Sowing the seeds of a cannabis practice
Make no mistake: Marijuana is on the march.
On Jan. 1, sales of cannabis became legal in Illinois, making it the second Midwestern state and the 11th nationwide to fully legalize, and one of 33 states that allow at least medical marijuana sales.
“Illinois is going to be humongous,” said Andrew Hunzicker, a CPA and co-founder of Dope CFO, which provides accounting services to cannabis companies, as well as teaching accountants how to serve the burgeoning industry. “I think it’s three times the size of Colorado, and that’s a $2 billion market. That just shows you what a state like Florida or New York can look like. As we move eastward the opportunity is huge.”
What’s more, it appears to be one of the few industries that haven’t been hurt by the coronavirus pandemic. “Since the virus hit, many states are having record sales,” Hunzicker said. “In Oregon, we had $84 million in March, which, annualized, is a billion-dollar market in what is a relatively little state, and that was a record month. You have new markets like Illinois completely open now and having record sales.”
As sales boom and more states open up to some degree of legalization, more and more companies will spring up in the space — Hunzicker estimated that as many as 8,000 launched in Oklahoma since the state legalized medical marijuana — and all of those companies will need accounting services.
“The demand is going to be very strong, partly because the individuals getting into the business haven’t run a business before,” explained Ed Pratt, the chief operating officer of Zenwork, which makes Zencanna, a suite of compliance tools for cannabis industry companies. “They don’t know if they should be an LLC, they don’t know those entities, they don’t know how to do the books or meet payroll, they don’t know what technology is available for time clocks or point-of-sale systems, or even accounting software — they just don’t know those things. They’re going to need the advisory capacity of accountants, the guidance of accountants, and overarching all of that is the regulatory compliance that is required in the cannabis industry.”
Based on the experience in states like Oklahoma, Hunzicker doesn’t expect those companies to wait for accountants to reach out to them. “I would expect Illinois to have tens of thousands of companies over the next year or two, and they’re going to be calling local firms or the accountants they do other business with,” he said. “At that point, firms will be making a decision — ‘Oh my gosh, we just got approached by 10 prospects.’”
Be a believer
Deciding whether or not to pursue those prospects is, obviously, the first step in building a cannabis practice — but it involves a level of thought beyond the usual decision to pursue a particular niche. To start, cannabis is still illegal at the national level (though the federal government has shown no interest in pursuing any kind of enforcement action against businesses that are complying with state-level rules); beyond that, it still carries a stigma for some. “Some accountants have said, ‘Nope, I’m never going to get involved with that,’ and others say they’ll be interested once it gets federal approval, and then there are some who are already doing it and it’s all they do, and finally some of the larger firms are building entire niche businesses around the industry,” said Pratt.
Comfort with the federal/state dichotomy and the difficulties that entails — such as strict state compliance regimes and banking restrictions — is important for accountants who want to serve the cannabis industry, but so is comfort with cannabis culture in general.
“For business owners in the cannabis space, they are interested in getting involved with people who are interested in supporting the idea of cannabis,” Pratt said. “Having a relationship to cannabis in some way — not necessarily even a personal one — is very useful with operators. They’re looking for someone who is authentically engaged with the business. They want to know that you are engaged on a personal level with supporting cannabis.”
To be sure, this doesn’t require that accountants consume themselves, or take April 20 as a personal holiday, but they can’t look down on those who do, and should be prepared to support efforts to promote and expand cannabis consumption and culture across the country. (One place to start would be researching why 4/20 is an important date for the industry.)
Understand the complexities
Accountants who are comfortable with all that can move on to the next step in creating a cannabis offering, which is to start educating themselves about an industry that is, for all intents and purposes, brand-new — and astonishingly varied. Hunzicker offered a rundown of the different aspects of the industry: “There’s farming; processing, which is very complex; food production; product production; delivery companies; labs for testing the pot before it gets to processing; and retailers,” he said. “Many of these are vertically integrated … Every one of them has complex accounting issues.”
“Study the tax codes, the court cases,” he recommended. “Get the knowledge before you jump in, as well as learning what products are sold and how do they make them, what does processing mean, or how are vape pens made. Know the industry; if you’re an expert, that will be a huge value add to getting clients.”
Developing local knowledge will also be important, according to Pratt: “If they’re getting into it or just getting their foot in the door, accountants can start by learning about that complexity of the compliance, and making sure they understand what their state rules are and what the state allows and what licensure is allowed, and what they can do in terms of setting up the business and monitoring the cash,” he said. “They need to understand the sales tax rules — all of those are areas where accountants need to educate themselves.”
