Marshall Custer has advised clients since the early days of Colorado's regulated marijuana industry. As a Partner in the Food and Agribusiness Business unit of Husch Blackwell in Denver, Colorado, Marshall co-leads the firm's cannabis practice, one of the largest and most experienced in the country. He brings a flexible mindset to his transactional practice as he helps clients navigate the shifting regulatory environment and structure their cannabis businesses for long-term goals.
Interested in using Clearbrief to streamline your cannabis regulatory applications?Click here to learn about the process from our experienced team members and schedule a demo!
Can you tell me about your legal background and describe your practice?
After law school I started working in an in-house position with a streaming music startup. It was early in my career so I felt I could take the risk. It was a tough position to be their in-house counsel because their streaming service pushed legal boundaries. It didn't work out.
From there, I wanted to get back onto a traditional career track. I joined a firm here in Denver, where I started working with a partner with whom I still work, Steve Levine. This was right when legal cannabis started coming into play here in Colorado, around 2010. Steve, who was a corporate lawyer, had friends getting into the marijuana industry, and our firm started dabbling in that area. As the junior associate, I ended up doing most of the day-to-day work. Now, 11 years later, we've grown what I think what I think is safe to say one of the biggest cannabis practices in the country.
What types of legal questions do clients bring to you related to cannabis law?
Clients typically come to me with questions that are more business issues than purely legal ones. And frankly, that's what I like about the cannabis world: we use our expertise as business advisors as much as we give legal advice.
When it comes to legal questions, they tend to be similar to the questions of any emerging business. How do I get my books in order? How do I form a company? How do I raise money? Here's a set of transactions I'm considering. How can I do it the right way?
Because these are cannabis businesses, each question is then viewed through the special regulatory lens specific to each state in which the business operates. That adds complexity to how I advise a client in approaching a deal that would be pretty simple in any other industry. Sometimes there are additional steps, and sometimes the deal is impossible.
The third bucket of questions relates to more policy work. We are starting to see a lot more sophistication in the industry and we now provide services more typical of a large firm around advocating for our clients in the policy arena.
Finally, the litigation arm of the practice has evolved from managing partner disputes - “you didn't pay me when you promised you'd pay me” - to now clients wanting to be more strategic about acquisitions so as to avoid potentially running afoul of evolving antitrust standards in the industry. The speed of growth in the industry has elevated partner disputes to a higher level. The stakes are much different when the $500,000 a year business is suddenly worth $1.5 billion. We also manage the litigation that comes along with bigger companies starting to get competitive with each other.
What tips do you have for young lawyers who are interested in practicing in the emerging area of cannabis law?
We are always looking for lawyers who have the right sort of flexibility and the right sort of problem solving attitude. That mindset is essential to be successful in any transactional setting. People bring us problems and we need to solve them.
While litigation also requires flexibility and problem solving, the focus can sometimes shift away from problem resolution to finding enjoyment in the fight itself. The litigators who I find to be the most successful are the ones who share the mindset of: I'm solving a problem and advocating for my client, and solving that problem is not about enjoying the fight, it's about achieving the best outcome.
The lawyers who do really well in the cannabis industry are less risk averse and are flexible in their thinking. Many folks in the legal industry focus on getting the right answer to a legal question and they get set in their ways about how to approach a particular problem.
Given the rapid evolution in the licensing of marijuana businesses, the right way to do something might change every couple of months. You need to be forward thinking enough to ensure that whatever you do now is flexible enough to be adjusted in the future.
There are many legal gray areas so you had better solve the problem in a way that won't be wrong in the future.
Can you share a story about how that flexible mindset has played out?
If we turn back the clock 7 or 8 years, the tax issue was a common story in the marijuana industry. It's called 280(E), where marijuana businesses, which are federally illegal, aren't allowed to take typical business deductions under the tax code. As a result, marijuana businesses pay a very high effective tax percentage. If you're running a compliant marijuana business, you're often paying an effective tax rate of 70 to 85%. Under some local tax rules, the effective tax rate can be over 100%. States usually fix that, but it takes a while.
