Why Your Cannabis Enterprise Is Only as Good as Your Accounting Team
It may be hyperbolic to say that the IRS is at war with cannabis enterprises, but they are definitely living rent free in the minds of most cannabis professionals. As the IRS continues to prey on the disorganization of hopeful and often inexperienced founders, this complicated relationship is forcing CEOs of cannabis enterprises to treat compliance as a year round, omnipresent concern that begs for a stressful routine to constantly colour inside the lines, as opposed to the once-a-year, seasonal cadence with most businesses.
Such a responsibility should be entrusted with a competent accounting team, and that just so happens to be Andrew Hunzicker’s most urgent advice for the founders of new cannabis enterprises. Andrew is a decorated CFO, president and founder, but also happens to be the brain behind Dope CFO, which offers resources, programs and blog posts for accounting professionals interested in learning the nuances and value in the new and uncharted cannabis industry. He’s also confident of the value that CFOs like him can add to a cannabis enterprise.
“We're not going to piecemeal any of it it's going to be we're going to do the cost accounting right,” Andrew said, describing his approach. “Everything's going to have an audit trail and we're going to do inventory accounts, cash accounts. We're going to reconcile the different processes - and by the way we're incredibly expensive to hire, because no one's doing that.”
Andrew is perhaps one of the most credible and contemporary voices in this newer niche, and spoke to a lot of the issues, barriers and opportunities on the Spend Culture podcast. He also represents a perspective of someone that actually does the heavy lifting with compliance and spend management, as well as the legal gymnastics necessary to survive in the current US cannabis market.
Leaving it to the Experts
Hiring a competent financial team seems like a no-brainer for any successful business, but as it currently stands, it’s most often a reactive measure that clueless cannabis founders resort to after having their wrists slapped or after narrowly avoiding a collapse induced by the enforcement of compliance. Not only are these companies leading with negligence, they’re also not even attempting to do accounting correctly.
“In reviewing over 300 companies last five years I've seen maybe one or two that even attempted to do cost accounting. When the IRS digs in deeper, they just keep finding this lack of basic [accounting] support.”
Although state-wide legalization is gaining momentum with New York, New Jersey and Illinois’ governments primed and prepared for new recreational marijuana laws, the federal laws are still only creating more obstacles for cannabis enterprises rather than advantages. Businesses that sell a Schedule I substance -- i.e., wholly illegal, prone to abuse, and not recognized as having any medical benefits -- are subject to Section 280E of the U.S. tax code, which was implemented in the early 1980s to crack down on those capitalizing on the black market.
To describe it briefly, Section 280E disallows businesses that sell illicit substances (as defined by the Controlled Substances Act) from taking normal corporate income tax deductions. This, of course, is with the exception of cost of goods sold, which was initially perceived as potentially opening a loophole strategy for early cannabis enterprises.
As time passed, cannabis professionals quickly realized this exception touches only a fraction of expenses, which means that little can be done to reduce a marijuana stock's effective tax rate. “The early strategy that attorneys and CPAs is in the industry were pitching was to beat the IRS, you’d have to create multiple entities to get around the cost of goods sold with 280E,” Andrew explained. “If you do all these tricks, you don't pay much tax. But that is not the way to win in cannabis, and that's being proven right now.”
A Better Strategy
Since it’s being proven that you can’t sustain this idea of beating the IRS and trying to lower your tax threshold, Andrew advocates for building your brand and building on your location, while embracing and being proactive about all tax and all compliance. Yes, you’re going to take a hit with taxes by steering directly into them, but by maintaining a brand based on being well capitalized, and having extremely clean books, it will make you ripe to be bought out by bigger companies that want a safe entry into the playing field. These larger companies are not going to care about net income, their priority is that you’re a trusted brand with a great location and your compliance and financials are completely up to snuff.
Andrew describes the current canna-biz industry landscape to be one that’s clouded in a lack of information and true industry guides. He also pointed out a pattern in the lack of accounting knowledge among the initial founders of cannabis companies, which means that these companies often begin their business journey with a reactive spend culture. “Cash is pretty well controlled [in this industry], but as far as their spending, tracking, and budgeting, it's just in its infancy.”
Software services and tools in this space are also in their infancy. Depending on your state, you’re actually obligated to work with 2-3 different compliance and tracking tools that are barely sufficient. It becomes even more important that your financial team is world class, as this guarantees a level of difficulty with ERP systems and compliance. It also means you’re also better off finding a purchasing solution that can, at the very least, be reliable for that half of the equation.
Andrew predicts that issues around compliance and capital will actually get better soon with the influx of capital and more legitimacy in the marketplace. This will draw top level accounting professionals and more professionals period to cannabis, which will have a positive effect on the books and financial strategies of cannabis companies. Once all the best practices of these professionals filters in, the demands for software are bound to increase and eventually catch up.
Avoiding the Shortcuts
When you're scaling a business, taxes can slip through the cracks and not be a point of focus. But not giving it sufficient attention can end up costing your business a fortune in interest and penalties. “Because one third of the industry is evolving out of the black market, the last thing that power players with that background are used to is thinking about compliance or keeping paper trails,” Andrew explains. That’s a brand new muscle that they’re learning how to strengthen for their business, and with the legalities being as defined, new and agile as they are, it takes a certain kind of CEO to know the best way forward is to pay the premium for financial controls.
Rather than focus on finding loopholes to preserve profits, cannabis enterprises are better off directing their focus on sustaining a brand and a loyal clientele. Even though tax compliance is going to eat a large percentage and it’s going to hurt, those blows are much easier to overcome compared to trying to find loopholes of cheat the IRS. The penalties for cheating compliance will put you under much faster than paying all your taxes and paying the premium for competent accounting teams.
Author Bio: Aman Mann is the CEO & Cofounder of Procurify, a SaaS startup based in Vancouver, Canada that is helping organizations reinvent the way they track, manage and control spending. Aman is passionate about disruptive technology, leadership, and organizational culture, and helping organizations cultivate a positive Spend Culture.