Right-sizing the Cost of Compliance in the Highly Regulated Cannabis Industry
With the first quarter of 2023 now in the books, many companies are looking to focus on liquidity management, streamlining operations by minimizing “nice to have” activities and operating cash-flow-generating activities. Although uncertainty in the markets has led to reductions in the workforce, restructurings and discontinued operations across most industries, those that are highly regulated face an additional challenge: executing changes without impacting regulatory compliance or putting the business in greater risk of fines and penalties.
The cannabis industry is one such industry that faces several compliance challenges, including various layers of requirements from:
1. State Regulations: The cannabis industry operates in a state-by-state legal landscape, which creates fragmented markets. Each state has its own set of regulations and compliance requirements that businesses must adhere to.
While some states have relaxed their cannabis laws, others maintain strict regulatory frameworks. Businesses must navigate complex licensing procedures and comply with a range of regulations related to product safety, labelling, packaging, advertising and marketing.
2. Federal Regulation: Cannabis remains a Schedule I substance under the Controlled Substances Act at the federal level, which poses significant challenges for businesses operating in states where it has been legalized. Federal law enforcement agencies may choose to enforce federal laws and regulations (HIPAA, BSA/AML, OSHA, etc.), creating uncertainty for those in the industry.
3. Markets, Banking and Financial Services: Because of the federal prohibition, many banks and financial institutions refuse to work with cannabis companies. This forces businesses to operate largely via cash or with numerous banking partners, which creates security risks and difficulties in tracking financial transactions.
4. Taxation: The cannabis industry faces unique tax challenges (280E) due to its status as a Schedule I substance under federal law. This limits the ability of businesses to deduct expenses related to producing and selling cannabis products, which can significantly impact their bottom line.
In more mature industries, operations are typically designed with regulations in mind. For the cannabis industry, however, it is common to see the opposite, where compliance requirements drive operations, resulting in costly expenditures. For startups and small cannabis businesses, it can be especially challenging to navigate the complex regulatory landscape while remaining profitable. In some cases, companies even overcompensate their compliance efforts, leading to excessive costs.
Cannabis license operators should ask themselves:
- How much are we really spending on compliance?
- How many operations personnel are primarily focused on compliance?
- How many assurance or support groups (inventory control, quality control, compliance and internal audit) exist within our organization, and are they effective?
- How many systems do we have focused on compliance?
If finding the answer to any of these questions is not simple or the answers are not aligned with current objectives, organizations should consider optimizing compliance efforts via the following:
There are many software and technology solutions available that can streamline compliance processes and reduce costs. For example, seed-to-sale tracking software enables companies to track their products from cultivation to sale, ensuring compliance with various state regulations. This technology can automate tasks and save time while reducing the risk of human error. What’s more, data captured by software systems to allow for improved reporting at every stage in the supply chain is key for a cannabis company’s success. Adopting digital tools and technology will help ensure full optimization of output.
2.Engage in Compliance Collaboration Across the Business
One of the biggest expenses associated with compliance is the cost of hiring outside lawyers. Training employees on compliance best practices can help avoid costly mistakes and reduce the need for external assistance. Deploying a culture of compliance creates an efficient and lean compliance team that is well-versed in compliance standards and can implement them effectively.
Outsourcing certain compliance-related tasks may be a more cost-effective option for some companies. For example, outsourcing quality control testing to third-party labs can save on equipment and labor costs while ensuring products meet regulatory standards. Additionally, establishing a formal internal audit function with purview across the enterprise can help streamline activities via a “Common Controls” approach.
Reducing the cost of compliance requires a strategic approach that prioritizes efficiency, training, collaboration and innovation. By implementing these strategies, cannabis executives can ensure their compliance processes are effective while keeping costs within budget.
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