“Choose your Structure Wisely”
This post is Part 3 in the series titled Navigating the Application Process in the Medical Cannabis Industry, where Mora Mota Group looks to share some of the keys to success as a small business startup look to emerge within this industry.
When deciding how to form your Medical Cannabis Company, there is value in understanding the various legal structures, the amount of record-keeping required, the degree of liability you will be faced with, and the ability to position your company to scale.
Medical Cannabis companies are challenged at the start of their new venture with choosing the appropriate way to structure their business. While one way may set your business on a path for success, another may create headaches and hurdles that impede your potential for greatness.
Deciding between one entity over the other requires first understanding the different forms of business structures, their inherent benefits and limitations, and how each choice can influence how your Medical Cannabis business operates.
In this post, Mora Mota Group will outline what to consider before choosing a business structure, how each can affect your Medical Cannabis startup, and we’ll recommend the appropriate entity structure for Industry-Specific segments.
What to consider before choosing a Business Structure
Before forming their company, Small Business Owners should consider the various qualities of each entity and their influence on the way they operate their business.
These considerations include liability protection, State and Federal tax burdens, the process in forming the business, any ongoing administrative expenses, the flexibility to structure future ownership and the ability to finance the business through outside investors.
Some business entities may allow for restructuring in the future to allow for ease of managing the growth of the business, however, your options may be limited by the particular State where you incorporate your business.
Types of Business Structures
A Medical Cannabis Business owner may choose from one of the following entities:
- Sole Proprietorship
- Partnerships (Limited and Limited Liability)
- Corporations (C, S, and B)
- Limited Liability Company (LLC)
A Sole Proprietorship is an unincorporated business structure that is owned by one individual. This structure is generally the simplest structure to establish since their is no filing necessary to form this entity, the owner has complete management control, and they are entitled to 100% of the profits earned.
There are several limitations to structuring as a Sole Proprietorship; since there is no legal separation between the owner and the business, the owner will be personally liable for the debts and obligations assumed by the business. This liability also extends to any actions by employees during the course of business, further risking the owners to actions outside their control.
Additionally, obtaining financing from banks or other financial sources is difficult due to the inability to sell equity in the company and the lack of credibility when it comes to repayment of their debts. Small Business owners should consider alternative business structures for their Medical Cannabusiness to provide a layer of insulation between the owners and the business.
A Partnership is a business structure that is owned by two or more individuals; with this structure, each partner shall contribute to the business in some way, whether it be their money, property, labor or skill, as they expect to share in the profits, and losses, of the business.
There are different Partnerships that exist include General Partnerships, Limited Partnerships, and Limited Liability Partnerships:
General Partnership: Where all parties are considered equal, and all profits, liabilities, and duties will be evenly distributed between each partner.
Limited Partnership: Where at least one General Partner and one Limited Partners exist, apportioning liability to each Partner dependent on the extent of their individual contributions.
Limited Liability Partnership: While more complex to setup, this entity allows each Partner to limit the amount of liability they are exposed to, dependent on the specific jurisdiction that establishes liability.
One of the key features of Partnerships are their tax benefits which are passed through to partners to report on their individual income tax returns. However, a major limitation inherent in this structure is that each Partner may be exposed personally to liability of the Partnership’s actions.
While not required, a partnership agreement is a transparent way of indicating the details of ownership, each Partner’s rights and their responsibilities within the partnership. If business owners are not able or willing to personally afford these risks associated with forming a Partnership, they should consider structuring as a Corporation or Limited Liability Company.
Corporations are entities are formed for the sole purpose of conducting business: they take on responsibilities like a person, are taxed and held legally liable for its actions, while providing the greatest protection for business owners.
The various types of Corporations that exist include C, S, and B Corporations:
- C Corporations: A separate legal entity that is set up under State law and limits the owner, or Shareholders, assets from claims from creditors.
- S Corporations: Similar to C Corps. as they require formal registration under State law, but elect to receive special tax status with the IRS.
- B Corporations: Created in 2010, "Benefit" Corporations are for-profit corporate entities that wish to pursue a social or environmental mission and make a positive impact on society.
Corporations are some of the most complex entities to set up, require extensive record-keeping and can be more difficult to manage than either a Partnership or Sole Proprietorship. It should be made aware that Small Business Owners may have to hire an experienced Accountant, Attorney or Consultant that works in the Medical Cannabis Industry to ensure their entity is properly structured, which will ultimately increase the cost associated with your startup.
Once Incorporated, the Corporation exists as an entity itself, Officers and Directors are appointed to make decisions on behalf of the company. Small Business Owners should note that structuring as a Corporation may help insulate them from liability and give them the opportunity to raise funds, they may be subject to the expectations from outside influence that can alter the direction of the Company.
Limited Liability Company (LLC)
Business owners who seek the liability protection and flexibility in ownership of the previous entities, starting a Limited Liability Company may be their best option. Establishing an LLC involves the formal filing process required by a Corporation, however, the entity will receive “pass through” taxation benefits similar to that of a Partnership.
There are many features of an LLC that are inherently different than the previous business structures: since they are managed by their Member-Owners, each member of an LLC will be insulated from personal liability; if outside parties wish to become members of the LLC, unanimous consent must be reached from members of the management. Additionally, the ability to secure financing by attracting outside investors is unavailable because of the inability to sell shares of the company.
Those looking to start a Medical Cannabis company for a charitable, educational, or religious purpose may look toward creating a nonprofit. This entity is formed similar to that of a Corporation as filing Articles of Incorporation, creating bylaws and appointing Board Members is required. Differing from a Corporation as its established for reasons beyond business purposes, nonprofits receive the benefit of tax-exempt status.
As some States have required Medical Cannabis businesses to form as nonprofits or cooperatives, Directors of nonprofits must secure a steady flow of income from donations or grants as shares of the nonprofit may not be used to raise funds.
Recommended Corporate Structures for Medical Cannabis Industry Segments
While some entity structures may be an appropriate choice for one Industry Segment, there are certain structures that Small Business Owners should stay away from. At Mora Mota Group, we would like to provide a breakdown of certain Medical Cannabis entities and the proper Corporate Structure for each:
- Cultivators: S Corp. or LLC
- Processors: S Corp. or LLC
- Wholesaler/Distributor: C Corp.
- Retailers: C Corp., S Corp., and LLC (Nonprofit if opening a Dispensary)
It should be clear that every Medical Cannabis entity should be formed with some sort of Corporate structure to provide protection to the owners and allow them to sell portions of the Company to raise funds.
It’s important for Small Business Owners to seek expert advice before choosing their business structure as specific entities can ease the tax burdens or administrative work associated with a complex business structure.
Check back next week to read Part 4 on Navigating the Licensing process in the Medical Cannabis Industry as Mora Mota Group provides more advice for small business startups in the Medical Cannabis Industry.