Good accounting has become critically important in an industry where legal, tax, and regulatory requirements vary at the state and federal levels. In the cannabis industry, whose main product is still a Schedule I narcotic in the U.S. under the Controlled Substances Act, businesses need strong financial leadership to forecast growth, maximize deductions, organize their finances, and start thinking about sustainability on an organizational and environmental level.
For example, what would happen if licensing resulted in over-saturation of cannabis in many states where it is now legal? It's currently happening in some markets and has resulted in increased competition and lower prices. This, combined with rising costs of equipment, less access to capital, and labor quality concerns has created a need for fractional CFOs and financial guns-for-hire in the industry to step in and help these businesses sustain and survive.
280-e and financial guidance
Tax code 280-e, which says businesses cannot deduct otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, is one of the biggest inhibitors of growth, according to experts.
“This rule denies a cannabis business what would be ordinary business deductions,” said Brian Whalen, founder and CEO of Green Bean CFO, a fractional CFO advisory service specializing in the cannabis space.
“This means the only way to reduce taxable income is through what’s included in the cost of goods sold,” Whalen said. “So, some cannabis businesses will get hit with a high tax bill because they’re paying tax on money they didn’t make, which is called phantom income. This can cause issues with the IRS if the business hasn’t made any money but still owes taxes at the end of the year.”
“This [280-e] rule denies a cannabis business what would be ordinary business deductions.”
Brian Whalen
Founder, Green Bean CFO
Whalen stressed the importance of financial guidance within the cannabis industry now, especially for companies that have grown quickly and can no longer sustain themselves amid new challenges.
“Sometimes, we see some people get a huge tax bill attached to them as an individual which is passed along to their spouse, it can get messy. So you want to have that corporate veil intact when you’re dealing with 280-e,” said Whalen. On day one Whalen makes sure businesses are being taxed as a corporation so that the entity holds the tax responsibility.
“Some cannabis businesses will get hit with a high tax bill because they’re paying tax on money they didn’t make, which is called phantom income.”
Brian Whalen
Founder, Green Bean CFO
Managing growth is also a huge factor according to Whalen, who works with clients who have the desire and capital to grow, but are sometimes unaware of the steps needed to take before risking everything on scaling the business.
“When controlling growth, we advise to test the market first before they go out and spend a ton of capital,” he said. “Because they don’t have the same tax deductions as regular businesses, they may have to lay out a bunch of cash to pay taxes that they could’ve used to reinvest in the business if these things aren't done properly.”
M&A and sustainability
In a market filled with large companies that are stalling in growth, M&A might seem like a reasonable remedy for big players to grow inorganically. According to Sean Yoder, founder of the Aldertine Group, a fractional CFO advisory firm specializing in the cannabis space, and the self-dubbed cannabis CFO, sees the potential but cautions leadership.
“What we’re seeing is, especially in the retail space when it comes to M&A, is that most people are doing just okay,” said Yoder. “[Some clients] are saying ‘My margins are good enough, and right now to survive and stay ahead of my competition, I am just going to start buying up distressed assets’.”
“Mississippi’s market is a great example here,” Yoder said. “It’s a relatively new market in terms of opening up, but they haven’t issued enough patient cards and no one knows how long it will take to issue them. So in the meantime, these businesses there are hanging on for dear life in what was deemed to be a very lucrative market.”
“There’s hope for an infusion of cash from investors and M&A action, but it’s not certain. As fractional CFOs in this space, it’s our job to help protect these businesses from things like this,” Yoder said.
Sustainability is, surprisingly, not a big focus in the industry. Despite companies’ reliance on artificial lighting, massive hydration systems, and farmland, the tax breaks aren’t there like they are for other businesses, so the incentive isn’t there either, Yoder said.
“I grew up in the illegal market where nobody cared about any of that stuff and “green” practices were definitely an afterthought,” he said. “And I continue to see that with most of the clients that I work with. They don't care, they're trying to survive.”
“I grew up in the illegal market where nobody cared about [sustainability] ... And I continue to see that with most of the clients that I work with. They don't care, they're trying to survive.”
Sean Yoder
Founder, Aldertine Group
“I do work with some craft growers and living soil regenerative soil, that's a major input cost for them. Most are dealing with living soil and working on some regenerative farming practices, but, honestly, most of my clients are not in a position to do that. They don't get any tax breaks or credits for it so they don't care,” he said.
International influence
Strong international influence, particularly from Chinese nationals, has been identified and accused of using slave labor on cannabis farms across America. Whalen, who is also a U.S. Navy veteran and former nuclear reactor operator for the U.S. Navy, serving for over six years, acknowledged the international influence making its way into his local markets in the Massachusetts/New Hampshire area, but declined to comment. Yoder however candidly shared how international influence impacts businesses he works with on the West Coast.
“I can tell you I am working with a client in Southern California right now that is 100% owned by Chinese nationals,” said Yoder. “The people I deal with on staff are American, but anytime I have to deal with the owners, they have different concerns and different needs, because they're not American, and some of them don't understand the pressures of doing business here in the States.”
“I also see companies working with German foreign investors,” Yoder said. “These people are putting money into the market in a legal way. They're trying to do their due diligence, the standard things that you see, in terms of like a responsible investor, responsible business owner, so there's money coming in from foreign spaces on the legal market.”
When it comes to the illegal cannabis sales, however, which is still a major component of cannabis sales as a whole, Chinese influence is dominant, at least in his area, Yoder said. “I see, especially where I live in the Southern Oregon and Northern California area, is Chinese national influence in terms of the illegal market.”
“Chinese presence in the illegal market is strong, and it's bad,” he said. “It’s worse than anything you could imagine what’s going on here in terms of the slave labor. That product doesn’t even end up in our area, it goes to the local illegal markets like Idaho and other restricted states.”