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 |
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 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.”