The type of business entity you establish has tax and legal implications. Here’s what you need to know.
- There are pros and cons to LLCs, sole proprietorships, general and limited partnerships, C-Corps, and S-Corps.
- Understand the tax implications for raising money and bringing on investors.
- Consider your expansion plans: different states have different rules governing how licenses can be transferred among business entities.
As part of writing your cannabis business plan, one of the first decisions you’ll have to make is how to structure your cannabis company.
There are many types of entities to choose from. Each one has different tax and legal implications.
Selecting the right business structure also means taking into consideration the inherent liability running a business with a specific risk profile.
Here’s what you need to know to find the best way to structure your cannabis business.
Legal Structures for Cannabis Companies
For tax reasons, we don’t typically recommend establishing your business as a nonprofit – however attractive that may have been in the past.
When setting up your for-profit cannabis business, there are five common business entity types that cannabis businesses typically use. They are:
- Sole proprietorship: the cannabis business is owned and operated by one person.
- Pros: there are no forms, agreements, or documents needed to register as a sole proprietor
- Cons: the owner is personally liable for all business obligations. Should the business fail, your personal assets may be treated as business assets.
- General and Limited Partnerships: one level up from a sole proprietorship. Two or more people are running the cannabis business and jointly share responsibility for the business’s obligations.
- Pros: lower risk profile; the business’s taxes are filed separately from the individuals.
- Cons: the business’ income – and loss – are passed through to the individual partners. The owners still assume a lot of personal risk.
- LLCs and LLPs: this type of entity must register with the state, and then individual members are protected from liability as long as the cannabis company obeys state regulations.
- Pros: there aren’t as many formal restrictions on an LLP or LLC as with a registered corporation, and partners are not liable for the behavior of other partners.
- Cons: members of the LLC must pay a self-employment tax for Medicare and Social Security.
- C-Corps: this is the form many businesses take. In this scenario, a business is owned by individual shareholders who have stock in the company. Shareholders vote on how to run and grow the business, and a Board of Directors makes the final decision.
- Pros: the shareholders are not personally responsible for debts and obligations of the company. Also, this structure opens the possibility for other funding options through stock and investment.
- Cons: entities face double taxation from business and personal income tax.
- S-Corps: the S-Corporation is a tax election, meaning that a corporation, LLC, or LLP is created at the state level and then elects to be taxed under the S-Corps heading. These businesses can have no more than 100 shareholders and only one class of stock.
- Pros: avoid the double taxation as a C-Corps and attract investors as shareholders
- Cons: typically have higher legal and tax service costs, and shareholder growth is capped at 100.
This is a high-level overview of the different business structures available to your business. If you have more specific questions about any of these options, reach out to our experts.
Which Business Structure is Right for Your Cannabis Business?
Unfortunately, there’s no one-size-fits-all when it comes to selecting a business structure for your cannabis business.
We suggest working with a cannabis-specific tax and accounting firm to analyze your growth goals and tax implications. Here are some of the things to consider.
Consider a C-Corp if…
- You are planning to raise funds through equity
- You hope to work with an institutional investor, like an angel investor or private equity firm
- You plan to limit the amount of dividends paid to shareholders
- You want to shield shareholders from personal liability for federal income tax
Consider an LLC if…
- You plan to restrict ownership to a small number of people
- You do not need significant investment and plan on self-funding
- Your other capital partners are comfortable with the risk level of an LLC
- You plan to distribute cash among investors rather than reinvest it back into the company’s growth.
- Ask yourself these five questions when structuring your cannabis business.
- Remember that different states have different rules governing how licenses can be transferred among business entities. This may have implications for the type of structure you choose.
- Learn about the B corporation, a benefit corporation. This for-profit structure can be achieved by scoring high marks for for social and environmental performance. It comes with certain tax benefits and is s a good marketing tool for potential investors. However, getting B-Corp certified is a tough process. B-Corps tend to face higher levels of scrutiny (internally and externally).
Green Growth CPAs can help walk you through any of these business structures in more detail. Set up a call to get some advice on which entity is right for your cannabis business.