The days of forming a partnership on a handshake are long gone for most; the sad fact of the matter is that–without a formal cannabis partnership agreement in place to protect your business interest–a cannabis partnership can be a dangerous thing.
Formal cannabis partnership agreements protect business interests–for all parties involved. They ensure your taxes are allocated equitably, as well.
But what else goes into an ‘elevated’ partnership agreement?
Here’s a basic rundown of what your cannabis business partnership agreement should cover:
- Ownership, profit and loss distribution, how long the partnership will remain in-tact, and each partner’s roles and responsibilities.
- Potential liabilities or issues and resolutions.
- How to handle taxes.
Need some expert help in creating your cannabis operating agreement? Contact us today for assistance.
What’s a Cannabis Partnership Agreement?
A cannabis partnership agreement is a contract that outlines the terms and conditions agreed upon–by all parties involved–for a business relationship. Here’s what the agreement should highlight:
- Profit & Loss Distribution
- Business Relationship Longevity
- Outline of Roles & Responsibilities for Each Party
- Partnership Termination Process
- How/If Other Party(ies) can Purchase Partnership Share
Before finalizing your contract, a lawyer should analyze it to ensure the terms are enforceable and reasonable. It’s also a good idea to have a CPA specializing in cannabis to look over the agreement’s financial implications to clarify who will handle the taxes.
Types of Cannabis Business Partnerships
In cannabis, two main types of partnerships have become the go-to; the general partnership and limited partnership. General partnerships are comparable to sole proprietorships. But the main difference is that in a general partnership, your business can have multiple owners. Setting up a general partnership is a relatively straightforward process, too; you’ll use your name or set it up under a different name after applying for a DBA certificate.
Limited partnerships are sometimes preferable, especially if investors are involved. This ensures the investors are not responsible for controlling or operating the canna-business while limiting their personal liability. These are easy and inexpensive to set up, have a single tax, and can be owned by multiple partners. But there’s still unlimited personal liability for general partners, the issue that all partners are legally responsible for the actions of the others, and general partners’ interests in the business cannot be sold without all other partners’ consent to keep in mind.
What Protection Does a Cannabis Partnership Agreement Provide?
All parties involved stand to benefit from a partnership agreement. This is one of the most effective ways to safeguard business investments because it offers better management and more protection.
Here’s what your partnership agreement offers:
- A way to set roles and responsibilities for all parties involved. The agreement should clearly show who is responsible for what. Explain who will take on the role of management and when/if/how the roles and responsibilities change.
- A safety net to prevent legal and liability problems. The agreement should highlight who is taking on the liability and what occurs to the other partners if one partner has a problem.
- A place to outline methods for resolving disputes. While we always hope nothing goes awry during a partnership, there’s still the possibility for something to go wrong. Even in the best partnerships, significant disputes can occur–and they must be handled appropriately to ensure the partnership survives. Outline the procedures regarding how you’ll vote on issues and make recommendations for resolutions in case of specific scenarios.
- A recording of the partnership’s profit distribution methodology. Profits could come from your partnership, and if/when they do, your partnership agreement will demonstrate how the profits will be distributed in a way that all parties have agreed upon. This distribution should also take generally accepted tax principles into consideration.
- A way to handle tax issues from the beginning. With so many layers of taxes throughout the cannabis supply chain, understanding who is paying what taxes when is essential for a lasting partnership. This is your opportunity to assess who will handle each tax burden to ensure no surprises when it comes to paying these taxes.
In essence, your partnership agreement should handle all potential situations that could cause confusion, change, or disagreement. With so much that could occur, it’s always a smart move to go in-depth while creating your partnership agreement, making them as thorough, mutually beneficial, and specific as possible.
Cannabis Business Operating Agreement vs. Partnership Agreement
Operating agreements differ from partnership agreements. They outline the operations of LLCs, comparable to how the by-laws of corporations show how the business operates. But the main thing these two agreements have in common is that they both set terms and conditions for all parties involved.
Similar to an LLC operating agreement, partnership agreements are relatively flexible. They show how you and your partner would like to operate the partnership. But these agreements also specify how profits and losses are handled, as well as each partner’s duties and obligations.
The complicated aspect of these agreements is in calculating tax liability. If you have a multi-member LLC, tax liability should be calculated in each member’s personal income. But there’s more to it than that.
For instance, in a case of personal income tax liability, if you’re receiving income from a partnership or LLC on a K-1 and W-2 income from a salaried day job, describing future tax liabilities becomes challenging. This is because if either of those incomes increases, you could find yourself in a new tax bracket.
So what would you do here?
You have a few options.
One option is to provide a rough proxy of tax liability in the partnership agreement. This could involve setting it up to ensure each party will receive what’s equal to the cannabis excise tax amount in addition to their distribution to cover taxes. In Cali, this would be 15%.
You also have the option to outline which partner is liable for certain taxes throughout the cannabis product supply chain. For instance, a cannabis retail operator must be responsible for collecting and remitting cultivation taxes from the cultivation partner.
