Jessica Velazquez, Managing Partner and CEO of Indiva Advisors
Jessica Velazquez is Managing Partner and CEO of Indiva Advisors. She brings more than 15 years of experience and is Indiva's main authority on 280E and general tax matters for individuals, partnerships, and corporations. Jessica holds a Master of Science in Taxation from DePaul University and a Bachelor of Science in Accounting from Southern Illinois University. She is a licensed CPA in Illinois and Nevada and is actively involved in several professional organizations including the AICPA and NATP.
jessica@indivaadvisors.com
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EPISODE TRANSCRIPT
[00:00:01] You're listening to Thinking Outside the Bud where we speak with entrepreneurs investors thought leaders researchers advocates and policymakers who are finding new and exciting ways for cannabis to positively impact business society and culture. And now here is your host Business Coach Bruce Eckfeldt.
[00:00:30] Welcome everyone this is thinking outside the bud. I'm Bruce Eckfeldt. I'm your host and our guest today is Jessica Velazquez. She is managing partner and CEO of Indiva Advisors and we're going to talk a little bit about some of the intricacies of setting up and running cannabis based businesses. We're going to talk about 280. We're going to talk about general tax matters. We're talking about investors probably both finding and finding investors as well as people looking for places to put their money.
[00:00:56] And talk a lot about what's going on the cannabis space. Jessica welcome to the program.
[00:00:59] Bruce thank you so much. It's a pleasure to be here.
[00:01:02] Yeah. So I always like to start with the guest just giving a little bit of the background. What was your kind of professional story. And how did you get into cannabis.
[00:01:10] Yeah. A good start off I've been doing this for about 18 years now. I started my career in big four public accounting so's TWC why then left that after a few years and moved over into industry to run several corporate tax departments. So I have sort of that benefit of knowing what it is to be the auditor and then knowing what it is to be audit in the OR and they did.
[00:01:40] You've been on both sides.
[00:01:41] Absolutely. Because it's different perspective from both sides.
[00:01:46] So we did that for a few years and my last corporate gig as corporate tax director of a publicly traded multinational gaming manufacturer got acquired. It took a hiatus. I really was trying to see what my next move was really the old age question of where do I want to be when I grew up.
[00:02:07] And this is back in 2013.
[00:02:10] So around that time cannabis was starting to hit mainstream media. And you know Colorado and Washington went recreational in 2014 and I just really started doing a lot of reading around the subject matter. I've always been a proponent for the industry. The movement of progression and certainly decriminalization. Now I come from that aspect.
[00:02:35] And so it was like kind of the the crossroads of this passion for supporting the industry. And then also this gap that I saw of true qualified professionals in this space I think at the time when I was doing my research it was a lot of sole practitioners a lot of small mom and pop shops servicing the industry but not real technical know what I would say technical experts really helping folks on the ground.
[00:03:05] So that's really how I came to be in cannabis and I've been loving it ever since the firm was born in April 2016. And coming up on our three year anniversary graduations. Thank you so much. And we're just heads down doing what we do best accounting tax and advisory services for the industry.
[00:03:25] Awesome. So we've talked a little bit about on the program and previous episodes about 280 and some other factors or considerations when it comes to doing running cannabis based businesses but for the poor people that are kind of new to the series or haven't gotten into it before.
[00:03:41] Give us just a high level. What is the issue. Right so we've got this sort of federal law state law conundrum that we're in. How does it impact kind of accounting fiscal management of a kind of a space business. Give us some ground groundwork here.
[00:03:57] Absolutely. I mean Bruce as you know it's federally illegal as of today. So cannabis is still on the Controlled Substances Act and again sends 14 really all of these states have come on board and legalize it at the state level both for medicinal and adult use. So as you said this conundrum between state and fed right now poses an issue on quite frankly both the accounting and the income tax side the accounting side from the respect of lack of access to banking. As we all know they don't want to bank the cannabis industry so that really provides challenges on just the fundamentals of running a business. I mean lack of banking means a whole lot of cash and we've just not dealt with this type of cash for many many years since the introduction of credit cards and debit cards etc. I mean it's funny it used to be that way right.
[00:04:53] I mean businesses just don't with. No and now it's like I don't even get change changed I really like it. It's really changed. So it's almost this kind of anachronistic like we're having to go back business or have to go back.
[00:05:06] What do I do I need bolts I need security I need like bags that hold money absolutely and armed guards to carry all that cash in I need is now set up an appointment with my local IRS office so that I can go make a tax payment.
[00:05:22] This is fascinating when you're actually making a tax but it's federally illegal. But yet they will take tax over there will accept the tax but it's gotta be in cash because you can't. You can't do electronic transfers.
