Successful cannabis businesses are strategic, savvy, and clever. They have to be, don’t they? With harsh regulations like Internal Revenue Code (IRC) Section 280E, banking restrictions, and the unfortunate fact the plant remains federally illegal, the industry is not for the faint of heart.
Business leaders in the space typically accept these struggles as “part of the job.” But recent advancements, such as the adoption of employee stock ownership plans (ESOPs), have enabled businesses to reap tax benefits and operate with higher margins.
What is an ESOP? To put it simply, ESOPs are another way for a company to sell itself. Sure, you can sell your company to a private-equity investor or a strategic buyer who will help the business grow. But you also can sell your company to your employees, creating an ESOP structure.
You might be wondering, “Why would I sell my company to my employees rather than securing a juicy offer from a high-profile investor?”
Consider what happens when you sell to a private-equity firm. Capital gains taxes alone can siphon off hundreds of thousands, if not millions, of dollars. But, when you sell your firm to your employees via an ESOP, you can defer those capital gains indefinitely.
Why would the government allow something like that? The truth is, the government wants employees to become owners. In the 1950s, the government wanted to find a way for capitalism to work for everyone. But capitalism only works for everyone if everyone has equity. So, the government began incentivizing companies to sell to employees by offering tax benefits. For instance, if you establish your company as an S corporation and then sell 100 percent of the company to employees by way of an ESOP, the company itself pays no federal income tax. In most states, it doesn’t pay state income tax either.
So, what’s in it for the business owner? Selling the company to the employees provides the business’s former owner with a substantial payout and a way to diversify their equity.
Publix is an ESOP. Inside a Publix store, the level of service is remarkable and distinctly different from other stores. Everyone is kind and helpful. Is it possible to have the same experience at Walmart? Sure. Is it common? Not really. Publix’s exceptional service is partly because the employees understand how their roles directly impact the company’s success. And the success of the company directly affects their personal profits. A Publix cashier potentially could become a millionaire due to the ESOP structure.
Which is why it should come as no surprise that cannabis businesses are adopting ESOPs. Earlier this year, Theory Wellness became the first employee-owned cannabis company in the country. Since then, more businesses have moved or are moving toward creating an ESOP structure. Some of these companies have doubled or tripled their cash flow, which is crucial in this industry. Additionally, employees now have substantial equity, making them a key aspect of the company’s success.
Employee ownership impacts company culture, employee motivation, job satisfaction, and overall business performance. Think about it: Once an employee understands they’re an owner, their mindset shifts. They’ll work harder, care more about the work they’re putting in, be more productive, and be less likely to quit. According to a Rutgers University Study, productivity increases by approximately 4–5 percent per year in an ESOP-structured company. In addition, employee retention increases by as much as 300 percent. According to the National Center for Employee Ownership, turnover at ESOPs is around 10.8 percent, whereas the turnover rate at more traditionally structured companies is about 27.1 percent.
But the cannabis industry has another benefit to gain from ESOPs. IRC Section 280E ensures this industry is taxed differently from any other industry in the United States. The tax code prohibits cannabis businesses from offsetting against income anything except cost of goods sold. Industry businesses can’t deduct salaries, rent, marketing, or anything else businesses in traditional sectors routinely deduct. An ESOP makes 280E irrelevant, because ESOPs don’t pay income taxes.
With the tax benefits, boosted productivity, and increased cash flow ESOPs provide, I believe the cannabis industry will embrace the structure.
As managing partner at MBO Ventures, serial entrepreneur and prolific angel investor Darren Gleeman assists clients with employee stock ownership plans (ESOPs) and capital management. He holds a patent on ESOP methodology for the cannabis industry and received Green Market Report’s 2024 Top Financial Advisor award.