In the earlier days, some tax people got very creative and came up with a workaround to spin off several affiliated companies, which then provided services to the main operating company, the marijuana retailer or business. Because these commonly owned and affiliated companies were not technically in the marijuana world, they took all of their business expenses there and pulled the money out of the operating marijuana company.
Well, I recall having many fights with clients about this. They'd say, “No, it's okay for us to do this, everyone else is doing it.” And I'd say, I understand everyone else is doing it, but I can tell you, just in my gut, this isn't going to work out for you. And lo and behold, court cases came down and the tax audits came out: No, you can't do that. Cannabis entrepreneurs who took this approach had millions and millions of dollars in tax judgments against them.
For some, they may still think in hindsight that all that trouble was worth not paying a tax at the time only to pay the tax later. But what about the time and effort that was taken away from your business to get that result by using these complex operating structures? I have a hard time believing it was worth it. It was penny wise and pound foolish.
This industry demands creativity, but you can't be flat out wrong. The lawyers who can walk that line to find practical solutions and the clients that are able to implement the thoughtful advice can outpace their competition.
They are the ones who are not cats chasing lasers like everybody else, trying to do the latest new thing.
To become a trusted advisor in the cannabis industry, you need to be able to spot and then avoid the strategies that you think can work in the short term, but in the long term are clearly not going to work out.
How do you view your role as a lawyer at a time when the cannabis industry still seeks greater legitimacy and entrepreneurs want to evolve stronger businesses?
I went into law school knowing that I wanted to work with startups, a goal that was very much informed by the tech startups of the early 2000s. Well, the environment of the marijuana industry mirrors that of the tech startups of the late 90s, early 2000s.
There are some major differences as well. For example, many people active in the early days of the marijuana industry were either extreme risk-takers or were, quite frankly, criminals who wanted to go legit. As you can imagine, neither the risk-takers nor those operating outside of the law care much what lawyers think and they have no need for documents. They don't care what a contract says.
By the way, neither of these groups are present in the regulated marijuana industry anymore. They have either evolved or washed out; or, as we see in some states, returned to the black market.
Our role as lawyers in the developing cannabis industry is to look toward the long term with each problem a client presents. We as lawyers are not here to placate the client; we're here to find and work with clients who share that vision and who we can help walk through these iterations of maturity in this market.
That's where we are now: our clients are not too different from any other large business within a traditional transactional practice. That said, they are still less risk averse than a regular business because we are still very much in the early years of plotting the path forward for this industry. The level of maturity and sophistication increases exponentially each year. We are at a tipping point after which the market will flow like the Fortune 500 and clients will operate just as any other multinational conglomerate business. Our goal is to help our clients make that leap.
Are there any special ethical considerations that attorneys have to think about when working in this space?
Most states have issued their own ethical opinion as to how lawyers can participate in the state regulated marijuana industry. Either the state supreme court or the governing ethics body for lawyers in the state issues those statements.
Colorado issued an ethics opinion several years ago that finally clarified, Hey, of course, if you're helping a state regulated business, you can practice here in Colorado and not violate your ethical obligations.
Our firm operates in every state where there is a regulated system. When we expand the practice into a new state, we first check to see if one of our attorneys is licensed to practice in that state, and then we run down the list of items with which we must comply. What needs to be in our engagement letter? Are there any special protocols we need to put in place to make sure that this client is acceptable under the state ethics plan?
What role does writing play in your cannabis practice, and does the style of writing tend to be more casual or formal?
My writing is definitely casual - I mostly send text messages and emails. I was an engineer before law school. Few things give me more anxiety than a blank page; I am not a writer. When I do write, it is almost exclusively in bullet points. My style of writing is very much, you asked me for this information and here's my response.