Prior to the coronavirus pandemic, the industry supported a host of events, conferences and other gatherings that were a great place to start that education; while face-to-face gatherings may be on hold for now, both Hunzicker and Pratt noted that many of them have migrated online. Pratt recommended starting with local associations or consortiums of retail shops or growers as a good place to learn the market and to develop a reputation and connections with cannabis businesses. “Firms can do a presentation to teach them the basics of business while learning some things themselves about the cannabis industry,” he suggested.
And Hunzicker added that it’s worth it to check with accounting authorities, as well. “Contact your state accounting board and see what their rules are and how they’re monitoring the niche,” he said. “More than likely they’ll have something to tell you, and the American Institute of CPAs has a tab on their website as well about serving marijuana.”
Pick your clients
The thousands of new businesses that are formed every time a state legalizes are certainly an attraction, but it’s particularly important for firms to do their due diligence when considering prospects. “We are careful to make sure we’re not getting involved with anyone out of the black market or the illegal market,” said Hunzicker. That is a far bigger problem on the West Coast, he noted, where California, for instance, has a half-century-long history of illegal growing, and it’s estimated that as much as three-quarters of all sales in the state are illegal.
“There is probably a very small illegal market as you move east,” he continued. “The vast majority of new companies in, say, Illinois, are going to be startups, and they’re going to be real businessmen wanting to jump into this market, as opposed to on the West Coast.”
Nonetheless, accountants who are new to the industry will want to vet clients carefully — and not just for a shady past. New and inexperienced business owners will often be ignorant of state requirements and their obligations under regulations from a wide range of agencies, such as the Environmental Protection Agency and OSHA.
“If you have a cannabis client and they have no compliance officer and no one tracking these things, that’s a red flag, and they’re probably in violation of different laws,” Hunzicker warned. That may not disqualify them as a client, though — it may simply mean charging them more for the extra handholding and education your firm may need to offer.
The right tools
By and large, a cannabis practice won’t require a significant monetary investment in technology. Their clients will need a number of different technologies — most commonly one of the “seed-to-sale” systems that states require companies to use to track every bit of the plant throughout the supply chain, and possibly a cannabis-oriented point-of-sale system, where appropriate — but their accountants’ needs are much simpler.
“There are a number of technologies out there, but for the most part, accountants won’t be in those so much as getting reporting from them, so when clients are getting audited by the state, they’re able to prove, say, that they had a certain amount of cannabis flowthrough and need to pay tax on that,” said Pratt. “Rather than being conversant on those systems, they’re going to be taking the reports and making them make sense and providing it in a readable manner to the auditor. They will be using the technology they’re very familiar with — QuickBooks or Xero, for instance — to pull the financial reports to understand profit and loss and cash flow; they’ll just be adding these extra layers of technology to make sure of the compliance of the business owner.”
Hunzicker had a warning for accountants regarding the cannabis-specific software systems that their potential clients will be using: “The No. 1 thing to know about them is that they don’t work very well,” he said. “So we have to do lots of testing, lots of inventory testing and tracing, and going back and testing to make sure they work.”
At the same time, he noted that accountants will need versions of their own tools, like cost accounting templates, charts of accountants, internal control workpapers, and so on, that are customized to the unique accounting involved in the cannabis industry. When he started his practice, these were not available anywhere, so he had to build his own (which Dope CFO makes available to all its students).
Accounting firms will also want to make sure that their insurance policies cover cannabis services, he added — or find an insurance provider that will specifically cover a cannabis practice.
Time to start
Firms of all sizes are taking note of the opportunities available in cannabis (to say nothing of the related, but entirely legal, opportunities in serving the CBD and hemp markets), with more setting up their own practices every day. “From my vantage point, it appears that the only types of accounting firms who are completely out of cannabis are the Big Four, and I doubt that will last for long,” said Hunzicker. “The fact is that the industry is vastly underserved by qualified accountants at this point.”
Despite the tremendous growth potential of the market, first-mover advantage will still accrue to those firms that start serving cannabis companies early on, and build the web of relationships that all strong practices rely on. That means that, for everyone from large firms to young accountants thinking of hanging out their shingle in this area, the earlier they make the decision, the better.
The rewards, according to Hunzicker, are considerable: “All these challenges and complexities and difficulties make serving cannabis companies hard, but on the flip side, they make it highly profitable to serve them. We can charge them a lot of money, and they get it … . They know they need to do this right, and they’ll pay for it — they’ll pay very well.”