Top 5 Steps to Take Before Obtaining a Cannabis License in a Newly Legal State

By Henry Baskerville

In November 2020, voters in five states passed legislation allowing some form of marijuana sales, joining the rising tide of cannabis legalization sweeping the nation. However, because cannabis is still classified as a Schedule 1 drug under the Federal Controlled Substances Act (CSA), each new state entering the fray will have its own maze of laws, regulations and oversight agencies for potential licensees to navigate.

Well before beginning the application process, hopeful cannabis dispensary operators should take five key steps.

1. Decide how to incorporate. There are pros and cons to each potential structure— individual, partnership, limited liability company, corporation, joint venture, etc. Consult with a cannabis attorney or accountant to determine which is best for you.
2. Establish your business as a legal entity in the state in which you plan to operate. Medical marijuana dispensaries are required to incorporate as nonprofits in several states, so be sure to review the specific laws in yours. Recreational dispensaries can typically be either for-profit or nonprofit and there are tradeoffs with either. For-profit dispensaries are subject to a higher state tax rate (sometimes double or triple that of a nonprofit), but generally require less procedural oversight. Nonprofits will benefit from a lower tax rate, but have significantly more legwork and documentation to manage in order to ensure compliance with nonprofit business regulations.
3. Register with state and federal tax authorities. Taxes will vary from state to state, and also depend on if the business is a recreational or medical dispensary. Because marijuana is still illegal under the CSA, Section 280E of the Internal Revenue Code can bar cannabis business operators from taking all of the usual federal deductions and tax credits normally available to other businesses.  As a result, consult with an accountant about the tax implications and make sure those are taken into consideration when developing a business plan.
4. Gather the pertinent documents for your state and local license application. State and local requirements vary by jurisdiction, but these typically include your business’s bylaws, shareholder agreements, or operating agreement, as well as written plans and procedures for inventory control, recordkeeping, security and more. For the cannabis industry, these measures go far beyond what is required of the average business. Draft a business plan that clearly outlines your site and floor plans, operations protocols, an explanation of how you will meet state compliance requirements, proposed staffing, and a detailed financial plan that projects both pre- and post-opening expenditures, as well as revenues after the business is up and running.
5. Obtain financing. With your detailed business plan in hand, you’ll be prepared to present to and find potential investors. This can be challenging thanks to federal and state laws that make it extremely difficult and labor-intensive for traditional banks and investment firms to do business with the cannabis industry. And, as with all things cannabis, banking regulations vary by state. There are firms that specialize in raising funds for cannabis companies, but many cannabis startups rely on capital investments from friends or family because the usual financing options are so limited. Work with an experienced attorney to draw up the necessary investor paperwork in order to ensure all parties are protected.

Once you have all your licensing application ducks in a row, here’s what to know about entering the cannabis business in newly legal states.

Arizona

Arizonans voted in favor of legalizing recreational marijuana for adults 21 and older with Proposition 207, aka the Smart and Safe Act. State health officials began issuing licenses for recreational sales in late January, making the turnaround from vote to sales one of the fastest on record. The state is likely to become the site of one of the top new business opportunities in the country, with Marijuana Business Daily projecting that Arizona’s recreational market could generate as much as $375-$400 million in its first year and $700-$760 million by 2024.

Current Arizona medical marijuana licensees get first crack at applying for a recreational license until Mar. 9, 2021, and the state has 60 days to issue a license from the time an application is filed. The total number of recreational dispensaries in the state will be capped at about 130, with sales taxed at 16%.

New recreational license applicants must either operate an existing medical dispensary or plan to open a recreational dispensary in a county with fewer than two registered medical dispensaries. In addition, applicants are required to have at least $500,000 in liquid capital, control of a dispensary location, and approval from the local jurisdiction in which they plan to operate.

Of note, Arizona plans to award 26 social equity recreational licenses to “individuals disproportionately impacted by the enforcement of previous marijuana laws,” e.g. minorities, people charged in the past with low-level drug crimes and/or people living in low-income areas.

