New cannabis-related businesses are opening throughout the state ahead of Rhode Island’s official legalization of recreational marijuana sales, but specialized accountants are warning enthusiastic business owners not to neglect an important piece of the puzzle: the financial books.
Coming Dec. 1, dispensaries in the state will be able to sell cannabis for adult recreational use, but with federal laws still branding the businesses as illegal, there are many hurdles that companies in other sectors don’t face. While financial literacy is vital for any business, it is particularly important for cannabis-related ones because of the complexity of the industry.
“It’s probably the most complicated industry that exists out there,” said Mitzi Keating, a certified public accountant with Citrin Cooperman & Co. LLP and co-leader of its cannabis advisory services practice. “This is a very difficult business to make money in.”
At the federal level, section 280E of the Internal Revenue Code prohibits business deductions in companies involved with the trafficking of certain controlled substances, including marijuana. Because of companies’ inability to deduct expenses such as marketing or salaries, cannabis-related businesses are often taxed at much higher rates than other businesses.
When added to growing competition and the reluctance of many banks to work with cannabis businesses, these limitations can cut deeply into profits.
“Because of 280E and the tax structure we work under, there’s heavy tax burden on the industry,” said Christopher DeSimone, vice president of finance at the Massachusetts-based Solar Therapeutics Inc., which is readying to open its first Rhode Island location in Warwick.
So what can businesses do to avoid running into financial problems?
“Setting up their books and records at the very beginning is extremely important because they have to be able to figure out upfront what to include,” said Steven Monacelli, a certified public accountant at Withum Smith+Brown PC in Providence.
Monacelli leads the cannabis division and said his team sees many companies make costly mistakes when setting up their businesses, from not raising enough capital to neglecting the economic model. Keating has a similar experience.
“There’s a huge need for a financial component to the business plan from the very beginning,” Keating said. “We’ve been in the cannabis industry from the financial side for five or six years at this point. We’ve seen many businesses come and go and fail.”
It is something that Keating sees all the time: businesses focus all their attention on obtaining a license, without setting up their finances at the very beginning, and ultimately find themselves with inaccurate tax filings and scrambling to pay their way out of a “disaster.”
Another common mistake, Monacelli says, is not hiring the right professional team. With laws and the market constantly changing, it can be hard for businesspeople at the beginning of their journeys to know what to do. Monacelli and Keating say it is not just important to hire an accountant, but an accountant with specialized knowledge in the industry.
“It’s unfortunate because we see a lot of businesses that don’t have that guidance from the beginning are the ones that struggle and oftentimes may end up needing to close their doors,” Keating said.
With the industry on the verge of significant growth, Keating said she would not be surprised to see a rising numberof accountants navigate to ward the industry.
Jason Webski, a spokesperson for Sweetspot Dispensary, is very familiar with the financial challenges that come with operating a cannabis-related business. Sweetspot recently opened a delivery-only location in South Kingstown, but it already operates in three other states. Sweetspot relies on a chief financial officer who often collaborates with accountants with cannabis experience in each state where they operate.
“You bring in professionals that have been doing it for a while in cannabis,” Webski said. “There’s accountants that have a lot of experience and understand what can and can’t be deducted.”
Some of these challenges are only bound to worsen.
Before the legalization of recreational marijuana, there were only three dispensaries open in Rhode Island. With such a large control over the market, Keating said, surviving this tax burden was easier. But with more players entering the field – the state estimates seven retail outlets will be ready to open come December and another two by April next year –things might look different.
“If your margins start deteriorating because there are more players and more competition in the marketplace, it’s going to be harder for you to cover all of your costs,” Keating said.
In recent years, some states have attempted to work around the limitations of 280E. In Massachusetts, legislators recently passed a bill to decouple the state’s tax laws from federal tax code Section 280E, 10 years after the state legalized medical cannabis. Other states have taken similar actions. In Rhode Island, enacting similar legislation should be “the next move,” Keating said.