[00:05:33] Exactly. They don't have access to banking. Yeah. And then again sort of further penalized even by. By that most you know over ten thousand typically must be AC H or wires or some sort of bank transaction. No one's really trying to take that amount of cash. So again just all of these issues from just the basic fundamentals of being able to run a legitimate business and then now we move over to the tax side to this application of IRS Code section to EDI e so maybe to give you some background on that to EDI was implemented in nineteen eighty two.
[00:06:10] It was a cocaine drug dealer that submitted his income tax return with all of his necessary and ordinary business deductions just like any other business right. His rent his payroll his car allowance meals etc.. And when the IRS got it. I mean there was this real fundamental issue of Oh what do we do.
[00:06:37] Do do we allow illegal operators to operate like their legal counterparts.
[00:06:44] And so because of that too Eadie was born again out of that case. And now here we are 30 plus years later well into 80 basically to 80 he said you can't.
[00:06:58] You're not allowed. Like if you're if you're operating on an illegal or a business that deals with a federally illegal substance or business that you can not deduct those things as legitimate business expenses.
[00:07:09] That is correct. I mean in a nutshell what to Eadie says is that you're only allowed to deduct your cost of goods sold.
[00:07:16] So so let's think about that sort of in the context of this cannabis businesses. If you're a retail shop you're literally only allowed to deduct the cannabis that you purchase that you put on shelves for customers to buy. Right. So you're not allowed to deduct your payroll. You're not allowed to deduct the rent.
[00:07:35] You're not allowed to deduct marketing cost which is a standard course for every other business in America here.
[00:07:44] So you pay tax on profits. I mean the way the tax code is set up is that you're paying tax on the profit that you've made at a business so you take all of your costs you deduct all your expenses you're left with the profit you take your your percentage on that. They're basically saying no the only the only thing you do is take out your cost of goods all of your other operating expenses. Basically you have to pay for your profit after you pay tax on it.
[00:08:05] You got it. That is essentially at a rudimentary example is I made one hundred dollars I bought fifty dollars of Canada's product to make that one hundred and I spent another 40 dollars on rent payroll etc. might not profit is ten dollars in a traditional business you would pay tax on that ten dollars in this cannabis business you would pay tax on the fifty dollars the one hundred minus the fifty of the cost of goods sold which which could be greater than the ten dollars you had left over.
[00:08:37] Exactly. You can be underwater quickly.
[00:08:40] Yeah. Clearly in this example. That's exactly the case rate. It's more than the ten dollars that you do have leftovers. Now you're having to come out of pocket to pay the tax man. Yeah. So definitely challenges for operators currently in the industry. Again both on the accounting just the very basic fundamentals of being able to operate a standard business and then on the tax side with this verdict of over taxation. This is really what it is now.
[00:09:10] So but yet there is a thriving cannabis market in many states. So I mean I guess on the kind of expensive side I mean that the implication or that kind of logic is is that while there must be so profitable that they can afford to not have to deduct those expenses I mean is that basically what's driving this industry right now is that they can they can do it despite the fact they're being double or overly taxed.
[00:09:32] I mean there are significant margins and certainly operators that are running lean and really watching every dollars that you know they're they're making money. There's no question about that. There's operators however that are are really not profitable there.
[00:09:49] They're really just kind of going as far as they go with the intent I think to sell their business and make their their money on the back end or really sort of ride this wave.
[00:10:03] Right now it's a legislative action in Capitol Hill and there's a lot of discussion right now. There's a lot of movement. We now have a split house.
[00:10:14] I mean so again there is quite a bit of buzz on Capitol Hill around cannabis and so who knows we may see federal decriminalization sooner than we think.
[00:10:25] I think everyone in the tree is kind of waiting with bated breath. What's going to happen with federal law.
[00:10:30] So that's kind of the the I guess accounting profit side is like how this affects your you know how you how you count expenses how you can profit how you what you pay tax on. Are there any I guess maybe point of clarification on point of detail this. How do you determine whether or not you are going to fall under 280 rules. Like what's the guiding principle or what. What is it that causes that to come into full force of effect.
[00:10:56] Yeah I would say the guiding principle that really puts you into a too easy sort of perspective is if your plant touching. So from the operator standpoint typically these are the licenses rate a dispensary a production or manufacturing facility or a cultivation facility.
[00:11:16] If you're touching the plant you are quote unquote trafficking as defined by IRS Code Section 2 EDT. Yeah OK. So again that's sort of that term limit.
