Though marijuana remains federally illegal, more than half of the states have various versions of legalized marijuana, with at least a half dozen more states expected to legalize within the next two years. With the growth in legalization, the potential for profits in the cannabis industry continues to increase at an exponential pace. The 2016 Marijuana Business Factbook predicts the cannabis industry will grow from a $14–$16 billion market in 2016 to a $44 billion market by 2020—an approximate 300 percent increase in just four years.1
Given the buzz surrounding legalization and the lack of large companies like Philip Morris/Altria or Monsanto dominating the cannabis market, all types of investors are examining the state-legal marijuana space. Though massive amounts of investment dollars have been pouring into ancillary marijuana companies (the businesses that support the marijuana industry but do not cultivate, manufacture, or distribute marijuana), institutional and noninstitutional investors alike have been relatively skittish about investing directly in the actual business of growing, processing, and dispensing marijuana.
Investor reluctance about the cannabis industry stems from a number of factors. First, because cannabis remains federally illegal, even investors conceivably can face federal criminal charges for aiding and abetting a marijuana business simply by financing it. Currently, all state-legal marijuana experiments hinge largely on an August 29, 2013, enforcement memorandum authored by then U.S. Deputy Attorney General James M. Cole. In this memo (well known in the cannabis industry as the Cole Memo), the Department of Justice essentially states that it will take a hands-off approach to marijuana enforcement in states that abide by eight enumerated enforcement priorities and that maintain “robust” regulations to control their marijuana markets.2
Second, the Cole Memo is not law and it did not alter the federal Controlled Substances Act in any way. Most importantly, it can be undone by a new attorney general at any time. Acting U.S. Attorney General Loretta Lynch opted to let the Cole Memo stand, but it is anyone’s guess as to what U.S. Attorney General Jeff Sessions will do. Sessions has on multiple occasions made clear his distaste for anything cannabis, stating that “good people” don’t use marijuana and that marijuana cannot be less dangerous than alcohol because “Lady Gaga is addicted to it.”3 Though a federal government rollback of state-legal marijuana would be politically unpopular, there is nothing stopping a Sessions-run Justice Department from slowing down marijuana’s legalization momentum via raids, arrests, and increased prosecutions of state-licensed marijuana operators and their financial backers.
Third, because they are arguably trafficking in a Schedule I controlled substance, marijuana businesses in every state are subject to section 280E of the Internal Revenue Code. Section 280E prohibits marijuana businesses from deducting their ordinary and necessary business expenses from the amount owed in federal income taxes. This results in marijuana companies facing much higher effective tax rates than similar companies in other industries. The effective rates caused by section 280E range drastically—from 40 percent to 70 percent to as high as 90 percent—but they tend to exceed the standard corporate tax rate paid by most other businesses in the United States. Such a high effective tax rate is a deterrent to prospective investors.
Fourth, prospective investors in marijuana companies are also dissuaded by how few financial institutions will open bank accounts for marijuana businesses, let alone extend them any kind of financing. Though the federal government’s Financial Crimes Enforcement Network in 2014 produced guidelines for financial institutions to bank the marijuana industry,4 most financial institutions have elected not to participate, forcing marijuana businesses in many states to run on an all-cash basis, which is not only a logistical challenge but also a public safety hazard.
Fifth, state regulations often restrict marijuana financing. Most legalized marijuana states require anyone who invests in a cannabis business to disclose his or her identity and secure state approval. Many states have further restrictions on investors, including state residency requirements. All of these requirements conspire to reduce the pool of cannabis funding. By way of example, in Washington, any investor (and his or her spouse) in a marijuana company must have resided in the state for at least six months before investing. And under California’s new legalization measure, only those who can demonstrate residency prior to January 1, 2015, are eligible to own a controlling interest in a marijuana business. Many states that do not require residency in their cannabis industries still give in-state residents various advantages, and all states still require everyone to jump through large amounts of red tape to invest.
