Jun 02 IMPORTANT CONSIDERATIONS FOR PROSPECTIVE NEW JERSEY CANNABIS BUSINESS OWNERS
Recent estimates for the New Jersey cannabis market range from $540 million to $740 million in revenue – and that is just for the market’s first year. These figures are expected to continue to increase and reach $1 billion in revenue by 2023. It is fitting that the emerging cannabis market is also known as the “green rush.”
What’s the Status of the New Jersey Cannabis Market?
In the November 2020 election, New Jersey residents voted to approve a constitutional amendment to legalize recreational cannabis by 67%. While the Garden State faced obstacles for the legislation to pass, New Jersey Governor Phil Murphy signed the legalization of adult-use cannabis into law on February 22, 2021. The Cannabis Regulatory, Enforcement Assistance, and Marketplace Modernization Act (“CREAMMA”) created the framework for the legal recreational market and established the Cannabis Regulatory Commission that will begin drafting the regulations for the new market. Applications for business licenses will then become available, and the Commission will select licensees based on the strength of the applicants. This process is expected to take six to nine months, which is ample time for operators seeking to enter the market to develop and submit an application. However, the market is extremely competitive, and essential decisions must be made quickly to ensure the appropriate team, processes, and business plan are in place when applications become available.
Prospective New Jersey cannabis business owners should consider the following items when submitting an application to enter this new industry :
NJ Cannabis Business Licensing
When entering the NJ Cannabis market, six different licenses will be available to applicants. While many licenses are specific to cannabis dispensaries and growers, other areas should be considered based on the business owner’s experience. For example, an applicant with a background in logistics and supply chain would benefit from a Class 4 Cannabis Distributor license. A lifelong wholesaler could transition easily to the cannabis industry by seeking a Class 3 Cannabis Wholesale license. An operator’s individual strengths and background should ultimately determine the license that is pursued. This process will yield stronger applications for licenses as well as greater success as cannabis business owners.
As cannabis remains illegal on the federal level, many traditional lending options are not available to cannabis businesses. While some institutions in the secondary markets are willing to lend, the interest rates are significantly higher than those of traditional companies. Many in the cannabis space have turned to the alternative of raising capital by selling equity. Therefore, it is crucial to know how much capital can be raised from one’s professional network to fund the startup and operating costs until a profit is generated.
Alternatively, cannabis business owners must consider the amount they are willing to spend until their businesses generate a profit. However, there are income limitations for those who want to enter the market with decision-making authority. New Jersey will not approve applications if any individual with a financial interest, who also has decision making authority within the cannabis business, had an adjusted gross income in the preceding taxable year of no more than $200,000 for single filers, and no more than $400,000 if filing jointly.
Cannabis license applicants should be aware of additional considerations and potential challenges that are unique to the cannabis industry. Business owners must address these areas when applying for a cannabis license.
The new regulatory Commission will award points to cannabis applicants based on various criteria including, but not limited to:
- Real estate;
- Insurance coverage; and
- The applicant’s plan to comply and mitigate the impact of IRC Section 280E.
For a business owner in most industries, obtaining a location and insurance would not be complicated. However, before New Jersey passed the bill to legalize the recreational use of cannabis, about 70 municipalities preemptively banned cannabis businesses. While the bill voided these previous ordinances, it is still likely that many municipalities will once again pass the ordinance to ban cannabis establishments.
Once a “cannabis-friendly” municipality is identified, it may be difficult to locate properties to lease that are in properly zoned areas. Landlords may be hesitant to lease to cannabis companies for the following reasons:
- Many landlords have mortgages on their properties. Often, these mortgages contain language to allow the lender to call the loan due if the property is being used to conduct any illegal activities, which cannabis will fall under due to its status at the federal level. In addition, obtaining new financing or refinancing existing debt may raise issues for landlords as banks may be unlikely to provide loans to properties with tenants in the cannabis space.
- If any damage or property destruction occurs on the premises, the landlord’s insurance may deny the claim because “illegal activities” occurred at the property. Before leasing to cannabis tenants, landlords will have to ensure insurance coverage for losses, or they would need to secure new insurance carriers.
Concerns regarding insurance coverage will impact cannabis companies as well. Not all insurance companies will insure companies involved with cannabis, and therefore options may be limited. However, proof of insurance will be one of the criteria that is scored on the license applications and must be considered.
Cannabis companies face unique tax complications. IRC Section 280E prevents expenditures in connection with the illegal sale of drugs. 280E disallows cannabis companies from taking many of the same deductions that other industries are allowed. Cannabis companies cannot deduct any operating expenses and are limited to expenditures related to the cost of goods sold, such as inventory costs. As a result, cannabis companies will pay taxes on their gross profit instead of their net income, increasing their tax liability.
Strategic tax planning is necessary as early as possible to mitigate the impact of 280E.
Is it Worth It?
While challenges in the cannabis industry exist, the right team of advisors with in-depth knowledge in this emerging space is essential to assist operators in addressing them. Based on the success of companies in other states where cannabis is legal, the rewards appear well worth the obstacles.
In addition, despite a global pandemic, nationwide cannabis revenue increased by 67% in 2020 to nearly $18 billion in revenue. This growth is not solely based on new states opening recreational markets. Established markets in Colorado and Oregon saw a 26% and 29% increase in annual revenue, respectively, compared to the prior year. Prospective business owners should begin developing relationships with attorneys and financial advisors, such as Sax Cannabis Advisors, to help navigate these difficulties and optimize success in the cannabis market.
For questions about the cannabis market and assistance with your cannabis business, contact Sax’s Cannabis Advisory Practice.
About the Author
ADAM HOLZBERG, CPA, MBA is a Senior Manager at Sax and specializes in increasing the overall operational efficiencies, financial reporting best practices, and internal controls for clients. As a member of the Sax Cannabis Practice, Adam supports companies from seed to sale in a variety of areas including but not limited to: innovation and growth strategies, attestation services, tax compliance, and pre-licensing consulting. He also assists clients by making meaningful introductions to other advisors in the cannabis industry such as attorneys, bankers, and insurance. He can be reached at [email protected].