IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Seth Rudin. Mr. Rudin is a senior business broker at IBA (www.ibainc.com):

What You Need to Know if Cannabis is Rescheduled from a Schedule 1 Drug to a Schedule 3

The possibility of Cannabis being re-scheduled to a Schedule 3 drug is now coming closer to a reality. The US Drug Enforcement Agency (DEA) and Human and Health Services (HHS) have stated their clear opinions that Marijuana/Cannabis provides a medicinal value to the public. This determination allows DEA to reschedule Cannabis to a Schedule II/III status, marking a substantial turning point for the Cannabis industry.

The Department of Health and Human Services has even made this statement that shows large-scale support for this change:

“There exists widespread, current experience with medical use of the substance by [health care practitioners] operating in accordance with implemented jurisdiction-authorized programs, where medical use is recognized by entities that regulate the practice of medicine.”

First, let’s understand what it means for a drug to be classified as a Schedule 1 drug or as any of the other four classes. The United States DEA started classifying drugs under the Controlled Substances Act, signed by President Richard Nixon in the 1970s. To be classified as a Schedule 1 drug means there’s NO medical benefit to patients, yet there is a high rate of addiction. Some drugs currently included in this category are marijuana, heroin, LSD, ecstasy, and bath salts.

Drugs classified as Schedule 2 have some medicinal benefits to patients but can be highly addictive or have a high chance of abuse. Some examples of Schedule 2 drugs are Demerol, Cocaine, Oxycontin, Fentanyl, and Morphine. A patient can only access these drugs with a  physician’s prescription.

Schedule 3 drugs demonstrate some level of potential abuse or addiction but provide medicinal benefits. Some current examples include ketamine, anabolic steroids, and suboxone.

Schedule IV drugs have viable medical benefits with a low case of addiction and abuse. Lastly, Schedule V drugs have minimal chance of abuse and addiction and include over-the-counter drugs such as Robitussin AC and Ezogabine.

Preparing for the Impact of Cannabis Moving to Schedule 3

We anticipate this change, and IBA wants to help you prepare your business for it.

While reading this blog, it’s important to remember that this is a very beneficial shift for you as a business owner of a cannabis company. The business landscape is changing and you want to be ready for it. The rescheduling may impact the industry in many different ways, but there is still more to learn.

This is what we expect you to encounter as an owner and potentially a seller of a cannabis business. Note: We will do our best to update our website with the latest news and expected impacts of this change. But as always, don’t hesitate to contact us with questions.

Rescheduling Cannabis: A Major Shift in the Industry

The move from Schedule I to Schedule III signifies a nationwide recognition of the plant’s medicinal properties and potential benefits. This change will have far-reaching implications for Cannabis businesses as it potentially alters the regulatory framework and opens doors to innovation and large financial benefits. We anticipate selling a cannabis business will become easier and more financially beneficial if the owner is properly prepared.

By understanding this change in detail, you can take advantage of new opportunities and demonstrate them to potential buyers as they conduct their due diligence. An interested buyer would rather purchase from an extremely knowledgeable owner than someone who has not adapted and stayed current.

The financial impact on daily operations and growth potential is clear to those who already own a cannabis business. But have you considered how this change will impact you if, or when, you sell your business? This change will likely increase the potential sales price and the number of interested buyers. We can help you be prepared, even if you’re not ready to sell, yet.

Potential Taxation Changes: The 280E Conundrum under IRC:

One of the significant challenges faced by Cannabis companies has been the burden of taxation under Section 280E of the Internal Revenue Code (IRC). This provision, originally intended for illicit drug trafficking organizations, has been applied to state-legal Cannabis businesses, subjecting them to exorbitant federal taxes. Normally, non-cannabis businesses pay tax based on Ordinary Income, allowing for deductions such as employee payroll and related benefits not related to the cost of production or inventory, accounting services, legal fees, marketing, etc. However, Cannabis companies and other schedule I companies subject to 280E are taxed on Gross Profit and thus cannot deduct the preceding administrative operating expenses.