Mississippi

Mississippians legalized medical marijuana with the passage of Initiative 65, allowing for the use and possession of up to 2.5 ounces of cannabis as a medical treatment for 22 qualifying conditions. In a boon for potential licensees, the state has not placed a limit on the number of licenses allowed. As a result, Marijuana Business Daily projects annual sales of $800 million by 2024.

But opportunities for new operators to begin generating revenue are still a ways off, as the state won’t finalize its licensing system, requirements and regulations until July 1, 2021 and is not yet accepting applications. Once the application process is open, licenses are expected to be issued by Aug. 15, 2021.

Montana

The passage of ballot initiative 190 legalized the recreational use of marijuana for adults over the age of 21, and imposed a 20% tax on sales by licensed vendors. The initiative also allows individual counties to prohibit dispensaries through a public vote.

The Montana Department of Revenue will begin making licenses available by Oct. 1, 2021, but businesses won’t be able to start sales until January 2022. There are two important licensing parameters in the state—only existing medical marijuana operators can apply for new recreational licenses for the first 12 months they are available and only Montana residents can obtain licenses—both of which are likely to make this market a much more limited opportunity for new entrants.

New Jersey

With the passage of A-21 , New Jersey is expected to ultimately be the most lucrative of all new recreational cannabis markets due to the state’s large population and easy access for New York’s millions of residents. Marijuana Business Daily projects annual recreational sales revenue could reach $1 billion by 2024.

However, two issues have already hampered forward momentum. First, applications for New Jersey medical marijuana licenses are stuck in limbo after a lawsuit was filed alleging that technical glitches in the review system had caused the rejection of up to two dozen applicants. As a result, the court has halted review and issuance of new medical marijuana applications until the suit is resolved, and there are concerns that this legal dispute could bog down the state’s expansion to recreational use as well.

Second, New Jersey Gov. Phil Murphy has thus far declined to sign the legislation into law due to concerns that the bill as currently written doesn’t penalize underage persons for using marijuana. Lawmakers’ efforts to mitigate his concern with a new “cleanup” bill are ongoing.

Finally, municipalities will have the option to prohibit dispensaries in their communities, or allow them and collect an additional 2% tax on revenues, in addition to the state tax rate of 6.625%. Yet the fact that the 2% tax can be imposed at the cultivator, manufacturer, wholesaler and retailer level has led to apprehension that it may be applied up to four different times in what is referred to as tax pyramiding.

Overall, there are still several sticky legal and tax issues to be addressed before the New Jersey market opens up and becomes the marijuana sales cash cow that the industry is expecting.

South Dakota

South Dakota voters’ passage of Amendment A, legalizing both recreational and legal marijuana, hit a significant roadblock in early February when a circuit court judge struck it down as unconstitutional.

South Dakota Gov. Kristi Noem’s administration challenged the amendment, claiming it violated the state’s requirement that constitutional amendments deal with just one subject and that it would create broad changes to state government and the lower court agreed. Amendment A’s sponsors are preparing an appeal, but for now, the timeline and legality of marijuana sales in South Dakota are in limbo.

Even without this new legal challenge, the state’s calendar for awarding licenses was lengthy, with no plans to even begin accepting applications anytime prior to 2022, making South Dakota by far the least promising option for those looking to enter the cannabis business in a newly legalized state.

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Overall, the cannabis industry presents myriad opportunities for entrepreneurs. However, the fact that marijuana currently remains illegal on the federal level and that the industry faces so many banking and tax issues, combined with a hodgepodge of various state and local regulations, makes it a challenging opportunity as well. New entrants into this industry will face unique obstacles in getting their businesses licensed and off the ground, with legal and regulatory sands frequently shifting beneath their feet. It takes time, effort and expertise to evaluate the viability of obtaining a license in a newly legal state and stay up-to-date on and adhere to numerous federal and state laws.

The best way to maximize your chances of winning a license in a newly legal state and minimize potential rejection or legal exposure is to carefully prepare the application, ensure compliance with the state’s licensing process and requirements, and stay abreast of any legal changes that are likely to occur. To that end, I suggest hiring competent advisors to help you along the way.