However, the method that we suggest is to make tax liability for personal income each individual’s responsibility in the partnership. This effectively removes tax responsibilities from the partnership. By outlining this in your cannabis operating agreement, you’re avoiding tax issues that could occur down the line.
But you can further decrease your tax liability in a partnership by charging it to your customers when possible. For instance, California charges a 15% cannabis excise tax that you can add to your customers’ receipts. This strategy covers some of the tax burden. However, you’ll still have to pay more in taxes on your gross receivables.
Are Operating Agreements Required?
One of the most common questions we get asked is, “Are operating agreements required?” This, of course, depends on which state you reside and your company.
While we recommend always having a partnership agreement in place, here are the states that demand you to create an operating agreement for an LLC:
- California – California LLCs must have an operating agreement. While the agreement can be written or oral, written agreements–along with any amendments made–have to be included in the company’s records.
- Delaware – Operating agreements must be created before, during, or following filing LLC formation paperwork. The law is rather lenient, though, and the agreement can either be implied, written, or oral. Regardless, the best practice is to put it in writing to ensure no issues arise at some point in the future.
- Maine – Similar to Delaware, Maine demands an operating agreement before, after, or during your time of filing for an LLC. This agreement can either be implied, written, or oral too.
- Missouri – Missouri LLCs also must have an operating agreement. However, it can be written or oral. The agreement should outline the affairs of the LLC, the conduct of the business, and the powers, rights, and duties of members, agents, managers, or staff.
- New York – LLCs in New York need a written operating agreement. The documentation must include any provisions related to the business and its affairs, as well as the rights, limitations, responsibilities, and preferences of all partners.
State laws in California, Delaware, Maine, Missouri, and New York require you to create an LLC operating agreement. But regardless of where you reside, it’s always best practice to craft a formal agreement between LLC members.
In some instances, you might not share an LLC with your partner(s). Even if this is the case, creating a cannabis operating agreement is something we recommend to minimize the chance for disagreements in the future.
So what happens if you find a company you want to partner with? Bringing another cannabis operator into your business operations should involve a cannabis business partnership agreement.
Should You Use a Simple Partnership Agreement Template You Found Online?
While a simple partnership agreement template you found online could be better than nothing, you may be opening yourself up to liability by using one. Whether you’re considering a partnership template in Word or are searching the internet for a 50/50 partnership agreement template, there’s usually more involved in creating a small business partnership agreement for operations in the cannabis sector.
Here are the reasons we suggest avoiding a simple partnership agreement template:
1. It’s easy to overlook the opportunity for arbitration.
While free boilerplate contract forms might seem appealing, they don’t always take everything that could go wrong into account. Arbitration is more straightforward and more cost-effective than litigation in a courtroom. Thus, it’s worth considering having an expert draft your agreement. A professional knows the proper partnership agreement format and should understand how to draft a contract that incorporates an arbitration clause following relevant state and federal law. This ensures your contract is enforceable and provides parties with the option to resolve issues outside of court.
2. A simple partnership agreement template doesn’t know your rights.
Contract forms don’t advise the parties of the law and their rights. This is especially important in cannabis as it’s still a maturing industry. While the process of creating a partnership agreement using a template is user-friendly, without knowledge of your rights, it’s challenging to create a contract that takes these rights into account. This can lead to additional expenses participants would otherwise avoid paying.
3. An expert knows how to write a partnership agreement from scratch.
Someone who has studied partnership agreement creation and has experience drafting them will know what you don’t know. This ensures you’re not leaving any money or opportunities on the table, missing an essential clause pertinent to the cannabis sector, or making an unnecessary obligation. Furthermore, it’s necessary to consider that ambiguity in contracts is marked against the person or people who wrote the agreement in a court of law.
4. 50/50 partnership agreement templates can omit crucial language.
Contract templates don’t always include the right language, typically copying information from free-source Internet sources. Amateur contract drafters don’t know this language, so it’s ideal to have an expert create the contract. Drafting the agreement using a template can result in the omittance of information and required language the law demands in the agreement. In most cases, it’s best to hire a lawyer to ensure the paperwork is correctly drafted as the delay the bad documentation causes usually exceeds the cost of hiring someone to create the contract right initially.
5. Templated partnership agreements aren’t tailored to your specific needs.
Free contract forms don’t always address the legal issues unique to the cannabis sector. For instance, if you’re a cultivator working with a retail store, you’ll find it challenging–if not impossible–to find a 50/50 partnership agreement template that fully covers the different complications that could arise while conducting business. You’ll need a series of clauses that address all issues that could push you into court to resolve a dispute should one occur.
6. A partnership agreement PDF will not account for how state laws and regulations differ.
This is especially the case for cannabis operations. Some states have laws demanding specific language for the cannabis industry, and leaving this out of your partnership agreement can result in consequences for all parties involved. An expert knows to check your state’s specific language requirements to ensure they’re drafted with legitimacy in mind, which could save you time and money that would otherwise be spent in a courtroom.
Interested in expert assistance drafting your cannabis partnership operating agreement? Contact us today for expert assistance.