded companies, on the other hand, may prefer Delaware registration for various reasons, including: 1) Delaware law protects directors and officers from derivative liability (to shareholders and non-managing members); 2) Delaware has a unique “Court of Chancery” solely dedicated to corporate law disputes and significant business cases; 3) Delaware has no state corporate income tax; and 4) Delaware’s LLC Act and General Corporation Law are both perceived as cutting-edge, on topics from fiduciary requirements to series LLCs.

New marijuana businesses may see themselves as just a few years away from being large and even publicly traded, and they may hope to grow into the perceived benefits of a Delaware company. But in the short term, their primary goal should be asset protection, avoidance of unnecessary company paperwork, and sound tax strategy. If a privately held company is run correctly, the Delaware statutes are not likely to afford meaningful protection beyond local state statutes in any of these categories. In fact, out-of-state registration may cause complications that produce improper governance, defeating the purpose of out-of-state registration entirely.

As to specific factors that may weigh against a Delaware registration, it should be noted that: 1) filing in Delaware requires payment of Delaware franchise tax; 2) the home state will require “foreign” registration of the Delaware entity, often at fees that are double or triple that for a native company; 3) in addition to dual registration, both the home state and Delaware will require ongoing reporting; and 4) formation of the company out-of-state has no impact on where the owners pay income tax. If the company is operating in Oregon, for example, all of the activity will be taxable there.

None of this is to say that Delaware, Wyoming, South Dakota, or any other state are never worth a look when it comes to forming a cannabis company. A founder may have access to venture capital that insists on seeing a Delaware C-corp, or perhaps she is motivated to keep her name off formation documents at all costs, given the status of federal law. (Delaware allows this; certain states do not.) The bottom line is that forming a cannabis company, like any new venture, brings numerous considerations. But it’s important to actually consider them, not just default to Delaware.

Leaving on a jet plane

Tom Price, Secretary of Health and Human Services (HHS), resigned his post last week amid public health and personal travel debacles. Mr. Price’s resignation drew very little coverage from cannabis reporters, however, which was sort of strange because the HHS Secretary wields more influence over cannabis law and policy than any other public official besides Attorney General Jeff Sessions, and whomever the new DEA Administrator turns out to be. If marijuana is ever to be re- or descheduled administratively, it will have to go through HHS.

The federal Controlled Substances Act (CSA), at 21 USC §811, provides that the Attorney General may remove substances from the CSA: (1) on “his” own motion; (2) at the request of the HHS Secretary; or (3) on the petition of any interested party. Number 1 will never happen and number 3 has often failed, but if a reasonable HHS Secretary were appointed, number 2 could get people talking. CSA §811 further provides that prior to the Attorney General moving drugs around, he must consult with HHS for scientific and medical findings. HHS recommendations to the Attorney General are binding, including any “do not control” recommendation.

HHS is also senior on its organizational chart to the Food and Drug Administration (FDA), a well-known agency with the power to conduct independent research on marijuana and to approve cannabis-based pharmaceuticals. The FDA is the agency that works with HHS whenever “any interested party” makes a petition to remove a substance from the CSA, as referenced above. In fact, the FDA made one such recommendation to HHS and DEA last year on marijuana. Unfortunately, it chose the status quo.

Tom Price is an old-school, War on Drugs hardliner, whose judgment as to cannabis is nearly as bad as his judgment on government travel. Cannabis advocates should be glad to see him go. Given the composition of President Trump’s cabinet, however, it seems unlikely we will have a fair-minded HHS Secretary anytime soon. Most of the candidates being floated as replacements have poor or unascertainable records on marijuana policy.

Ultimately, it seems more likely that marijuana will be re- or descheduled through Congressional action than administrative channels. And as it stands today, two of the three most critical cabinet posts on cannabis—the HHS Secretary and the DEA Chief—are oddly vacant. For cannabis professionals and consumers alike, it seems better to have these posts remain vacant, than occupied by the Chuck Rosenbergs and Tom Prices of the world.

Let’s enjoy it while it lasts.

Chuck “pot probably isn’t as bad as heroin” Rosenberg

Tuesday afternoon, the Washington Post broke an article that acting Drug Enforcement Administration (DEA) chief Chuck Rosenberg plans to resign within a week. Rosenberg is an Obama administration holdover going back to 2015, so the news was not totally unexpected. President Trump will be tasked with selecting a successor, which will lead to a confirmation hearing process, which will lead to yet another public referendum over U.S. law and policy regarding cannabis and other controlled substances. Such a referendum occurred most recently during Jeff Sessions’ confirmation hearing, and had begun to ramp up again with Trump’s recent nomination of Terrible Tom Marino to the post of National Drug Control Policy Director (a.k.a., the “Drug Czar”).

