Cannabis businesses are usually limited liability companies (LLCs). There are a lot of reasons for this, starting with the fact that LLCs are more flexible than corporations, which have much more rigid rules. To take advantage of those flexibilities, and for a lot of other reasons, LLC owners (called members) need an operating agreement. Below, we’ll look at a few big reasons why cannabis LLCs need operating agreements.
Cannabis LLC operating agreements don’t need to cost a fortune!
Cannabis entrepreneurs don’t want to incur massive costs just to simply get a business on paper. The good news is that cannabis LLC operating agreements don’t need to be overly complicated. Unless a business has a very exotic setup or tons of classes of equity with different rights, they can often be pretty simple to put together. Any good cannabis attorney will have a number of templates to work from. And the simpler the LLC, the lower the cost.
The one big side note here is that like with any other contract, there are TONS of bad examples floating around online. We’ve seen tons of people try to pull LLCs from a search engine result and tweak them to fit their business. Without legal training, this is a bad idea. Even though LLCs don’t need to be rocket science, there are intricacies that non-lawyers just won’t be familiar with.
What happens to a cannabis LLC without an operating agreement?
Starting a cannabis business is expensive. People often ask whether getting corporate governance docs like operating agreements is even necessary. The answer is almost always yes, and here are some of the issues that can arise without them:
Financial institutions may not let a business open an account without basic corporate governance documents.
Regulators may demand that licensees show them operating agreements.
Other state laws may require operating agreements.
Even in states that don’t have operating agreement requirements, LLCs without operating agreements would be governed by statewide corporate law. This can be a big wasted opportunity in states that allow operating agreements to be more flexible than what’s allowed under state law.
There can be all kinds of ownership issues without an operating agreement. The members will have a hard time establishing ownership percentages. They’ll also have a hard time establishing different management rights. And they also probably won’t be able to create different classes of equity.
These are just a few of the consequences of not having an operating agreement. I want to now talk about a few additional reasons why they are so important.
Cannabis operating agreements limit infighting
A while ago, I wrote a post entitled “50/50 Cannabis Business Ownership: A Terrible Idea.” The thesis – which still holds today – is that in LLCs with 50/50 ownership, decisions can be impossible to make if members aren’t on the same page. This can cause companies to fail hard. I have seen this happen many times. It’s truly an unforced error. Cannabis LLCs need operating agreements with deadlock provisions that can easily negate these issues. Even beyond this though, having an operating agreement that clearly defines management, profit-sharing, capital call rights, etc. is the only way to tamp down the myriad micro and macro disputes that occur during the life of a cannabis LLC.
Cannabis LLC operating agreements make life easier in the future
Imagine a company that starts off with an overly simple OA and a few members. Over time, new members come into the company. At the point where there are a dozen members, the cannabis LLC decides it needs an operating agreement with teeth. Chances are, the cannabis LLC needs to get the consent of all members. This can be really challenging– even more so with hostile members who don’t want to make changes, or if changes would materially affect members. This is why cannabis LLCs need operating agreements to be solid from the outset.
While a cannabis operating agreement doesn’t need to cost a million dollars, getting it right is a huge investment. To some extent, this requires a bit of future telling: a cannabis entrepreneur who knows she wants to be the sole member of her LLC forever can stick with a single member LLC. A different entrepreneur who intends to expand in the future probably will want a more comprehensive LLC operating agreement. Getting this right on day one can save tons of money and pain in the future.