[00:11:27] So I'll give you a couple of edge cases and see where this falls so if I'm say like a testing facility so if I'm I am someone who takes your product and I help you figure out what is your percentage of THC and CBD.
[00:11:40] Turpin is always like I'm touching the plant but is my company gonna fall under 280.
[00:11:46] That's a great question.
[00:11:47] And that is sort of the million dollar question as it relates to labs and distribution. Some states really. All states require lab testing. Some states require distribution licenses to actually move the product. And so those two specific licenses I think are still sort of TBD. One could argue that they're really just a service provider. They're mandated by the state. You cannot operate without them. And so they're not quote unquote trafficking. They're really like another service provider if you will do the plant touching operations so that they can get that product on the shelves. So I think we're we're still kind of waiting to find the answer to that. Yeah all of the Tax Court cases that have been published or brought to conclusion in the last two years have been made be around Spencers. So we've yet to really see the guidance from an IRS perspective on cultivation and production and sort of what the appetite for cost of goods sold. Allocation is there an application of another code section 471 which is the over arching principles on how we compute cost of goods sold. So so again still yet to see anything come really substantially live from that aspect and or the labs and distribution licenses.
[00:13:19] Yeah. So I see that you know when we talk about the cannabis business I think a lot of people think about the other cultivators that the processors the distributors dispensaries. But there's a huge market in and around the cannabis space of everything from consultants to lab to suppliers. You know there's lots and lots of services on you this this kind of nebulous or potentially uncertain area on how these companies are going to be treated makes it risky. It makes it having you know the risk is opportunity but it is part of the nature of being in this kind of spaces you have to be able to deal with a certain a certain amount of uncertainty which is which is tough.
[00:13:52] So I think that that gives us a good sense of what I guess in terms of some of the legislation and other state by state twist to all this. I mean this is all kind of federal like how you do your federal returns and calculation of federal income our federal tax you know as a cannabis operator on a state by state level. What are the things that I need to kind of think about or understand when it comes to operating my business and state taxation.
[00:14:15] Yeah great question. So on the state level you know maybe picking up from the income tax perspective some states have allowed for sort of this pullback of 280 e meaning they do allow you to deduct payroll and rent and everything else so they don't apply to the e an example of that is California.
[00:14:37] And so again they understand that it is a business a viable business in their state.
[00:14:44] And so as such they do not follow to EDI and do allow for those expenses to be deducted. I think further on sort of in the state or local taxes that operators should be aware of is all of the excise taxes that come about when you're operating cannabis business and so excise taxes meaning.
[00:15:06] So for example here in Nevada there is an excise tax.
[00:15:09] Once the product comes out of cultivation. So as soon as the flower leaves the cultivation and goes into production or retail it is taxed there's a 15 percent tax at that point.
[00:15:23] And then there is another excise tax at the point of sale so that and consumer is paying another 10 percent excise tax in addition to sales tax on the end product to your patients.
[00:15:37] This is so their attempt 10 percent excise tax and then whatever your state sales tax would correct. Also gets added to that ad as well. And who. How does collection work on that. So as a as a grower am I. I'm paying the excise tax when it goes to the to the processor or the retail. How do I pay that taxes. I'm paying this on a monthly basis quarterly basis. Like what is how does that work. Logistic companies.
[00:16:00] Sure. Here in Nevada it's monthly every month you're filing an excise tax report very similar in other states. So it's a monthly excise tax reporting where you tell the state. This is how much flour I sold. The states are using some sort of fair market value approach to the amount of weight. And so that times the weight that came out of the cultivation facility is what you're paying. And then that gets remitted again to this state.
[00:16:32] Oh I got it so I pay. So if the state saying you know if it's X amount we're we're going to call the market rate x amount per pound. I'm not I'm not literally paying a tax on the on what I sold it for. I'm paying a tax on the volume I produced at the at the market rate. Got today. And how do they do that they adjust. I mean they have a review a review board or something that sets the market rate every month.
[00:16:52] You got it. Yeah yeah. Not every month. It's looked at a plot every six months right now in Nevada.
[00:16:57] Again it's it's still a fairly new market. Bruce right.
[00:17:01] We in Nevada just one adult use one was it summer of 2017. So we're coming up on our two year anniversary this summer. And I think the way the regulators operate is they're looking for data points right. So as they get more data points they're reassessing all of that information and making sure that they're there in line with with what the market is doing.
[00:17:23] Yeah such a dynamic market. I mean it's like not only is the is the commercial side changing but the regulatory side the States I mean everything is everything is just kind of in flux.