The DEA Administrator and the Drug Czar are both important government posts, with the DEA Administrator wielding considerably more power. The DEA Administrator is head of the chief U.S. agency for Controlled Substances Act enforcement, whereas the Drug Czar coordinates anti-drug propaganda and advises the President. The DEA is also seated within the Department of Justice (DOJ), directly downline from Attorney General Jeff Sessions.

Trump can, and probably will, appoint someone with retrograde views on marijuana to fill Rosenberg’s vacant seat. It would be a surprise if he did not. That said, cannabis supporters should not be sad to see Rosenberg go, as his views on cannabis were none too enlightened. As Rosenberg packs up his office, here are a few of his greatest hits and misses:

  • May 2015. President Obama taps Rosenberg, a former FBI official, to lead DEA. This happened because DEA agents were participating in sex parties with prostitutes supplied by drug cartels in Colombia. Rosenberg was expected to focus less on marijuana than his predecessors. Cannabis boosters cheered.
  • November 2015. Rosenberg called medical marijuana “a joke.” Cannabis boosters collected 160,000 signatures demanding his resignation, and high-ranking officials called for his head, but Rosenberg survived.
  • December 2015. Rosenberg opined that marijuana is “probably not” as dangerous as heroin. This was an outlandish statement, but one that his predecessor refused to concede. A few days later Rosenberg caved to public ridicule, telling reporters that “heroin is clearly more dangerous than marijuana.” Cannabis boosters cheered, a bit.
  • December 2016. DEA issued a final administrative rule, establishing a controlled substances code for “marijuana extract.” That rule maintained marijuana, hemp and their derivatives as Schedule I substances. Cannabis boosters booed. And sued.
  • August 2016. DEA pledged to make it easier for private companies to grow and obtain marijuana for study. This was welcome news at the time, although nothing much has happened over the past 13 months, apparently due to DOJ stonewalling. But on August 11, 2016, at least, cannabis boosters cheered.
  • August 2016. DEA teamed up with a few other agencies to author the Statement of Principles on Industrial Hemp, which construed the 2014 Farm Bill to permit cultivation for “industrial purposes (fiber and seed)” and not to authorize sales “for the purpose of general commercial activity.” Cannabis boosters booed.
  • August 2017. Rosenberg instructed DEA agents to disregard President Trump’s call to be rougher with suspects, including those suspected of drug crimes. Cannabis boosters cheered.

The record shows Rosenberg was no friend of cannabis. Still, given the posture of recent Trump appointees regarding the plant, we may wish him back one day. Industry advocates should watch the pending developments closely. Aside from Jeff Sessions, Trump’s next DEA appointee could have more impact on the cannabis industry than anyone in the current administration.

We should know more very soon.

Receiver time?

Back in 2014, we wrote that bankruptcy is not an option for marijuana businesses. That issue has been litigated here and there since then, but as of today, cannabis businesses are no better off than before. The hard reality is this: all bankruptcy cases are handled in federal courts under rules outlined in the U.S. Bankruptcy Code. Those courts have held that it would be impossible for a U.S. Trustee to control and administer a debtor’s assets (cannabis) without violating the federal Controlled Substances Act.

Bankruptcy laws are designed to afford a fresh start to honest but unfortunate debtors, while providing equal treatment to creditors. Without recourse to bankruptcy, parties can only: (1) liquidate without court supervision, or (2) explore state court receivership. Liquidating without court supervision offers no protection to pot business creditors. State court receivership does afford protections, but adds complexity because states closely regulate who is allowed to possess and sell marijuana (through licenses). For a while, it was an open question as to whether a state court receivership would actually work in the cannabis context. Recently, one actually did.

In the case at issue, a landlord (creditor) had leased space to a licensed marijuana business tenant (debtor). The tenant failed to pay rent, and the landlord evicted the tenant and acquired a judgment for unpaid rent. Because RCW 7.60.010 et seq. provides that a Washington state court may appoint a receiver over a marijuana business, the landlord convinced the court to issue an order appointing a receiver to sell the tenant’s cannabis and satisfy the judgment. The landlord then successfully navigated the licensure issue with the Washington State Liquor and Cannabis Board, sold the pot, and collected on its judgment.

