insight magazine

Capitalizing on Cannabis

CPAs willing to wade through the weeds of evolving regulations and risk can find growing opportunities in the medicinal and recreational marijuana markets. By CLARE FITZGERALD | Fall 2019

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Mom-and-pop shops aren’t driving the U.S. cannabis market anymore. Big domestic and international players have rolled those businesses into their own as the cannabis industry has rapidly grown and evolved over the past few years. Today’s market leaders are large, complex, capital hungry, high-revenue-generating entities, and according to CPAs working in the field, they’re in desperate need of high-quality accounting and finance expertise and guidance.

Professional service providers ranging from plumbers to soil experts and lawyers to real estate agents have jumped to meet the needs of emerging cannabis growers, sellers, and distributors, but the accounting and finance industry has been much slower to engage.

That’s starting to change, according to Andrew Hunzicker, CPA, co-founder and owner of DOPE CFO, a Bend, Ore.-based provider of education and tools designed to help accounting and finance professionals enter the cannabis industry. As more states legalize both medicinal and recreational cannabis production, sales, and use, and acceptance of cannabis as a legitimate business industry grows, small accounting firms are planting their seeds and many mid-market firms are growing full-fledged specialized cannabis divisions. Hunzicker also predicts the Big Four will enter the sector if cannabis is ever legalized at the federal level.

For now, cannabis is still classified as a Schedule 1 drug at the federal level. It’s equated with heroin and is considered to have no medical value despite studies suggesting otherwise. But even with the stigma that classification carries, cannabis is growing into a massive market domestically and internationally, and the rush is on to grow with it.

A Maturing Market

According to Illinois CPA Society member Taylor Schuck, cannabis industry specialist and accounting services supervisor at Mueller CPA in Elgin, Ill., the cannabis industry has moved well beyond its infancy stages. It’s evolving, maturing, and driving global economic growth and development.

Here in the U.S., cannabis is gaining mainstream momentum. So far in 2019, 27 state legislatures have considered bills to legalize cannabis for adults, according to the Marijuana Policy Project, a cannabis policy reform group. Illinois—where legal recreational cannabis sales are expected to start Jan. 1, 2020—is one of 10 states that have legalized both medicinal and recreational cannabis use. Medicinal cannabis is legal in some form in 33 states, and possession of small amounts of cannabis has been decriminalized in 26 states.

On the national level, the U.S. House of Representatives this summer held its first hearing on whether to end or reform federal marijuana prohibition. The U.S. Senate Committee on Banking, Housing, and Urban Affairs also held a hearing to discuss financial challenges facing the cannabis industry and considered legislation that would prevent federal financial regulators from punishing financial institutions that provide services to state-legal cannabis businesses. The Farm Bill that President Donald Trump signed into law last December legalized hemp—a strain of cannabis grown specifically for industrial uses of its derived products.

As policy and legislative discussions continue in the political arena, public support for cannabis is growing. In a recent Marist College poll conducted for NPR and PBS NewsHour, 62 percent of registered voters said legalizing recreational cannabis is a good idea. In a 2010 Gallup poll, only 46 percent of Americans supported legalization.

More states are moving to legalize recreational cannabis via ballot instead of referendum, which could increase momentum for national legalization in the coming years, according to the 2019 Cannabis Market Report from Brightfield Group, a predictive analytics and market research firm for the cannabis and CBD industries. As more markets open, the industry’s value is expected to explode. The total U.S. cannabis market is predicted to reach $22.7 billion in 2023, according to the report, and the majority of that is expected to be driven by recreational sales, particularly from newly opened, fast-growing Midwest and East Coast markets.

The Brightfield Group also reports that the hemp-driven CBD market (think edibles and other infused products) is growing even faster than cannabis in the U.S. and will soon be a $22 billion industry. Cannabis companies are increasingly pushing into the CBD space through mergers and acquisitions as a precursor to THC legalization—THC, or tetrahydrocannabinol, is the chemical responsible for most of marijuana's psychological effects.

The cannabis and CBD industries also are driving job growth. According to cannabis information hub Leafly’s 2019 Cannabis Jobs Count, the cannabis industry added more than 64,000 jobs in 2018, and it now directly employs more than 211,000 full-time workers in the U.S.

Weighing Cannabis’ Complexities

Producers, sellers, and distributors operating in the rapidly evolving cannabis marketplace face complex challenges—and they need solid expertise to help guide them. Many cannabis businesses have operations in several states, and the legal and regulatory environment is changing quickly in each. According to Schuck, that complexity offers plenty of opportunities for CPAs to provide a variety of accounting, tax, and consulting services.

However, anyone interested in serving the cannabis industry has to be well versed in relevant court cases, committed to staying on top of legislative changes, and highly knowledgeable on Section 280E of the Internal Revenue Code, which forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances as defined by the Controlled Substances Act. Helping cannabis businesses evaluate what is deductible and what isn’t under Section 280E is one of the main areas where CPAs can guide cannabis clients.

