The cannabis industry could reach sales of $35 billion by 2022, creating significant opportunities for CPA firms to expand their practices in bookkeeping, auditing and tax. That was the message of Matthew A. Karnes, founder and managing partner of GreenWave Advisors LLC, who presented an overview of the cannabis industry at the Foundation for Accounting Education’s Cannabis Conference on Dec. 11.
With New York state expected to legalize cannabis for recreational use this year, the NYSSCPA hosted the conference in order to educate the profession about opportunities and challenges in this fast-growing industry, and to provide a forum for candid and in-depth discussion.
Zachary Gordon, the chair of the NYSSCPA’s Cannabis Industry Committee and the founder of CH3 Ventures, LLC, served as the chair of the conference, whose theme was “Navigating the Cannabis Industry.” Sessions included a keynote address by New York Assembly Member Richard N. Gottfried and a presentation by Peter A. Metz on “IRS 280E and How to Manage Your Client’s Tax Burden.”
In his overview presentation, Karnes noted that there are currently 33 states permitting medical cannabis and 10 states, plus Washington, D.C, that allow cannabis for recreational use, resulting in about $10 billion in sales. By 2022, he predicted, cannabis will be legal for one or both uses in every state. “We’ll see a big ramp in 2022,” he said, noting that, by that time, New York, New Jersey and Michigan will likely have legalized recreational use.
The opportunities for CPA firms will be numerous, he said, explaining that the cannabis business is mostly cash, and the people working in it are often right out of college or otherwise inexperienced. “The internal control environment is something that will be a big challenge for auditors,” he said. “One of the biggest opportunities for CPA firms is the need to get books ready for an audit.” On the tax preparation side, CPAs can help clients comply with Section 280E of the Tax Code, which disallows credits and deductions for Schedule I drugs, other than costs of goods sold.
Karnes said that there has been a gradual shift from illicit to legal markets, although it is difficult to report reliably on the size of the shift because of the scarcity of credible sources for compiling figures from the illicit market. Estimates for illicit sales are often based on plant confiscations by the Drug Enforcement Administration and the Department of Homeland Security. The plants are converted into pounds, and then estimates are based on the average price per pound. Karnes said he has been tracking that information since 2012.
Positive developments
Karnes cited several recent positive developments in the industry, including the legalization of cannabis in Canada as of Oct. 17, and the tremendous amount of capital entering the industry. In addition, he said, the 2018 Farm Bill will allow for cultivation of industrial hemp and the sale of CBD (cannabidiol) in all 50 states. (The Senate passed the Farm Bill on the day of the conference, and the House of Representatives passed it the following day.)
Karnes also cited the following positive developments in the industry:
• The Trump administration has announced that it will allow each state to make a determination about marijuana laws. “If they were going to shut it down, they would have done it already,” Karnes said. He noted that a bill introduced into the Senate—the STATES (Strengthening the Tenth Amendment Through Entrusting States) Act—would, if passed, decriminalize cannabis nationwide.
• Former Speaker of the House John Boehner and former Massachusetts Gov. William Weld have joined the board of directors of Acreage Holdings, a cannabis investment company.
• Canadian cannabis company Canopy Growth Corporation is now listed on the New York Stock Exchange.
• Canadian cannabis companies Tilray and Cronos Group have listings on the Nasdaq.
• Alcoholic beverage company Constellation Brands, Inc., has increased its stake in Canopy Growth to 38 percent, after buying shares worth 5 million Canadian dollars (CA$5 million).
• Altria Group, Inc., which owns tobacco company Phillip Morris, has taken a 45 percent stake in Cronos, after buying shares worth CA$2.4 million.
• The Food and Drug Administration (FDA) has approval the epilepsy drug Epidiolex, which is significant because it’s based on CBD from the cannabis plant. Previous FDA-approved drugs, such as Marinol, were synthetically created.
With regard to investment opportunities, he said they are divided between plant-touching operations and ancillary operations. Plant-touching operations include cultivation, processing, manufacturing and retail. Those operations cannot be listed on U.S. stock exchanges. Ancillary operations include lab testing, data analytics, delivery services, agriculture technology and professional services (such as accounting and legal services). Some of these services are listed on U.S. markets.
Karnes said the infused product market, which includes edibles, is gaining significant market share and now represents 30–50 percent of revenues, as smoking has grown more unpopular because of health concerns.
Still, Karnes acknowledged that the industry faces many challenges as long as marijuana remains a Schedule I drug on the federal level, the same classification as heroin or LSD.
“I can tell you that I have never spoken at a heroin or LSD conference,” Karnes said. “[That’s how] how ridiculous that law is.”
He noted that the Section 280E tax burden can yield an effective tax rate as high as 80 percent, which is why cannabis companies need to maximize what they can claim as cost of goods sold. (In a separate session, Peter Matz provided details about complying with 280E.)
Banking also remains an obstacle for the industry, said Karnes. Most of the major banks do not want to become involved because it requires a great deal of oversight. There are currently 111 credit unions that work with cannabis businesses, and there are 486 financial institutions, up from 412 at the end of 2017. In Colorado, he said, one credit union, Partner Colorado Credit Union (PCCU), maintains 32 percent of all marijuana deposits. But there have also been 15,363 account terminations in the past year, which occur when depositors conceal that accounts are being used for the cannabis industry and banks discover the truth. He said that, frequently, as one account opens, another closes. Only 14 percent of marijuana businesses have bank accounts, he added; many of them conceal the nature of their business, a practice he strongly advised against.