Washington is not the only pro-cannabis state with statutes and administrative rules that seek to bridge the bankruptcy gap by allowing creditors to seize and sell cannabis. In Oregon, OAR 845-025-1260 provides “Standards for Authority to Operate a Licensed Business as a Trustee, a Receiver, a Personal Representative or a Secured Party.” Our Oregon and Washington cannabis lawyers have assisted numerous clients in acquiring and perfecting security interests under the relevant rules. We expect California to adopt a similar regime.

One of the reasons creditors get such high rates of interest for loans to cannabis businesses—in addition to the fact that banks won’t lend to them—is because many pot businesses lack lienable collateral. For many of them, the net worth of the business is mostly tied up in the cannabis itself. It is now clear that, at least in Washington, the cannabis can be liquidated by a third party, whether or not the pot was initially proferred by the debtor as collateral for a loan. In that way, cannabis businesses are being treated by progressive states much like non-pot concerns.

That we finally have had one successful state court receivership probably won’t nudge circumspect lenders to reach out to the cannabis industry. However, cannabis businesses can feel encouraged that their number one asset (their cannabis) may have marketable value when looking for loans; and lenders can feel hopeful that if everything falls apart, there may be liquidation value in the cannabis crop. None of this “solves” the bankruptcy issue, but it’s a step in the right direction.

It could happen.

On Monday, ace cannabis reporter Tom Angell broke a nice story regarding a Senate Appropriations Committee report that, among other things, does the following: (1) expresses “concern” at “the [limited] amount and [constricted] type of research that can be conducted on certain schedule 1 drugs, especially marijuana…”; (2) directs federal agencies to formulate a “National Testing Program for Schedule I Marijuana-Derived Products”; and (3) specifically asks for distinct “analysis of marijuana and marijuana derived from products sold commercially in dispensaries or online.” As far as federal government reports and cannabis, that’s about as good as it gets.

We have written here before about the federal cannabis research fail, and ensuing efforts by states and local actors to fill in the gaps; and we have observed that expanding research should be promoted by industry advocates, prohibitionists and everyone in between. The reasoning is as follows: advocates should welcome the opportunity for scientific inquiry to validate their position that the plant has medically valuable effects, or is benign; whereas prohibitionists should seek to validate their view that pot is a gateway drug, or has no medical value.

The Senate report takes an agnostic approach, observing simply that research “is necessary for informing substance abuse prevention efforts, public health policy and law enforcement tactics across the Federal Government.” In further support of its recommendations, the report observes that “scientific rationale and laboratory studies suggest a decrease in addictive potential when botanical derivatives, including cannabidiol extracts, are used with an opioid in treating patients” (our emphasis). That CBD may help combat opioid abuse, which is a problem we have pointed out could also use some attention from law enforcement, is promising indeed.

Just because the Senate committee recommends more funds for cannabis research does not guarantee those funds will be allocated. These recommendations may have wings, however, in that they accompany a bona fide bill (SB 1771). Given that Congress has voted for years to extend state medical marijuana programs—at least when votes have been allowed—the report’s recommendations could become law. And if SB 1771 does make it through, the funds for cannabis research would be allocated for the coming fiscal year, which begins October 1, 2017.

The fact that we have a powerful, bi-partisan committee making recommendations of this sort is good news for the cannabis industry, and for the public generally. Reasonable public policy on cannabis should produce reasonable laws. So keep your eye on SB 1771, and any following authorizations. It certainly would be a great start to the new fiscal year.

We recently mentioned that the Oregon Health Authority would soon offer guidance on seed-to-sale tracking requirements for medical cannabis. Last week, the Oregon Health Authority (OHA) did exactly that, with its Medical Marijuana Information Bulletin 2017-07. The Bulletin comes pursuant to Senate Bill 1057, the most significant pot bill of the recent Oregon legislative session. In our recap of that bill, we ended with our oft-repeated observation that “the OHA regime will soon recede to strictly limited, patient-caregiver relationships. The money there is gone.” So, this is a public service post for anyone out there growing marijuana in the OHA system with the goal of helping patients and not getting rich.

As a reminder, the goal with SB 1057 and tracking medical marijuana in Oregon is to limit diversion and black market activity. To accomplish this, SB 1057 gave the following parameters for tracking:

  • Required marijuana produced and transferred within OHA’s Oregon Medical Marijuana Program (OMMP) system to be tracked by the OLCC tracking system. (The OLCC oversees non-medical, adult use marijuana.)
  • Specified funding for the tracking system to be paid from the Oregon Marijuana Account prior to any other distribution.
  • Required OHA to impose an additional fee on marijuana grow sites, processing sites, and dispensaries to pay costs incurred by the tracking system.
  • Specified timelines for tracking system phase in.

