Entrepreneurs, Investors High on the Pot Business

Despite weighty challenges, the fast-emerging legal marijuana industry invites a ‘Green Rush’ of interest.

With Colorado, Washington and other states loosening up marijuana laws, investors and entrepreneurs are rushing in to take advantage, dubbing the phenomenon the “green rush.” But amid the excitement, CFOs of pot-related businesses will have to navigate a tricky landscape of banking issues, taxes and possibly discrepancies between federal and state laws.

Aside from licensed marijuana growers and dispensers, there is a diversity of companies in the field. For instance, High Times, a publication that covers the marijuana industry, recently started its own private-equity firm, HT Growth fund, which plans to raise $100 million over the next two years to invest in marijuana-related companies.

750px-MarijuanaAnother example is Advanced Cannabis Solutions, a real estate company that specializes in leasing space to growers and dispensaries. It signs clients to 10-year leases in facilities it owns. Banks and landlords are reluctant to do business with such companies, not only because of what they sell but also because most of them are cash-only operations.

The publicly traded company (CANN on the OTC Bulletin Board) issues convertible debt, which is appealing to investors because the debt eventually converts to equity and the investors get paid 12 percent interest annually over a five-year period, but they are not required to hold the debt that long. They can convert when the stock price is $5 per share and are forced to convert when the stock reaches $10; the stock currently is trading at $9 per share.

“We’re positioned to take advantage of the next two to three years by acquiring assets at a high rate,” says Chris Taylor, the firm’s CFO. The company is also working on ancillary nutrient and technology products as well as consulting services.

In Colorado, it became legal to buy marijuana for recreational purposes on Jan. 1, and Washington has passed constitutional amendments to accomplish the same early this year. And many more states are allowing the use of marijuana for medical purposes; New York this month became the 21st state to do so.

The legal marijuana market in the United States was a $1.4 billion industry in 2013 and will grow to $2.3 billion this year, according to an ArcView Market Research report. Colorado reported revenue of $329 million from July 2012 through June 2013, generating $9 million in state taxes, according to the Colorado Department of Revenue.

One major concern for companies doing business on Colorado has been that while marijuana is now legal in the state, federal laws still deem it illegal. Federal agencies can, for one thing, seize properties that are used for illegal activity. The Justice Department, though, eased the fears with an August memo saying that if a state tightly regulates the industry and marijuana businesses comply, the department will defer to the state’s rules.

Another continuing challenge for marijuana providers derives from the tax code. Internal Revenue Service Section 280E, which refers to marijuana sales as “drug trafficking,” prohibits marijuana retailers, regardless of state law, from deducting any expenses, including rent, payroll and equipment. Some retail pot businesses are effectively subject to 80 percent tax rates and are handicapped in their efforts to reinvest in their businesses, says Aaron Smith, co-founder and executive director of the National Cannabis Industry Association.

Another problem is the industry’s newness. While interest in investing in the industry is growing, investors are “much more cautious” about entering the field compared to more established industries, says Taylor. “It takes multiple meetings and much conversation” to win an investor over.

Taylor says he is optimistic that the Justice and Treasury departments will address some weighty banking issues in the first quarter of this year. As of now, marijuana dispensaries still have trouble obtaining small business loans from banks that are unwilling to hold money for fear of being implicated in money laundering.

ACS works around this by collecting rent twice weekly in cash and transport it to banks via armored cars. He says it’s “not a perfect solution” but one that he hopes will change in the next few months.

Once the banking and tax industry catch up with new state regulations, the marijuana industry’s potential will be massive, Taylor adds. For example, an operator can expect a 40 percent profit margin if an operator can sell 70 to 75 percent of what it grows. “It’s much more profitable than the restaurant business,” he says.

Image courtesy of United States Fish and Wildlife Service via CC.

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