As Maryland’s adult-use cannabis market approaches its two-year anniversary, dispensary owners now have a way out of a business without having to wait five years before they can transfer their license.
Gov. Wes Moore signed SB 215 into law on April 22. As part of a larger assortment of adjustments to the state’s market, the legislation created an exception to the five-year restriction for cannabis businesses that wish to convert to an Employee Stock Ownership Plan (ESOP).
Aside from the ESOP waiver, the bill included a series of reforms for the state’s relatively young adult-use cannabis market, such as clarifying some of the rules for consumption lounges and allowing the Office of Cannabis Management to ensure that at least 25% of dispensary shelf spaces are reserved for producers with social equity status.
“Given the current pause in federal rescheduling efforts and challenges facing cannabis M&A, ESOPs represent a compelling exit strategy – particularly in Maryland’s evolving regulatory landscape,” wrote Charles Alovisetti, a partner at Vicente LLP, in a social media post in response to the news.
ESOPs allow companies to bypass 280E
An ESOP is a form of business ownership where the equity of a private company is held in a trust that acts as a benefits fund or a 401(k) for the employees because they all own a piece of the company. In order for a business to convert, the owner has to essentially sell the business to this trust with a third party financing the transaction.
“It’s another way for a business owner to sell their stock or their equity in the company,” said Andrew Nikolai, vice president at New York investment bank CSG Partners, during a February 2024 webinar on cannabis ESOPs. “Instead of selling it to a strategic or financial buyer like a private equity firm, you’re selling the company to your employees.”
ESOPs offer valuable tax benefits. The seller can defer paying capital gains taxes on the transaction if they elect to convert the company to a C corporation. If the company is converted to an S corporation, it becomes exempt from paying income taxes. For cannabis companies, this is particularly significant, because it allows them to avoid the 280E tax restriction, which prevents them from writing off business expenses on their federal taxes.
Setting up an ESOP can be complicated, however, and it typically requires an administrator and ongoing costs to keep it active. This means that an ESOP may not be beneficial to all companies.
“The floor for an ESOP would be about $2.5 million in net income and 20 employees,” said Darren Gleeman, managing partner at MBO Ventures, another ESOP investment bank in New York. Gleeman was speaking as part of a panel on cannabis ESOPs hosted by AAFCPA, a Massachusetts-based CPA consulting firm.
Gleeman noted that ESOP conversions do not have to be for the entire company. An MSO could convert in a single-state market, or a vertically integrated company could consider converting just one part of their business.
“I think retail is certainly where you get it the hardest,” added Hannah King, a partner at Dentons, during the same panel. “That is probably where you’re going to get the best benefit.”
Cannabis ESOPs are rare
ESOPs in the legal cannabis industry are rare, according to the National Center for Employee Ownership (NCEO).
“There are a handful of cannabis businesses that are now ESOPs in other parts of the country. For businesses that are large enough and profitable enough to have an ESOP, an ESOP can help avoid some of the particularly onerous tax obligations that cannabis companies can face,” says the NCEO website.
The first cannabis company in Massachusetts, and possibly the country, to convert to an ESOP was Theory Wellness in December 2023. Other companies have followed.
“Providing an opportunity for our team to benefit from the value we are all building in Canna Provisions has been our top priority,” said CEO Meg Sanders in a March 28, 2024, press release announcing that Lee, Mass.-based Canna Provisions had converted to an ESOP.
“We are incredibly proud to ensure that with this move, we now all win together,” she added. “This transition, and now our ‘ownership’, will extend to a diverse spectrum of the community across social equity, veterans, and women in cannabis.”
Washington’s legislature considered allowing cannabis businesses to convert to an ESOP this year. Similar to Maryland, Washington also limits who is allowed to own cannabis licenses, so the state would need a legislative fix to allow ESOPs to take part in the industry. The bill, HB 1348, was discussed in the House Committee on Consumer Protection and Business in February. However, April 27 marked the official end of the legislative session for Washington, so ESOPs will likely have to wait until 2026 before state legislators can make another attempt at legalizing cannabis ESOPs.
