Guide to Corporate Structure Types for Cannabis Operators

Guide to Corporate Structure Types for Cannabis Operators

C-Corp? S-Corp? LLC? Operating Company? Holding Company? If you're launching a cannabis business, it pays to understand the corporate structure from the very start. Get your house in order with this quick guide to the most common—and most flexible—corporate cannabis structure types.

Cannabis Structure: Corporate Structure vs. Tax Treatment

Before we tackle the question of how to distinguish the different types of corporate structures, it’s important to understand that there are actually two decisions to be made here, not just one. In addition to choosing a cannabis corporate structure, you must also select its tax treatment.

The question of tax treatment is ‘its own kettle of fish,’ as they say, and we’ll delve into that in a subsequent post. Suffice it to say that cannabis entrepreneurs must be aware of the implications of IRS Code Section 280E, which disallows cannabis businesses from deducting ordinary business expenses beyond cost of goods sold.

There are three basic types of corporate structure for a cannabis business:

  • C-Corp: A standard structure utilizing shares of capital stock to represent equity and voting rights. It files and pays taxes on its profits at the entity level.
  • S-Corp: A corporation that offers “pass-through” taxation, so the profits of the corporation are passed through to the shareholders who are taxed on their allocated share of the profits.
  • Limited Liability Company (LLC): An increasingly popular cannabis business corporate structure. It’s the most flexible because it can elect almost any type of tax treatment (C-corp, S-Corp or partnership) and its provides its owners the same legal protections as a corporation.

Which one is best for a cannabis structure? While each type has upsides and downsides, we generally advise our clients to form a Delaware LLC, aka a “holding company,” that owns 100% of a C-Corp, aka an “operating company,” in the state where they intend to do business.

Why? For starters, due to continuing federal illegality, cannabis is a highly localized industry. Local regulators anticipate a cannabis business applying for a license will conform to the corporate statute in the local jurisdiction.

Having the operating company structured as a corporation under the local state corporate statute simplifies your license application and subsequent communication and interactions with local regulators. What’s more, if the business is incorporated under the laws of the state that issues its cannabis license, it dramatically lowers the risk that the operating company will be deemed to be formed for an unlawful purpose under the governing corporate statute.

In addition, a C-Corp doesn’t have pass-through tax treatment. In other words, tax liability doesn’t flow through the corporation to its owners. In the case of an unfavorable tax audit that results in a large tax liability, this is protection keeps that tax liability at the corporate level, and not pass it through to the owners as personal tax liabilities. While a C-Corp is subject to “double taxation” because the corporation pays tax on its profits, and the owners pay tax on any dividends of profits, in practice very few start-up cannabis companies are both profitable and have enough cash to pay dividends out to the owners.

Having the holding company structured as a Delaware LLC provides much greater flexibility in granting equity to employees, contractors and other key contributors who provide sweat equity for reduced or no salary – a topic of future posts. Additionally, outside investors and their legal counsel are familiar with Delaware LLCs, which greatly facilitates raising outside capital.

Corporate Structure for a Cannabis Business: Get Expertise on Your Side

If you’re considering entering the cannabis or hemp industry—or looking to streamline the structure of an already existing business—it’s critical to understand the legal and regulatory landscape. You’ll want a skilled and knowledgeable cannabis lawyer to help you navigate the nuances.

We can help. We’re Culhane Law, and we can bring our extensive experience in this fast-moving and dynamic industry to work for you. If you’re ready to take your business to the next level, reach out. We’d love to talk.