September 22, 2023

Cannabis Reclassification? Big Cash Implications

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The cannabis industry has experienced unprecedented growth and transformation in the past two decades, with the majority of U.S. states having some mechanism for legalization and countries worldwide embracing sale and use for both medical and recreational purposes. A pivotal development on the horizon has come with the announcement that the U.S. Department of Health and Human Services (HHS)has recommended that the DEA reclassify cannabis from its current Schedule I status to a Schedule III “drug” under the Controlled Substances Act. This reclassification has the potential to shake up all sectors of the cannabis industry, with far-reaching implications for investment, banking, capital raising, and taxation.


The current classification of cannabis as a Schedule I drug has posed substantial challenges for those operating legally within the industry, as it is placed alongside substances like heroin and LSD. This renders cannabis illegal at the federal level and subjects the medical and recreational markets to rigorous regulatory scrutiny. As a result, cannabis businesses have an enormous barrier to entry, encountering numerous obstacles including limited access to banking services, difficulties in securing capital via conventional channels, and complex tax issues.


The potential reclassification of cannabis to Schedule III would signify a significant shift in the federal government's stance on the cannabis industry in general. Schedule III substances are generally considered to have a lower potential for abuse and recognized medical applications: a stark contrast to the current classification. Such a change could unlock numerous opportunities for the cannabis industry, notably in many key financial areas:


Investment Prospects: The immediate impact of reclassifying cannabis to Schedule III may generate increased interest from investors. Currently, many investors are leery of wading into the uncertain waters of an industry that deals in a federally illegal commodity and the inherent risks associated with such. Currently, prospective investors remain cautious about entering the cannabis industry due to the inherent legal risks associated with Schedule I substances. However, a shift to Schedule III would substantially diminish these risks and stigma, which may lead to an increase in investment capital through a variety of equity mechanisms. With more investors willing to participate, cannabis ventures may have less difficulty in obtaining the funding required for business expansion, applicable licensure, product development, and research initiatives. This could result in a more competitive and innovative industry, ultimately benefiting consumers and patients.


Improved Access to Banking: One of the most formidable challenges confronting cannabis businesses has been their limited access to banking services. Given the federal illegality of cannabis, many banks have been reluctant to offer financial services to these entities. Although a select few banks are willing to back cannabis businesses, many enterprises within the space have been compelled to operate primarily on a cash basis, introducing security risks and hindering effective financial management.


Reclassifying cannabis to Schedule III could reshape the current status quo. Banks may become less reluctant to working with cannabis businesses, granting them access to crucial financial services that “regular” businesses take for granted such as checking accounts, loans, and merchant services. Expanded access to banking would not only enhance the financial stability of cannabis companies but also foster transparency and regulatory compliance.


Capital Raising and Initial Public Offerings (IPOs): Another significant area where reclassification could exert a substantial impact is in private and public capital raising and initial public offerings (“IPOs”). Presently, cannabis companies face formidable obstacles when attempting to go public or raise capital through traditional financial markets. The stigma associated with the Schedule I classification, combined with legal risks, has deterred numerous investors and institutions from involvement.


However, if cannabis is reclassified as a Schedule III substance, it could potentially facilitate more cannabis companies in going public transactions, such as reverse mergers and IPOs.  This may present a new avenue for growth and expansion within the industry, as well as offer opportunities for investors to engage with the fledgling cannabis market.


Taxation Considerations: The tax implications of reclassifying cannabis to Schedule III cannot be understated. Currently, cannabis businesses face unique challenges related to federal taxation, including Section 280E of the Internal Revenue Code, which restricts their ability to deduct ordinary business expenses. Reclassification could lead to changes in federal tax policy, potentially allowing cannabis companies to benefit from tax deductions just like other legal businesses.


In summary, the prospective reclassification of cannabis from Schedule I to Schedule III is a development that could have extensive implications across the board. While the move would not automatically legalize cannabis at the federal level, it could significantly reshape the investment landscape by enhancing access to banking services, unlocking avenues for capital raising and IPOs and addressing complex tax issues. Nevertheless, any adjustments to cannabis' scheduling will hinge on legislative and regulatory decisions, with the timing and extent of these changes remaining uncertain. Regardless, the potential for reclassification has generated excitement and anticipation within the cannabis industry, the investment community, and among taxation experts– hinting at a potentially transformative moment on the horizon that touches all aspects of the cannabis industry landscape.