Succession planning can bring up feelings of fear and uncertainty in business owners. Much like with estate planning, it can be difficult to think about a future where you are no longer in charge of your affairs. But succession plans are not about death—they are about preparation.
Due to the strict regulatory framework surrounding the cannabis industry, cannabis business owners must be diligent when thinking about their business’s future. Succession plans are necessary, not just for when there is a death of an owner of a business, but also when an owner retires or becomes mentally or physically disabled. An effective succession plan (1) ensures a business can continue to thrive or (2) lays out the terms for an intentional exit.
If you own a cannabis business and have not taken steps to develop a succession plan, this is why you should start now:
1.) If you do not decide, your state will decide for you.
Every state has laws that dictate who will inherit a business if an owner dies without a succession plan. In Ohio, if a member of a limited liability company dies without a succession plan, the deceased member’s business interests will pass to the member’s heirs. This means, if your business partner unexpectedly dies, you may find yourself running a business with your partner’s spouse or children, who may not be business savvy or care about the success of the business. The heir could also sell their inherited business interest to whomever they please without your approval or involvement.
It is also important to note that, while the laws of the decedent’s residence prior to death will govern the transfer of assets, the laws of the beneficiary’s residence may restrict the heir’s ability to assume ownership of the business, depending on that state’s cannabis laws. For example, most states do not allow for the transfer of cannabis licenses without express approval by state regulators. This means that although an owner’s business interest passes to the heir, the business license may not. Without a license, the heir does not have the authority to run the business and potentially exposes the business and the heir to risks.
2.) You can appoint trusted fiduciaries.
When business interests are transferred through a will or trust, a fiduciary, such as an executor or trustee, will be responsible for managing your affairs and will be subject to fiduciary duties to ensure your business is protected during the administration of your will or trust. For a cannabis business, a fiduciary must take additional steps to properly protect your interests.
For example, in Colorado, a court-appointed executor can apply to become a temporary appointee. Becoming a temporary appointee allows an executor to apply for a marijuana license from the state licensing authority. If appointed, the executor can manage and operate the business in addition to executing the terms of the will. Such an appointment is temporary, and a judge determines how long it remains in effect.
Given the uncertainty surrounding marijuana on the federal level, a fiduciary may be concerned about exposure to civil or criminal liability. Additionally, because states closely regulate the control and operation of marijuana businesses, a fiduciary may face the same issues as an heir in undergoing the application and approval process by the state’s regulatory authority. For these reasons, cannabis business owners should select an executor or trustee they trust not only with personal matters but also with the intricate regulatory requirements governing cannabis operations. A well-drafted estate plan also identifies alternate qualified fiduciaries available in the event your first choice declines to take on the responsibility.
3.) You can prepare for regulatory actions.
Even when you designate a successor, regulatory agencies decide whether to grant that successor a license. A good succession plan includes a contingency plan in case regulators do not approve your intended successor.
Example: Suppose you own a cannabis cultivation business in Ohio and wish to transfer it to your nephew through a buy-sell agreement (discussed below) or a will. Upon your death, your nephew attempts to assume ownership, but the transfer is delayed because your nephew must first apply for and be granted a cannabis license. In Ohio, the Department of Commerce, Division of Cannabis Control may deny or delay approval if the proposed owner fails a background check, lacks proof of capital, or otherwise does not meet licensing criteria. A good succession plan will consider all possible scenarios.
When planning, consider the following:
- Understand your state’s specific licensing requirements and eligibility standards before naming a successor. Have an open discussion with your intended successor about these requirements so they understand what’s necessary to qualify.
- A plan can make ownership transfer contingent upon the successor meeting all state licensing and eligibility criteria. Reassess your plan periodically to confirm that your chosen successor remains qualified.
- If a named successor no longer meets your state’s criteria, consider requiring other members of the business to buy out your interests (more on cross-purchase agreements below).
- Plan for potential delays, as even qualified applicants may face lengthy review times. Include provisions that allow other license-holding partners, employees, or fiduciaries to manage or temporarily assume ownership until approval is granted. If there are no other license-holding partners or employees who can temporarily assume ownership, ensure that your designated executor or trustee understands what to do if the business is interrupted for long periods from both a regulatory and financial standpoint. For planned events, such as retirement, require the successor to begin the approval process early on, before the owner’s final departure.
4.) A succession plan can be tailored to your needs.
A succession plan can include contractual agreements, often called buy-sell agreements. One type of buy-sell agreement is a redemption agreement, where the company buys back the shares or interest of an owner. This way, the interests do not pass to the owner’s heirs, or anyone else, and the value of the decedent-owner’s interest is liquidated for the benefit of the estate.
Another type of buy-sell agreement is a cross-purchase agreement, where the owners of a company purchase the shares or interests of the deceased, retiring, or incapacitated owner. One can also include these buy-sell provisions in the company’s operating agreement, which may include rights of first refusal. The best practice is to coordinate your estate planning documents (will and trust) with the operating agreement.
Many businesses use life insurance policies to fund these types of arrangements. There are some specialized insurance companies that have key-person insurance policies available specifically for cannabis businesses. Businesses pursuing life insurance policies should ask a professional about the implications it will have on the valuation of the company.
Lastly, an owner can always choose to sell their business to another cannabis business as an exit strategy. However, business owners should keep in mind that transactions of such nature may take a long time to close. That is why an effective succession plan is essential for cannabis business owners who wish to preserve the value and legacy of their enterprise. A properly drafted buy-sell agreement that aligns with state licensing rules and is supported by a coordinated estate plan can prevent costly interruptions and legal complications.
By preparing early, maintaining compliance, selecting qualified successors, and considering alternatives, cannabis entrepreneurs, you can facilitate a seamless transition that protects your business.