“Cannabis businesses need qualified accountants who know how to do 280E right,” Hunzicker says, adding that experienced CPAs shouldn’t try to take an overly aggressive approach to interpreting the code.

In addition to providing 280E-compliant tax returns, CPAs also are being called on to develop tax strategies, provide M&A and due diligence services, and advise cannabis clients on entity choice and how to structure their businesses. Valuation is another challenging area. “Cannabis businesses need to be well capitalized, because they have high operating costs and high volatility in revenues related to commodity price swings,” Hunzicker says, citing high start-up costs, rents, payroll expenses, and complex tax burdens as other pressing expenses.

Even businesses that have their own accounting departments still need help. “These companies have been in need of quality accounting services for years,” Schuck says.

“Cannabis companies have been massively underserved by the mainstream accounting industry,” Hunzicker exclaims. “Cannabis companies have a lot of compliance needs. States are coming up with their own sets of rules—and then changing them. Keeping on top of those very detailed and complex rules requires someone who is very heavily compliance oriented. Cannabis CEOs are too busy running their businesses to do it.”

Unique Market, Unique Risks

Although cannabis is a large and somewhat untapped market offering a variety of service opportunities, CPAs and their firms also need to be aware of the unique professional risks the industry presents. Legal, regulatory, ethical, reputational, and practice management considerations all arise if you’re providing services to businesses that produce, sell, or distribute a substance that is still illegal under federal law.

Cash management is one issue, according to attorney Stan Sterna, vice president and accountants’ professional liability risk consultant for Chicago-based insurance broker, Aon, the national administrator of the AICPA Member Insurance Program. “Federally insured banks may not accept deposits from federally illegal enterprises because of potential money-laundering or aiding-and-abetting charges,” he explains. “As a result, cannabis clients deal primarily in cash, increasing the risk of both unreported revenue and defalcation, which increases a CPA’s professional liability risk.”

Cash transportation also is an issue, according to Schuck, but he expects some of the industry’s banking woes to be eased by new regulations. And although it can still be difficult to find a bank in some states, Schuck says many financial institutions are confidently banking cannabis clients without any federal enforcement.

Sterna encourages CPAs to be aware of other risks. He explains that many cannabis businesses struggle financially or fail, and their ability to discharge or restructure debt is limited because they have limited access to the U.S. judicial system, including the bankruptcy process. Also, the Section 7525 tax preparer-client privilege may not apply to cannabis clients. “If the client is under investigation, the CPA may be placed in the awkward position of being required to testify against that client,” he says.

The complexity of the business also can create the potential for CPAs to make mistakes. “Multiple taxing authorities may impose taxes or fees on the product. With so many returns to prepare, the likelihood that a return could be audited or that the CPA could make an error or omission increases,” Sterna cautions.

But as Schuck sees it, the big risks, such as a client breaking the law or taking an unreasonable tax position, could happen with any client in any industry, and the risks can be mitigated through proper onboarding and due diligence procedures. And as for the federal versus state law gap, Schuck says CPAs are licensed by the states, and they have a right and responsibility to provide services for cannabis businesses operating legally in them. “CPAs are actually helping cannabis companies comply with state laws and statutes,” he says, which is why he doesn’t give much weight to the idea that a firm’s reputation would suffer or a firm would lose clients simply because it provides services to the cannabis industry.

At this point, Schuck says many small practitioners are quietly serving the cannabis market and continuing to move forward confidently. “Those firms are signing tax returns without facing any repercussions. If you take proper steps, exercise normal due diligence, and have strong client acceptance procedures, you don’t have anything to worry about,” he says.

Hunzicker advises CPAs to treat cannabis businesses as they would any other client. “If you apply the same risk management standards, you’re highly unlikely to encounter trouble,” he says.

Connecting With Cannabis

For those willing to take on the risk, there’s a high potential for reward. According to Hunzicker, with average dispensaries hitting $1 million in sales per year, and many in the $4 million to $5 million range, accounting and bookkeeping needs alone can reach several thousand dollars per month in billing for CPAs. Providing other CFO, HR, payroll, and consulting services can create additional billing opportunities. “Cannabis companies have intense, complex needs, and they understand that they need our services,” he says.

The clients certainly aren’t hiding, either. With all the media attention surrounding the industry, Hunzicker says cannabis CEOs and investors are easier to find than clients in other industries. Schuck agrees that meeting people and getting involved in the industry is relatively easy. He suggests attending municipal meetings where local governments are considering the entry of cannabis businesses, finding educational resources and training programs, and staying current on industry changes by joining industry groups (like the Illinois CPA Society’s Cannabis Industry Member Forum) and subscribing to email distribution lists.

For CPA firms serious about developing cannabis as a specialty area, Hunzicker also recommends jumping in and participating in the marijuana movement. He notes that many industry groups are welcoming and communicate daily about constantly changing issues and regulations. “Cannabis is an exciting industry and offers an amazing opportunity to grow your success by building a niche,” he says. “It’s also a fun time to get involved. You will meet interesting people and find very appreciative CEOs.”

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