As provided in last week’s OHA Bulletin, December 1, 2017, has been chosen as Oregon’s tracking system phase in date. On or before that date, OMMP registrants will be required to track the production, processing and transfer of all marijuana items in the OLCC’s Cannabis Tracking System (CTS), and pay an associated fee of $480. The alternative is to apply for an OLCC license prior to January 1, 2018, or to indicate that the registrant falls under an exemption. The exemption is narrow: it occurs only where a registrant is a patient growing for him- or herself, with a ceiling of 12 mature plants and 24 immature plants.

Did we mention it would be impossible to make any money in the OHA system going forward? It is. Going forward, the only marijuana sold at retail to medical cardholders will be at OLCC licensed dispensaries, tracked in CTS. In that sense, the December 1 deadline should come as a surprise to no one: SB 1057 has been on the books since May, and OHA licensed dispensaries had become vanishingly rare before that. If any OHA licensed dispensaries still exist after December, they will likely be vestigial to sparsely populated eastern Oregon counties, where bans on adult use sales continue.

Even with all of this context, we still get occasional clients coming to our office looking “to invest in an Oregon medical marijuana grow.” If the individual has been pitched on that, we tell them to run. As a business proposition, the medical marijuana program in Oregon had a good run from 2013 to 2016, but those days have passed. The recent OHA Bulletin regarding December 1 and CTS confirms it.

Cannabis lawyers
A good look indeed.

The Irish poet and dramatist Oscar Wilde once said, “You can never be overdressed or overeducated.” There were no cannabis companies in those times, but the idea that a little formality never hurt anyone holds true today. In the context of running a pot venture, Wilde’s aphorism remains particularly useful as a matter of policy. So, this is a post about cannabis companies doing things right.

We represent a large number of marijuana companies up and down the west coast. Though they are all eager to comply with state and local laws, some of our clients are dangerously informal regarding company structure and documents. These companies may suffer from inexperience, budgetary constraints, practical hurdles (i.e. lack of banking services), or lack of discipline. In nearly every interaction we have with informal businesses, we admonish them to get some basic paperwork in order. Today.

Marijuana companies are similar to other companies in that a lack of formality can be fatal. Take your standard C-corporation, for example. At a minimum, this type of company should have bylaws, a shareholder agreement, stock certificates, subscription agreements and articles of incorporation that comport with state statutes. When key company decisions are made, they should be documented through consent resolutions. Company funds should be kept separate from personal funds, and actions by directors and officers should be taken in their official capacities. Failure to follow these touchstones will expose shareholders to both legal and tax liability (through “piercing the corporate veil”). Often, lack of basic documents defeats the purpose of having a company altogether.

Long-time marijuana entrepreneurs are accustomed to informality. Historically, these individuals come from black and gray markets, and are used to operating underground. New market entrants tend to be more cautious, but as a general matter, they too have a belly for risk, given the status of federal law. But, although federal illegality is a difficult risk to mitigate, running an unstructured and improperly documented business is wholly unnecessary. It is taking risk for risk’s sake, and it is unwise.

In seven years of representing cannabis businesses, our firm’s cannabis lawyers have yet to see a client shuttered by federal agents. We have, however, seen plenty of them buckle under from disputes or tax headaches that were foreseeable, preventable and directly attributable to either a lack of basic documentation, or a lack of adherence to protocol. Often, we meet these clients for the first time mid-stream: sometimes the situation is salvageable; other times, not.

Even a company with the tightest, most polished documents possible may stumble if its owners or agents fail to follow formalities. Having an exquisitely tailored operating agreement, for example, will not avail an LLC member if he commingles business and personal funds. Similarly, if a corporation’s president ignores her company’s bylaws for an end-run around the board, she could find herself in peril. It is not enough to have good paper: good governance is also needed.

Getting appropriate documents in place should not be terribly challenging for a cannabis venture. It is something that should be done thoughtfully at the outset with guidance from an experienced corporate cannabis attorney, and it should not break the bank. As the business grows, existing documents will be amended or restated from time to time, and new documents will be generated. And if company owners and agents keep it formal enough — as Oscar Wilde would have it — things are likely to work out fine.