Written by Louis Levey
Cannabis companies are in need of top-notch financial teams to stay afloat. However, few professional financial teams are willing to become involved in this budding sector. This is unfortunate as many fledgling cannabis companies find themselves facing a plethora of finance-related challenges alone, which is especially problematic during the start of their ventures.
The cannabis sector is one of the most highly regulated industries. As a whopping one out of five cannabis companies get audited, compliance with these regulations is essential. And with 280E plaguing the industry, the heavy tax burdens associated with this industry demand a sophisticated and expert financial and accounting team to mitigate these issues, while ensuring these companies remain profitable and compliant.
Traditionally, companies seeking help with their financial functions had two options: third-party accounting firms and in-house teams. In cannabis, however, each of these options has serious shortcomings.
In this article we explore a third, new paradigm that was created specifically for cannabis companies and has quickly emerged as the option of choice for many companies looking for leading-edge financial solutions at a price they can afford: the fully-integrated financial partner model.
Third-Party Accounting Firms for Cannabis
Third party accounting firms, including traditional accounting firms and the more modern virtual accounting firms, aren’t a permanent financial solution for a company’s financial function, but they can benefit companies during the beginning stages of development and with more specialized tasks such as due diligence and financing support.
The primary benefit of using a third-party accounting firm is efficiency, namely that they’re paid for the services they provide; there’s no training, no salary, no severance, no office, and no overtime pay. Instead, these service providers receive payment for the precise number of hours the company needs and for the specific services they provide.
Third-party accounting firms are also flexible. This makes them excellent for supplemental financial services, which can be vital to a cannabis operation’s success during times of intense growth or slow-downs. However, in the cannabis world, this option is far from a panacea to the financial struggles facing companies.
First, there are very few outside firms that actually specialize in cannabis and such specialization is crucial to success in the industry. In large part, this is because prior to federal legalization, such firms could be opening themselves up to potential liability. In the cannabis industry – which is characterized by regulations demanding compliance and costly infractions – this is problematic.
Second, third-party services often can’t offer the level of support to guide cannabis companies through the murky waters of compliance. Because they are not operating as an integrated partner, clients of such firms need to face the obstacles inherent in dealing with outside third parties. Several intangible factors also play a role here, such as the third party’s own independent rules and procedures, firm culture, and general modus operandi. Thus, they’re likely best used as a crutch to facilitate growth during the beginning stages of a cannabis venture or as supplemental services, but not as a replacement for a company’s full financial department.
Finally, many cannabis companies themselves are reluctant to outsource their entire financial operation. Given that the financial aspect of any business is so integral to its success, companies want to retain close control over their financial team. In other words, cannabis companies demand a level of dedication and attention that is often elusive from a service provider that is not part and parcel of the organization. For that reason, many companies choose instead to hire in-house financial teams. That solution, however, is also riddled with problems when dealing with the cannabis sector.
In-House Financial Teams for Cannabis
Historically, building out an in-house financial team was considered the most desirable option for financial services. “This lasted till about a decade ago. As technological advances allowed for alternatives to became viable, costly in-house teams became less appealing to business operators looking to save on costs,” according to Wallstreet Capital’s Cristian Cecchini.
While having an in-house team allows companies to have constant access to financial services at will and on demand, in-house financial teams don’t always work as expected. This is especially the case when a cannabis company brings in an in-house CFO, which it hopes will manage the entire financial function. “Most of the time, this single hire becomes the go-to for all financial responsibilities”, says Cecchini.
Regardless of an in-house CFO’s professional background or experience, having a single person handle all financial matters becomes a bottleneck for cannabis companies. While this individual might be skilled in certain aspects of the business, they likely lack expertise or capacity to cover other areas. The single in-house hire can quickly become overwhelmed as a result, and this risks the company’s financial health.
Conversely, hiring a larger in-house team becomes a major financial strain on companies. According to CFO.com, the starting salary for a competent in-house CFO alone costs at least $175,000, with the more qualified individuals commanding nearly $400,000 annually. For larger teams consisting of bookkeepers and controllers, between salaries, training, overtime, benefits, paid holidays, overhead, and other expenses, these costs can easily enter the seven-figure range and can become prohibitively expensive.
This is exceptionally costly for cannabis companies in particular because 280E doesn’t allow plant-touching companies to deduct finance and accounting expenses. Since these expenses are non-deductible, it can have a significant impact on company cash flow. Accordingly, neither of the two traditional models of an accounting and finance function (i.e. the third party accounting firm model and the in-house house team model) works for cannabis.
These challenges inspired the development of a third, new type of financial solution: the fully-integrated financial partner.