[00:17:33] It's a brand new industry Bruce. I mean the reality is is there's no playbook not for the regulators not for the operators. And to some degree. Not for us is the service providers right. We're all kind of learning as we go. And I think the key really is working together in all three of those components right.
[00:17:51] With regulators with operators to really understand the pain points and sort of where we need to take this industry is where does that work.
[00:18:00] I mean do you find do you find that that that's you know people are collaborative. How's it going. I actually do.
[00:18:06] I've got to tell you in my experience in new ways over the last four years I have found it to be very collaborative. I think it's probably one of the new experiences I've had in my profession and I've been doing this for 18 years. I come from a heavy regulated industries like gaming. I was working in gaming for many many years. And so there it's like well no this is the rule. You know the Gaming Control Board pushes town the rule and that's what the rule is and you follow it and you apply you know accounting and audit procedures to those rules.
[00:18:40] This is different in that they were having conversations about what should the rules be. Not really sure.
[00:18:50] So getting opinions and feedback from again operators and other constituents in the industry is what's making I think successful certainly in Nevada now you know we've had some great success here. Our state has seen a lot of activity over the last twelve months. From outside foreign dollars to our market from an investment standpoint a lot of money activity just within our borders outside brands and folks trying to get into this. This Nevada market.
[00:19:25] Yeah. So let's talk about a little because I think that's the whole other kind of interesting dynamic of the cannabis space right now is the investment activity and yeah I think on one hand there's this kind of idea or or know general feeling like there's we're floating in money like everything the green rush and you know if you if you've got a cannabis business idea you know you just you'll have people throwing money at you.
[00:19:47] You know I guess is that really the case for from what you've seen and b how is this investment space different than you know investing in a tech startup. I mean why. What is the what is the uniqueness about cannabis investments and being a cannabis ambassador or a company that gets money.
[00:20:04] Yeah I think the industry is again different from an investment standpoint and not you know how best to say this but it's kind of like the shiny new thing right.
[00:20:15] You know the dot com era had had its time. You know tech I think also had its time. Like everything kind of comes in waves and so here it is it really is literally the green rush. Right. It's all the news.
[00:20:30] And so I think it's more of Hey this is really interesting and I want to know more about it. No different than anything bitcoin.
[00:20:37] Last year two years ago right. You know cryptocurrency was all the buzz and so it got a lot of investment dollars. I think cannabis is no different. It's what's in the news it's what's in the spotlight.
[00:20:49] It's getting a lot of attention and people just don't want to feel like they're missing out. Yeah maybe said another way. Why. I'm not sure that it's necessarily for every investor though.
[00:21:02] I think from an investor's standpoint if you're getting into this industry thinking that you're just going to make millions on the money that you're investing I'm not sure that that's an appropriate way to approach this. Yes still very risky. These are startup companies. You know the failure rates are still pretty high. The cost of operating a cannabis operation is high. We just talked about the tax implications of a cannabis operation. And so again most investors are not aware of that. They don't know what 280 is.
[00:21:38] They can't imagine businesses dealing in this kind of volume of cash where where things can happen with cash. There's no good controls there. So I think for any investor it's really understanding what you're getting into having a good understanding of these accounting and tax issues that we certainly talked about earlier. And the risk appetite. What is your risk appetite and understanding that no the money's not going to be coming in in six months or a year or two. Typically you know the payouts are upon sale or merger or acquisition some kind of transaction.
[00:22:19] So I think that you know on one hand yeah I mean just just like any any risky early stage investment you know there's a risk component and a good investor is one of the reasons are good investors as they can pick can calculate that risk and they can you know know what that risk is and plan or invest accordingly.
[00:22:39] But some of these other factors I think our fascinate me it's like a you know that it's kind of the unknown unknowns you know it's the like I like I know that I don't know exactly when the return period is going to be I know that there's always a chance of something on a bill but this whole thing of oh wow I hadn't thought of the fact that there's going to be so much cash. I've never dealt with a business that had that risk before. So I don't even know how to factor that into my you know to my calculation. What are some of the other things that from an investor point of view get kind of sticky either because I mean I'm curious if there are situations where the federal illegality of this business kind of taints portfolios or ends up being impacted and investors in other ways that they hadn't either thought of in the beginning or they may end up having to manage differently because of the the the federal aspect of it. I mean did these things come up for investors to investors you know think about Oh well yeah I'd love to invest in this but if I do this and then I'm risking other businesses or I'm going to like it's going to cause me problems some way.
[00:23:34] Yeah. You sort of hit the nail on the head I recently had for a client where they are doing distributions to their masters in cash.
