After helping form lots of cannabis companies, the conclusion that the limited liability company (LLC) organization structure is almost always the right choice is an easy one to make. A business plan may have different distribution schedules for profits and want to separate limited from general partners, all of these goals and more can be best served by an LLC.
Top three benefits of using an LLC for your cannabis startup.
- flexible ownership
- less formality
- strong limited liability protection
So our offices at Collateral Base have helped lots of cannabis teams organize the company and apply for a license, and as more states come online, there are going to be a lot more. Typically, the entrepreneurs fall into a few different groups. There is the group that has a crap load of people there all with different percentages that really have no rhyme or reason for them. Beware of these teams, they probably will waste your time because you have to multiply disclosures for review of the principal officers of the cannabis license applicant.
Very often we see a family or friends that came together to get the license, or the one guy that is calling the shots and will only have partners if they are required by regulations. Sometimes they have already filed something, or at least think they have filed something – or have picked out a name. Our clients may be confused about how to structure their company.
Why don’t cannabis startups need to be a c-corp?
Most cannabis startups probably do not need to be a c-corp, unless they want to be sold for an all stock deal and go public quickly. The vast majority of companies are closely held. For all of those clients, I don’t understand why people would become a c-corp other than personal comfort levels. The benefits of an LLC outweigh the restrictions of a corporation, at least in most client use cases.
First, there is just nothing – sole proprietorship, or general partnership. If you have no governing documents, have filed nothing with the state to limit your liability – they you are either in a general partnership or a sole proprietorship if you are the only business owner. These are really bad ideas in any business that makes real money and extremely bad ideas in Cannabis.
Next you can use legal zoom and file an LLC – most people do this, and they work. They don’t work well because most of the people have not thought through the process and just filled out the form as quickly as they can. This causes huge problems in execution, which may lead to a business dispute between partners.
Why are LLCs, or limited liability companies, a great vehicle for investing in cannabis?
Why pick an LLC? LLCs may enjoy even greater limited liability protection. In states like our home state of Illinois, LLCs provide even greater protection than regular corporations because of statutory and case law restrictions against piercing the corporate veil. So take that pro-business Delaware that still allows for piercing the corporate liability protection for LLCs.
Granted some states do not allow for state income tax, which may or not make sense for your cannabis company as in-state residency requirements may make you file for organization in the state that is issuing the license. Cannabis means tax dollars and the states know it.
What does it mean that an LLC is flexible?
Well, LLCs can have more than one type of share of stock (called units for LLCs), unlike an s-corp, plus they can split ownership and management, and even make any type of profit split they want despite what the ownership says. That’s what it means when your lawyer explains that LLCs are flexible. Ask your cannabis lawyer about what type of LLC organization serves your business goals best.
But what does it mean LLCs have fewer formalities?
Corporations require certain actions to keep their corporate limited liability protections – but LLCs do not have to observe these formalities to keep their liability shield. For example, having meetings with minutes and corporate resolutions for any actions, are required by corporations, but LLCs just have to have their managers or members agree to do an action and can keep their limited liability protection. So LLCs are also less formal than corporations.
This flexibility, less formality and great liability protections make LLCs the go-to choice for cannabis – or really any company – that is being organized. In fact unless your exit strategy is to be absorbed for an all stock deal that will offset tax liability – and there’s a 99% chance you’re not – the LLC is right for your team.
Conclusion on why LLCs are probably the right choice for your cannabis startup.
If you’re going to start a cannabis company, form your LLC and then get some help from cannabis lawyers that have seen it before. They can help you organize your venture, your ownership structure, and even your management so that your LLC is ready to grow – but it may need to become a c-corp one day…if it goes public.