Now, that being said, there's a lot of nuance in the legal field, and especially in a cannabis practice. To communicate that nuance effectively, I have found that email isn't enough. I can get the big points out there and share what they need to think about under each bullet point, but then I find a phone conversation is needed to make sure the client understands and dig into that nuance.
Can you describe the types of applications or regulatory documents that you might work on for clients?
The cannabis vertical in the firm's practice touches a bit of everything because it's a highly regulated business. In that regard, we handle many of the same types of legal questions as any other business practice: labor and employment, tax, IP, litigation. We're also flooded with marijuana M&A right now, though that is likely to hit pause here in 2022 for a bit.
We also work with clients to obtain and maintain their license to operate a cannabis business in each state that has a regulated system. The requirements of each application vary by state.
For new marijuana licenses, some states have a competitive application process while others have a lottery. The licensing application is for the individual owners of marijuana businesses. What that means is that it's not just the entity that is under review, but each person who owns a certain threshold percentage of the business.
Most states require a license to be renewed every year or at least every couple of years. The renewal process essentially requires a redo of the original license application. While cumbersome, it's easier in that many pieces of information can be repeated from before.
State regulators ask for a lot of documentation, such as inventory reports or certain financial reports. The renewal process is a mechanism for the regulator to make sure that this emerging industry is being run in the most compliant way possible.
It seems like strong evidence is really important to the success of an application. How does your approach to the evidence change at different points in the regulatory process for a marijuana business?
Through the background check part of the process, the client is able to say to the regulators, “We have people running this business who have the experience and can run a compliant business.” For the renewals, they usually say, “Hey, I'm proving to you that we have continued to run the business exactly as you expect us to.”
Each change in the business is scrutinized through a new application. For example, if there is a change in ownership or if you want to sell your company, that's another application. If you change a room in your facility, that oftentimes requires approval.
Each of these take place at the state level and very often also at the local level. What this means is that you must submit a whole new set of applications to each state and sometimes locality in which you have a facility.
The compliance and licensing pieces of this industry are a heavy, heavy lift. I understand the reasons for them, and I don't see a better alternative right now. In fact, I view more stringent and sophisticated regulation as a welcome opportunity for our industry to prove its safety and legitimacy to the public.
For companies that are just starting out and want to build a compliant cannabis business, what mistakes should they try to avoid?
The biggest mistake that I've seen people make on the business side is to be too cavalier about the details. The way in which a company's organizational documents are set up and the way that the equity stack is built matters a great deal when you get down the line.
If you just plan to run the business with your four buddies for the next 20 years, like a family or lifestyle company, it may not matter as much. But in this industry, I see that most everybody plans to grow and is thinking about selling as an exit strategy. It's hard to watch clients disregard advice because it will cost money up front to do something the right way. Or they may not call to get the opinion in the first place because they disregard the value of good legal advice. Then 3 or 5 years down the line when another company wants to buy them, those early decisions come home to roost.
Do you understand the impact of the valuation cap that you gave to these convertible note holders? You massively diluted yourself. We could have helped you run the numbers, but instead you just googled some free forms to structure your business, and now you're out of luck.
Get the help where you need it when you're building a business. I get that there are many things going on in the earliest days, and that it's a really exciting time when most people don't have a ton of bandwidth for paperwork. But there are some mistakes that are incredibly costly to make. The details on your organization's documents, the details on your equity stack, and the financing options you choose — those are some of the biggest mistakes that I see people make in this industry.
As for compliance, most people are pretty solid on compliance when starting out because they understand it to be their biggest asset. Without a license, they don't have a business. So folks are very keen to give regulators what they ask for and to be very thorough in their application process. It's the nuts and bolts of running a successful business, the basic operating chops, that is where I see some folks can be a little lax. You don't have to get everything right, but you have to get the important things right. And that is what a good lawyer does for you, help you figure out what is important for whatever stage you find yourself in.