[00:23:46] You know the investor lives across the country. We can just yeah we can't just go deposit that at the local bank. Well you know there's the raising question. But if the investor gets to do distribution how does that. Are they now in that same chip. They are in that situation. Deposit their cash if they deposit that cash. Now they are. They have proceeds from an illegal business.
[00:24:08] Technically yes and technically they can have their account shut down. I mean this is like a real thing. This is exactly what what we're talking about here. Now it's time to collect the money in cash. You know how do we do this. What's the work around and what's the plan here. Right. And now I do have there is an investor that's you know asking himself like what what am I going to do with this.
[00:24:33] Yeah well I guess you set up different vehicle. I mean I could not.
[00:24:36] Not that I want to have you give tax advice or you know strategy advisors helping others but yeah I could see it just. It does have those kind of ripple ripple effect. You know this derivative questions around risk at trolls and things like that.
[00:24:50] So do you think how are people or who do you see kind of making good smart investments and the kind of a space or how are you. How are they doing it. You know when when you look at a sophisticated or well-structured know cannabis business investor what are they doing that's different than than other folks.
[00:25:07] I would say that the successful ones that I've seen so far are you know investing in good brands. They're investing in organizations that have a really great C suite right or management teams. They're both cannabis savvy and business savvy they bring a mix of both to their operations and the tend to have a really positive culture within their organization. I mean I think those are all things that are pretty standard from an investor betting perspective. You know when you're looking at any investment what do you look for.
[00:25:49] Yeah you're looking for X amount of you but if you're looking for you know what your rate of return is going to be you're looking for growth potential within that opportunity.
[00:26:02] But some of these other factors as to the actual operations rate again the management team culture and then who do you have on your bench and with what skill sets.
[00:26:14] Right to really drive this business to the next level. Those tend to be the best investments. And again it is a little bit the same as you would view any non cannabis investment. You know those are the same kind of questions. What I see is investors again trying to rush in and grab what they can and took advantage of.
[00:26:38] Again quote unquote the gold ride or the green Roger excuse me but they're not really asking those questions. They're not really asking you know who's in charge of the Finance Department who's the CFO or the controller. What are some of these controls around cash. Let me see the tax return for last year. I want to know what the Tweedie e implication was. So those kind of questions are not being asked. And then what we see is a year later two years later. Now they are asking hey where's my money.
[00:27:13] Is this investment going already. But it's the lights are on and I want to figure out like why wait what do we do. Exactly. Hey I got this key one. I mean we had a loss but I have to pay tax. Makes no sense to me. It's always a rude awakening.
[00:27:32] Yeah.
[00:27:33] So it's those things that I think are so important that an investor really understand before just diving in. And then even from the operators side you know maybe a few tidbits there is they're looking for investors right. You mentioned that Bruce. That's kind of both sides of the coin. You know from an operator perspective not all money is the same. You know not everyone is the appropriate investor for you. I think from an operator they have this vision of what that company their company is to be and you know what product lines the culture cetera. And I also find that they'll bring in investors because they need the cash flow to continue to operate and grow their business or expand. But then it's not a meeting of the minds. They have different interest in the vision for the company. And sometimes the investors just want to sell. Yeah they don't want to keep it. And so now you have an operator that's potentially no longer a majority shareholder or majority owner and they really don't have any say anymore. Yes to those kind of decisions.
[00:28:46] We see that all the time people going out and raising money and they don't realize that the obligation on the treadmill it's going to put them on. I got to think hard and long before really doing that. And the whole idea of you know there's money and there's smart money and it's kind of figuring out what else what else you're getting from that relationship other than just the cash. You know a lot of certainly an early state round. So it's much about the people you're bringing on as the cash that they're bringing. Absolutely. So this has been good. We're gonna we're gonna hit time here. We could spend probably several hours. All the details we could do more episodes later but this has been really helpful. Actually I learned a little bit myself. So just go. Thanks for being on the program. If people want to find out more about you about the firm what's the best way to get a hold of you and get more information.
[00:29:27] Absolutely Bruce. And again it's been my pleasure to be on here.
[00:29:30] Folks can find us at our Web site www.indivaadvisors.com/ . We're all over social media under and diva advisors. You can find us on Facebook Instagram and LinkedIn.
[00:29:42] It's been a pleasure. I will make sure that all those links are on the show notes. And again thanks for the time. This has been great.
[00:29:46] You've been listening to Thinking Outside the Bud with Business Coach Bruce Eckfeldt to find a full list of podcast episodes. Download the tools and worksheets and access other great content. Visit the Web site at thinkingoutsidethebud.com. And don't forget to sign up for the free newsletter at thinkingoutsidethebud.com/newsletter.