Disruption in medical use sales
Karnes said that notable trends include a continued disruption in medical use sales, as the recreational use market comes into play. In Colorado, he said, patient counts have been coming down since recreational cannabis became legal, as have revenues. He has seen the same trends in Nevada, Oregon and Alaska. Most states with recreational use have been merging the two markets, but Colorado still maintains a bifurcated market. He also said it has become more difficult to become a cultivator because of the growing costs and the declining wholesale price of the plant.
Using Colorado as a case study, he said that the industry took five years to reach maturation. While sales increased over that period, and the state benefited from “cannatourism” when it was the only state with recreational use, sales have flattened in 2018.
Karnes then turned to New York state, where medical marijuana was legalized in 2015. He said the program started slowly, with limited products, limited licenses and qualifying conditions. There hasn’t been a lot of doctor participation in the program, he said, and there are only about 83,000 patient card holders, who represent about 3.4 percent of the addressable market, that is, patients with diseases that cannabis can treat. He noted that recreational use has a good chance of passing in 2019. (New York State Assembly Member Richard N. Gottfried discussed those prospects in a separate session.)
During a question-and-answer session following his presentation, Karnes discussed, among other topics, research into medical cannabis. For many years, he said, the University of Mississippi was the only university authorized to conduct research. “Only small amounts were tested,” he said, and “it went nowhere.” But slowly, the federal government “started to open up the gates," he said. Last year, it expanded the number of universities that can apply for a grant, and there are now about 19 universities that have applied to conduct research.
“There is clearly an opportunity and a need for the research,” he said
Other conference sessions included the following:
“Cannabis and the Blockchain”
Compliance can be a difficult and time-consuming task, but Derek Abdekalimi and Nicholas Shook, the founders of the firm Cannaledger, said that blockchain—the technology undergirding digital currencies such as bitcoin—can make the process much easier for cannabis businesses. Abdekalimi said he’s happy that states are coming around to recognize the need to legalize and regulate cannabis. On the other hand, he’s wary of states collecting data from cannabis businesses in one centralized location. He said this is where blockchain can help: “We want to use blockchain to decentralize the information. We don’t want the state to store it all but, collectively, we can store it all.”
“Legal and Operations Issues Panel: Practical Applications”
In a discussion moderated by Robert M. Bernstein, a partner at Grassi & Co., panelists discussed the challenges of running a cannabis business, including some unique to the industry, such as the difficulty of valuation, defending trademarks when federal protection is unavailable, and defending against “hacktivism” by industry opponents. On the panel were Karl Kispert, a principal in the Cyber and Information Security Practice at Grassi & Co.; Metz; Daniel T. McKillop, counsel at Scarinci Hollenbeck; and Pasquale Rafanelli, valuation senior manager at Grassi & Co.
“Cannaquiz”
The panelists/contestants in this game show, based on “Jeopardy!” were Jason A. Hoffman, senior manager at Janover LLC; Mitzi Hollenbeck, co-founder and practice leader of the Cannabis Advisory Group at Citrin Cooperman; and Larry Lipman, founder and CEO of eXPO. With NYSSCPA Digital Editor Zach Simeone serving as emcee, they answered questions such as: “What percentage of Americans currently support legalizing marijuana in some form?” (answer: 62 percent) and “Approximately how much revenue did Colorado collect in 2017 from cannabis taxes and licensing fees?” (answer: $247 million). The panelists then answered questions from the audience about compliance challenges, focusing on such topics as the role of local governments, which control where dispensaries are located; negotiating banking regulations; and the importance of CPAs and lawyers collaborating on compliance issues.
“Should I Take This Cannabis Client?”
In a discussion moderated by John V. Pellitteri, a partner at the Cannabis Service Practices at Grassi & Co., panelists stressed that it takes many hours to attain expertise in the industry; it’s not something that CPAs can do part-time. On the panel, again, were Hoffman, Hollenbeck and Lipman. Hollenback said that the first thing CPAs should do is establish an acceptance procedure for clients. Some questions she said she often asks are: “Are they working with a cannabis attorney that we know? Do they have a bank? What are they doing about their compliance piece? Have they thought through those things” She stressed that CPAs have to be “absolutely flexible” and “ready to pivot at any moment.”
“Investing in Cannabis”
This session began with a role-playing exercise called “Spark Tank,” in which four NYSSCPA volunteers—Social Media Coordinator Leah Gay; Marketing and Communications Manager Onyi Atanmo, NYSSCPA Director Rumbi Bwerinofa-
Petrozzello and Digital Editor Zach Simeone—assumed the identity of cannabis industry executives and made presentations seeking investment capital for particular cannabis enterprises: seed-to-sale software, security services, a Las Vegas dispensary and vaping pens. Playing the role of the investors were Zachary Gordon, the chair of the Cannabis Conference and the founder of CH3 Ventures, LLC; Robert D. Birnbaum, president of Peartree Trading LLC, who has a substantial investment background; and Peter McGough, who has been active in raising capital for both recreational and medical cannabis. The trio offered their candid assessment of each of the pitches. Following the exercise, the panelists took questions from the audience about investment considerations.
This article has been updated.