A 21st Century Innovation in Cannabis Finance
More and more cannabis companies are turning away from the traditional models discussed above in favor of a novel solution coined the fully-integrated financial partner model. In the fully-integrated financial partner system, an outside financial firm provides a team of dedicated experts to operate as an in-house team, but on a fractional basis, while leveraging the platform and resources of the broader organization. According to Okitoki CEO Sasan Salek, who was one of the earlier adopters of the new system, the fully-integrated financial partner model has enabled his company to “gain access to top-notch financial services that we could have never afforded otherwise.”
The concept of the fully-integrated financial partner was first created by Northstar Financial Consulting Group in 2016 and quickly gained traction helping to propel Northstar to become one of the most recognized cannabis-focused accounting and finance firms in the country.
Lorenzo Nourafchan started Northstar in 2011 after a successful career running the financial department for multiple Fortune 500 Companies in the technology and entertainment sectors. As he began to take on cannabis clients, Nourafchan recognized that cannabis companies needed something different from the traditional models. Many of his clients, although wanting to take advantage of Northstar’s platform and breadth of expertise, did not want to relinquish control over their financial functions, especially in light of the unique dangers facing the cannabis industry at the time. Specifically, given cannabis’s status as a Schedule I narcotic and the unrelenting audits facing the industry, any misstep on the financial side could mean potential criminal liability for business owners.
Nourafchan realized that his cannabis clients needed the comfort of an in-house team, even if they could not afford to hire one full time. “Cannabis clients want to know that they have a financial team that is dedicated to them, that is invested in them, and that they can call upon at any time of the day or night, whenever there is a need,” said Nourafchan. “Unfortunately, hiring a full-time bookkeeper, controller and a CFO to be on staff is not always in the cards.”
For that reason, Northstar created the fully-integrated financial partner model, which in practice means that “Northstar’s bookkeeper becomes the company’s bookkeeper, Northstar’s controller becomes the company’s controller, and Northstar’s CFO becomes the company’s CFO,” in Nourafchan’s words. “Cannabis is unique that way,” said Nourafchan; “these companies need a level of dedication that is beyond that which other industries need.”
By using Northstar’s model, cannabis companies have been able to get access to much needed sophisticated financial and accounting solutions, “which is especially important given the very complicated financial and tax rules”, according to James McCalister of Regal Investment Advisors. The fully-integrated partner model also avoids the cookie-cutter approach third-party service providers commonly use, and enables companies to bring on specialized roles such as a Chief Financial Officer and Treasury, even when such companies normally would not have been able to afford such positions in their operations.
This is made possible because clients are able to pay only for the hours they are using, which Nourafchan says leads to substantial cost-savings, especially since his firm has streamlined the financial process to a large degree and is now able to take advantage of economies of scale.
Companies also save on common administrative expenditures. The model bypasses the need to pay benefits, training, overtime, and costly salaries typical for in-house teams. Clients also don’t have to pay for HR or office space. This is made possible because financial partners operate as an in-house team working remotely, which has enabled more companies to improve efficiencies, reduce expenses, and ultimately enhance earnings.
“It’s essential that cannabis companies have an accounting and finance team that knows cannabis inside-and-out, which is a rare trait in today’s world,” says Robert Yadgarov, a corporate attorney on the east coast. “Not just because many companies can’t afford to hire in-house, but also because the finance team needs such a level of cannabis-specific specialization, such as with regards to 280E and 471 cost accounting, and there aren’t that many people with those skills on the market.” After working with Northstar on an engagement, Yadgarov noted that “Northstar’s partner model gives cannabis companies the best of both worlds. These operations receive the expertise of a leading accounting and tax firm with the dedication and care of an in-house team at a fraction of the cost.”
The Future of Financial Services for the Cannabis Sector
The success of Northstar’s fully-integrated financial partner model was in large part made possible thanks to the technological advances that have enabled financial teams to operate remotely, yet effectively. This has also helped drive down costs in terms of office space and transit time, which savings are then passed down to clients. This has become especially vital during the COVID-19 pandemic, which ironically has become a massive boon for Northstar’s business.
Northstar is one of a handful of firms that has experienced explosive growth in 2020, nearly tripling its workforce. “Prior to the pandemic, several potential clients were weary of working with a financial team that was not housed in their own brick and mortar buildings. Today that has changed. Luckily we were fully geared up to work remotely from day one so we didn’t waste any time getting up to speed, and our clients were able to use that to their advantage,” says Nourafchan.
The fully-integrated financial partner model is something more cannabis companies are moving towards. As more people are working remotely than ever before, the model has been a proof of concept for businesses in need of a financial solution that performs more effectively than a third-party firm and more efficiently than an in-house team. With firms like Northstar leading the way, this model is likely to become an industry standard as cannabis business operators experience the benefits this model has over traditional financial service solutions.
Published: January 28, 2021
Founder & Interim Editor of L.A. Cannabis News