All of the above investment negatives lead to investors favoring ancillary cannabis businesses over cannabis companies that “touch the plant,” and make fundraising difficult.
Financing Options and Risks
Despite these issues, various forms of financing are regularly available for marijuana operators. Though banks are often not an option for financing, marijuana businesses often avail themselves of financing through friends and family, hard money lending, crowdfunding, accredited and unaccredited investors, and the utilization of turn-key real estate.
All forms of financing carry risks, but those risks are increased in the marijuana industry because of the federal law conflict and because of the other risk factors inherent to the cannabis industry. Financiers must understand what they can and cannot do under applicable state and local financing laws, including residency thresholds and criminal background checks. With real estate, financiers and investors need to know applicable local laws surrounding zoning and permitting of a proposed property. Marijuana is a heavily regulated industry on the state and local levels and the applicable regulations are ever changing, especially in the context of real estate. Marijuana businesses are increasingly finding themselves in situations where their city or county rethinks its local marijuana land use or permitting regulations and enacts a moratorium against cannabis or a complete rezone that may render a given property completely useless for cannabis businesses.
Concerning asset forfeiture, the federal government may seize any personal or real property used in the commission of a crime or that is the fruit of a crime. Because cultivating, manufacturing, and distributing marijuana are federal crimes, real property or personal property, including any and all investment dollars, used to facilitate the commission of those crimes is potentially subject to federal seizure. There are some protections against forfeiture and criminal prosecution for investors and medical marijuana businesses since Congress in 2014 passed an appropriations bill that includes a prohibition against the Department of Justice spending money to interfere with a state’s implementation of medical marijuana laws:
None of the funds made available in this Act to the Department of Justice may be used, with respect to the States of Alabama, Alaska, Arizona, California, [and every other state with a legalized medical marijuana program], to prevent such States from implementing their own State laws that authorize the use, distribution, possession, or cultivation of medical marijuana.5
Congress has consistently renewed this language in the form of appropriations riders, and at least one federal district court and the Ninth Circuit Court of Appeals have interpreted the above language to mean that the Department of Justice cannot expend funds on shutting down state-law-abiding medical marijuana businesses.6 This same language does not apply to recreational marijuana businesses.
Finally, most businesses getting directly involved with marijuana are start-ups that carry the same risk as start-ups in other industries. Even though many of these businesses are now owned and managed by people with substantial business experience and acumen, the cannabis market and pricing are neither stable nor predictable. Add in significant, always changing government regulations that touch on everything from the ability to contract to quality assurance, and the survival of the typical marijuana business is at least somewhat precarious.
Though the financial prospects for marijuana appear rosy, the industry continues to pose significant hurdles for investors looking to dive in. ◆
1. Marijuana Bus. Daily, Complementary Excerpt of Marijuana Business Factbook 2016, https://mjbizdaily.com/wp-content/uploads/2016/03/Factbook2016Executive Summary.pdf.
2. Memorandum from James M. Cole, Deputy Attorney Gen., to All U.S. Attorneys, Guidance Regarding Marijuana Enforcement (Aug. 29, 2013), available at https://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf.
3. See Jacob Sullum, Jeff Sessions: Marijuana Can’t Be Safer Than Alcohol Because “Lady Gaga Says She’s Addicted to It,” Forbes (Jan. 29, 2014), https://www.forbes.com/sites/jacobsullum/2014/01/29/jeff-sessions-marijuana-cant-be-safer-than-alcohol-because-lady-gaga-says-shes-addicted-to-it/#7ee0e0c3175f.
4. Fin. Crimes Enf’t Network, FIN-2014-G001, BSA Expectations Regarding Marijuana-Related Businesses (2014), available at http://www.fincen.gov/statutes_regs/guidance/pdf/FIN-2014-G001.pdf.
5. Consolidated and Further Continuing Appropriations Act, 2015, Pub. L. No. 113-235, § 538, 128 Stat. 2130, 2217 (2014).
6. See United States v. McIntosh, 833 F.3d 1163 (9th Cir. 2016).