The rescheduling of Cannabis may not directly alleviate the 280E tax burden as it pertains to the IRS tax code. However, it signals a shift in perception and could lead to reconsidering tax policies for Cannabis companies in the future. Many in the industry are eagerly anticipating that change sometime in 2024.

While this tax change has not yet been stated, it is possible, and as a business owner in the industry, it will alter your financial statements significantly. Not only will your company be able to show higher profits and enable more flexibility in setting your product pricing,  but it will also make your business more sellable at a higher price.

Many industry experts believe the retailers will price away the tax savings to drive out competitors and gain market share. The question is, will the entire tax savings be priced away or only some of it. Only time will tell…and we’ll be watching.

In addition to these potential tax changes, the following opportunities exist for current owners. At IBA, we encourage Cannabis owners to take advantage of one or more of these opportunities whether you plan to sell your business or not.

Opportunities on the Horizon:

1. Research and Development: With Cannabis now recognized for its medicinal properties, you can invest more heavily in research and development, unlocking new possibilities for sales concerning medical applications. Being current on new research increases a business’s sales price when you are ready to sell. The potential investment in R&D may allow for additional tax incentives as well.
2. Market Expansion: Schedule III classification could facilitate broader acceptance and market expansion (geographical and product-based), attracting new consumers and investors to the Cannabis industry. Begin planning for new markets now so you are ready. Demonstrating a marketing plan, even if you have not begun to use it, will help potential buyers visualize more profit when they take over.
3. Financial Services Access: Rescheduling may encourage financial institutions to be more open to providing normal banking and merchant credit card processing services to Cannabis businesses, easing the industry’s banking challenges. This will reduce operating costs and increase efficiencies as heavy cash management and security burdens can be significantly reduced. Stay current on opportunities that may change in banking and other financial institutions. As potential buyers begin their due diligence, having this information for them will speed up the sales process.
4. Investment from Traditional Buyers. Buyers who have stayed on the sidelines to ensure their companies are not subject to 280E and the higher level of scrutiny will increase, easing the challenges of selling your company at the time of your exit.
5. Acquisition Loans and Bank Lending. Some feel that the change of 280E will enable banks to provide acquisition loans and other bank lending that have been absent. It will most likely take both the 280E reform and the application of bankruptcy and receivership laws to be put in place before banks and financial institutions (including the SBA) start lending to Cannabis companies.

Challenges To Keep In Mind:

1. Regulatory Compliance: While rescheduling is a positive step, Cannabis companies must remain vigilant about evolving regulations to ensure compliance in this quickly changing industry. Join and participate in your local cannabis trade organizations.
2. Taxation Reforms: Advocacy for reforms in taxation policies, potentially revisiting the 280E provision, will be crucial for relieving the tax burden on Cannabis businesses. Ensure you are using a financial institution and accountant who is current on these changes to ensure you can take full advantage of the tax benefits once they are announced.
3. Pricing: Be cautious not to underprice your services and products as the financial changes begin to occur in taxation. While staying competitive is crucial, balancing pricing and profitability is essential. You want to ensure that financial changes do not inadvertently erode your bottom line. When and if the 280E tax regulation is relieved, be on the lookout for competitors instigating price wars by spending their tax savings in return for market share gains.

IBA is always here to help you whether you are ready to sell, or not yet. Having a plan to stay current on regulations and compliance issues will make selling your cannabis business faster and easier, and we anticipate it will sell at a higher price! Please contact Mr. Seth Rudin, Director of IBA’s Cannabis Transaction Team, today, even if you’re not ready to sell; we can help you be ready when the time comes.

Source of scheduling classifications

https://americanaddictioncenters.org/prescription-drugs/classifications

If you have questions relating to the content of this article or the process associated with selling or buying a cannabis industry business in Washington or Oregon, Seth Rudin would welcome the opportunity to talk with you. Mr. Rudin is licensed to sell businesses & real estate in both Washington and Oregon.  Mr. Rudin can be reached at (425) 454-3052 or seth@ibainc.com.   

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, real estate, accounting, legal, and financial planning communities on subjects relevant to the purchase & sale of privately held companies and family-owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.