Opinion: The 5 biggest problems faced by cannabis social equity founders

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Alyson Jaen

Social equity founders still face an uphill battle in the cannabis industry, despite policies specifically designed to level the playing field for minorities and those affected by the war on drugs.

While lawmakers’ social equity provisions help some founders get a foot in the door, they don’t always reduce barriers enough for those founders to turn a profit and keep the lights on in the long term.

Here are the five biggest problems social equity founders face in the cannabis industry – and how to navigate them:

1. Capital

Even with a cannabis business license in hand, social equity founders face a tremendous hurdle: financing their business plan.

Because of the federal prohibition of marijuana, many of the financial networks and investment tools that mainstream small and midsized businesses and startups rely on for financing simply aren’t available to cannabis businesses.

Banks, hedge funds and private equity funders often have shied away from the cash – and crypto-heavy – aspect of the cannabis industry – whether it’s because cash-only businesses suggest potential for fraud or because of the extra work required to keep accounts compliant.

An increasing number of financial institutions, ancillary services and grant programs, however, now specialize in marijuana brands – and many give priority to or are eager to work with, social equity founders.

A lawyer who specializes in cannabis business law can be particularly helpful in this arena.

It might feel counterintuitive to pay for expensive legal services when your company’s whole problem is an empty bank account.

But a good attorney who is plugged into your state marijuana industry will likely know fruitful places to start looking for capital and which options best align with your background and intended business.

2. Connections

Connections are important in any business, and they represent another challenge that cannabis social equity founders often must navigate.

Step 1 is to meet other entrepreneurs – particularly those in cannabis.

Because the marijuana industry is small, it often feels as if everyone knows everyone – even in bigger markets such as Denver, Los Angeles or New York.

Seek out networking opportunities around industry conferences such as MJBizCon or thought-leadership events such as the South by Southwest festival in Texas.

Awards ceremonies such as The Emjays also are great places to learn who’s who in the industry.

In addition, social equity applicants can join state or local cannabis business groups, where experienced and like-minded entrepreneurs can offer not only offer camaraderie but also pointers on how they have navigated the challenges and legal problems that social equity founders face.

3. Contracts

The path to success for marijuana companies rests on paperwork – more of it than mainstream businesses face.

That’s exactly why they need to engage a cannabis attorney early on.

Yes, attorneys can be expensive. But reading a contract wrong is potentially far more costly.

From dates to recitals to defining terms, representations and warranties, dispute-resolution clauses and the specific compliance requirements set by different state regulatory bodies, there’s a lot to keep track of.

The consequences for even unintentional missteps can be dire.

4. Taxes

Cannabis businesses have notoriously complicated tax issues.

Because taxes are collected federally as well as on the state level, federal prohibition has an enormous impact on how marijuana brands settle their accounts at the end of the year.

Section 280E of the federal tax code is a notorious thorn in the side of cannabis brands, as it stipulates that most of the expenses that mainstream businesses can deduct or use to qualify for tax credits are off-limits to marijuana companies.

Another bugaboo is that the way state and local excise taxes are enforced often favors large-scale enterprises over small to medium-sized businesses.

For example, a coalition of Colorado cannabis businesses in 2022 wrote to the state’s Marijuana Enforcement Division (MED) requesting a tax holiday to offset the burden of distribution that they saw as harmful to smaller operators and new entrants to the industry, including social equity operators.

As they are in several other states with regulated marijuana markets, Colorado cannabis regulations are structured in such a way that there can be a large gap between the average market rate by which wholesale prices are set and actual market prices.

Large marijuana enterprises and vertically integrated companies are at an advantage because they don’t have to pay additional taxes when products are transferred from the cultivation operation to their retail arm.

Smaller, horizontally integrated businesses must negotiate a contract price that might be very different from actual market prices, forcing newcomers and startups to sell marijuana for a lower rate than larger competitors.

In addition to bringing less revenue per pound, such pricing also distributes a heavier tax burden to companies that are already financially disadvantaged.

As the coalition put it in an open letter to the Colorado MED, “When the market experiences a steep decline, cultivators must continue paying a higher rate of taxation despite their declining revenues. … Any business that sells its crop for less than (the average market rate of) $991 per pound pays an effective tax rate of greater than 15%, and in effect they are subsidizing the tax burden for cultivators who can sell their crop for higher prices.”

5. Long-term resources

As social equity founders know well, it’s best to start off on the right foot.

A misstep on something as routine as a contract or taxation can not only mean lost revenue or human resources, but it also can result in the loss of a business license.

Social equity founders get priority for coveted licenses in states such as New York, where plenty of non-social equity-involved individuals would like to enter the market.

But despite that initial advantage, this cohort faces even greater challenges than average in an industry already full of hurdles.

There is always someone waiting in the wings for social equity founders to fail – and create a new space for their competitors in a fast-moving industry.

That’s why it’s so important to connect with long-term resources in the earliest days of launching a marijuana business.

Many states have special resources for social equity founders – from accelerators to advisory groups to grant programs intended to help social equity founders bridge capital and investment gaps.

Look for conferences dedicated to social equity leadership in cannabis or for broader industry events with dedicated panels or tracks designed to connect social equity founders with the expertise and tools they need to succeed.

And, of course, the connections you forge with fellow founders and ancillary companies serving marijuana businesses are invaluable.

Cannabis is a close-knit community full of potential allies and partners to lean on as you navigate this complex, fast-changing space.

Alyson Jaen serves as of counsel at Messner Reeves law firm. She specializes in corporate and business law for cannabis brands, including licensing and regulatory compliance. She can be reached at ajaen@messner.com.

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