Welcome to the Cannabis Business, East Coast; Here’s What We’ve Learned in the West
Guest post by Emily Gant of Foster Garvey
I was representing wineries and other clients in the alcohol beverage industry in 2012 when voters in Washington legalized recreational cannabis. Because the voter initiative based the new cannabis statutes on the rules for alcohol, I had a bit of a “head start” in understanding these laws and their implementation.
As East Coast states such as New Jersey and New York venture into recreational cannabis – and as businesses aim to supply these new markets – I humbly offer what I’ve learned while watching this industry mature over the last nine years.
Get to Know Your State Regulators
Developing relationships with state regulators will help you navigate the inevitable gray areas that will surface in a new regulatory system. It’s far easier – and cheaper – to resolve concerns with a phone call or two instead of a flurry of increasingly tense emails or, worse, legal filings.
For example, Washington requires anyone who owns or controls a cannabis-licensed business to be a state resident who also meets stringent vetting requirements. Early on we realized that the definition of “control” of a company extended to include licensors of intellectual property used by cannabis companies because the IP companies exercised control over how their brands could be used. This rule spooked some IP companies out of doing business with our cannabis clients, but discussions with legislators and regulators led them to adjust their rules.
The Two-Company Solution
New Jersey and New York are two huge markets in which players could move their product from state to state just by going over a bridge or through a tunnel – if doing so wasn’t a federal crime.
However, intellectual property such as recipes, methods, packaging and logos can cross state lines. Unless or until federal legalization occurs, these intellectual property rights are among a cannabis enterprise’s most valuable assets.
Many cannabis players on my side of the country protect IP and accomplish other tasks by creating two companies.
One (let’s call it CannaCo) handles only operations that directly involve the cannabis plant, such as production, processing, distribution and retailing. Accordingly, CannaCo must have a state cannabis license.
The second company (SisterCo) handles everything else, including intellectual property, equipment, real estate, consulting and employment services.
Like Washington, many cannabis states require anyone who has a right to profits or control over your CannaCo to be a state resident. This limits your pool of investors, all the more so because they have to undergo extensive background checks to be listed on the state cannabis license.
But SisterCo, which does not hold a cannabis license, can draw from a wider pool of investors. SisterCo can buy equipment or real estate, and lease it to CannaCo. SisterCo could also license intellectual property, or provide consulting, employment or other services to CannaCo.
A word to the wise: If SisterCo and CannaCo do not have an appropriate “arms-length” relationship, your state regulator could determine that SisterCo needs to be disclosed and vetted on CannaCo’s license. That’s why it is important to ensure that these agreements are commercially reasonable and otherwise comply with your state’s laws.
Franchising, Suppliers and the Reason Behind the Rules
A couple of other issues may come up as East Coast cannabis gets moving.
Some cannabis players may consider organizing a franchise through which businesspeople can buy a turnkey operation to sell the franchise’s product in a particular area. However, we’ve found that most of the benefits of a franchise – the ability to sell products of a well-known brand, for example – can be accomplished with IP licenses as I’ve described above, without the downsides of a franchise. Those include state registration requirements, and restrictions on the ability to terminate.
Questions may come up about regulations around suppliers, and they remind me of my winery clients who will sometimes offer to buy a vineyard’s entire crop of grapes. The same could occur with cannabis farms, as processors are always looking for biomass that meets their specifications. (Just as SisterCo must sell products to CannaCo at a market or reasonable rate, many states require the producer to sell its cannabis products to processors at or above its cost.
Finally, a word about the nature of the business. This is a highly regulated industry. This is seen through the licensure process, where the regulators often require extensive information about owners’ criminal histories, assets and liabilities, and other sensitive personal information. It is also seen in the manner in which cannabis is sold and advertised. A number of our clients are sophisticated businesspeople with experience in tech, real estate or other non-cannabis industries. At the outset, they were surprised to find that many otherwise standard business practices are not permissible for a cannabis business. Case in point, in Washington, a processor cannot pay a “slotting fee,” provide a discount or other things of value to a retailer in exchange for placing its product at a prime location within the store. So, be mindful that your sales and marketing strategies from other industries may not work in the cannabis space.
About the author:
Emily Harris Gant chairs the cannabis practice at Seattle-based law firm Foster Garvey, where she advises licensed producers, processors and retailers, along with those hoping to join the industry. She can be reached at emily.gant@foster.com.
This article is intended for informational purposes only, and does not contain or convey legal advice. Please consult with your financial and legal advisors.
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