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Marijuana Small Businesses Getting Burned

Stocks in this article: ZDPY CANN

NEW YORK (TheStreet) -- Many entrepreneurs are hearing about the huge sums of money to be made in medical marijuana, but the risks never seem to make the same headlines. Owners of these businesses are finding that the harsh reality of selling a federally illegal product never really goes away.

California, which was the first state to legalize medicinal marijuana, is experiencing raids on dispensaries from the Drug Enforcement Agency. Four locations were raided by the DEA in early March, even though the Attorney General had stated that this was not a priority and efforts should be focused elsewhere.

California law officials said it was just enforcing a law intended to cut back on the dispensaries that weren't operating within cities' guidelines. No arrests were made, but cash and cannabis were confiscated. In most of these cases, the owner rarely gets their property back, even if they are never arrested. Owners must put up a 10% "cost bond" of the value of the property and according to the Justice Department, 80% of forfeitures go uncontested in court. A study found that 80% of those whose property is seized are never arrested.

Small business owners should be aware that the DEA is heavily reliant on forfeiture money for its budgets. The Justice Department recovered over $1.7 billion in property in 2011 and it shares this booty among many departments including the DEA. Many small business owners have thousands of dollars invested in these businesses and to lose inventory, as well as cash on hand can be devastating.

Some of these small business owners make outright stupid mistakes, like locating their businesses in places that local laws don't allow. Most cities don't want a marijuana dispensary near a school, for instance. It's critical that before making a commitment to a building, owners are completely sure the site won't run afoul of the law. Some real estate companies like Advanced Cannabis Solutions (CANN) or Zoned Properties (ZDPY) specialize in finding sites that answer the challenging real estate issues for cannabis businesses.

Some municipalities and counties are opting out of marijuana businesses completely, similar to local alcohol bans that result in dry counties or cities. The city of Fontana, Calif. has prohibited dispensaries and is shutting down businesses that have opened within the city limits. While these businesses argue that that they have state law on their side, the state recognizes that cities have the right to opt out of these businesses.

Some cities are issuing moratoriums on the businesses, even after initially approving them. One business, Mary Jane's Attic in Medford City, Ore., received a business license in March of 2012. Then the city decided it wanted to revoke the license and accused the business of engaging in unlawful activity. The business though argued that they operate within the Oregon Medical Marijuana Act, pitting the city against the state.

First, the Medford police staged controlled buys that the District Attorney declined to prosecute. Then the police cited Mary Jane's Attic three days in a row for operating without a business license, even though it was still in effect. In this case, the business won't have to pay the three $250 citations. However, it does demonstrate that these small business owners can't assume any level of security while the drug is still federally illegal. Businesses can take steps though to try to lessen attacks from law enforcement:

  • Choose a neighborhood and town that are welcoming. As for any small business, the first rule is location, location, location.
  • The Cannabis Career Institutes advised that dispensary owners also become patients. CCI Founder Bob Calkin said, "The best way to know the rules is to be a card-carrying patient." The approved medical conditions can change without notice and vary from state to state. "Plus, you need to know the relationship between the doctor and the patient," he added "This knowledge will help keep the business in compliance."
  • When applying for the business license, sellers permit and even a bank account, Calkin says to choose your wording wisely. Be honest and descriptive, he says, but not specific. It is crucial for the language not to be criminal. For example, a dispensary in Denver called Kushism uses the legal name Herbology.
  • Make sure the taxes get paid. CCI advises creating a corporate structure to pay taxes. Most dispensaries are run as a non-profit, but that creates problems in order for the owner to reap all the possible income. Many marijuana businesses create a C Corporation as the management company to run the dispensary, especially if you plan on taking in more than $100k in salary. The Feds may not care about tax money, but the states do.
  • Keep a good paper trail. Make sure everything is in order. Make sure everyone signs a contract. Every patient, every employee, every doctor. In the case of Mary Jane's attic, the business still had an active license, which allowed them to fight the citations they received.

Ultimately, until marijuana is no longer illegal at the federal level, every business that directly touches cannabis is largely unprotected. Small business owners have to realize they enter at their own risk.

-- Written by Debra Borchardt in New York

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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