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Darren Gleeman, Managing Partner at MBO Ventures – Interview Series

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The cannabis industry grapples with a formidable challenge in the form of Section 280E of the IRS, a tax provision that significantly impacts cannabis businesses. This tax code disallows canna-businesses from deducting ordinary business expenses, placing an onerous burden on their financial viability. This heightened taxation has created a lopsided competitive landscape, making it increasingly challenging for legitimate cannabis businesses to contend with the thriving illicit market. As the industry seeks innovative solutions to navigate these taxing hurdles, one individual stands out for pioneering a transformative approach.

In this interview, we dissect the groundbreaking milestone achieved by Darren Gleeman, Managing Partner at MBO Ventures, a trailblazing firm in the cannabis industry. Darren spearheaded the completion of the first-ever Cannabis Employee Stock Ownership Plan (ESOP), offering a novel strategy to mitigate the impact of Tax Code 280E. His insights shed light on how this innovative ESOP structure is poised to revolutionize the landscape for cannabis businesses, providing a beacon of hope amid the challenges imposed by the intricate tax codes.

MyCannabis: How did your career path lead you to the cannabis industry?

Darren: In the early 2000s, I managed a hedge fund focused on stock trading. While working with colleagues, we identified a lucrative stock market pattern. We attempted to sell the idea of automating this pattern to our superiors who were enthusiastic, but we faced resistance from the compliance team.  Undeterred, we bootstrapped our efforts. The successful implementation of our pattern, resulting in trading multiple stocks, inadvertently led us to accumulate a wealth of data which gave us patterns to trade other stocks as well. Eventually, in 2018, we sold the company to an Israeli firm, concluding my tenure in the hedge fund world.

Driven by a desire to explore investment banking and employee ownership, I founded MBO Ventures in 2018. The shift to the cannabis industry occurred in 2022 when a colleague posed the question of implementing an Employee Stock Ownership Plan (ESOP) within this unique sector.

Initially, I was skeptical, considering that valuations for the majority of cannabis companies were disproportionately three to four times their actual revenues, rendering the prospect of an ESOP seemingly incongruent. However, a pivotal shift in perspective occurred when he introduced the factor of 280E, a provision prohibiting cannabis businesses from deducting routine business expenses from gross income. It was akin to recognizing a pattern in the stock market; once you see it, you realize its significance. It was at that moment that the potential to leverage ESOPs for alleviating the impact of tax code 280E became evident. This realization marked the decisive pivot of MBO Ventures into the realm of the cannabis industry.

MyCannabis: Can you briefly explain how the ESOP structure works?

Darren: An ESOP in simple terms is a way for a company to sell its stock to employees. A company can sell stock to a private equity firm, a strategic buyer or competitor and what most people do not realize is that a company can also sell stock to its employees.

Let's look  into the process of how employees acquire company stock through an ESOP. To provide context, we'll first examine the mechanics of private equity transactions. In a typical scenario involving a $100 million deal, approximately $20 million originates from the private equity fund, directed straight to the owner. Subsequently, the private equity firm secures the remaining 60% by leveraging the assets or cash flow of the company being sold. The final 20%, referred to as an earn-out, is contingent upon the company meeting the revenue targets established during the negotiation phase. Should the business fall short of these commitments, the owner forfeits the outstanding 20%.

In comparison, the ESOP model mirrors this process closely, with a notable distinction: there's no requirement for employees to provide an upfront 20% equity since it is essentially a gift to them. The company borrows $60 million against its own assets and cash flow, directing this sum to the owners. The remaining 40% takes the form of a seller note or IOU from the company back to the owner.

In the cannabis space, securing such substantial loans is a challenging prospect, and even when available, the associated interest rates often prove unsustainable. Consequently, opting for a complete IOU or seller note for the entire 100% becomes the more favorable choice. Under this arrangement, the owner is immediately owed the full $100 million upfront. Furthermore, the inclusion of seller notes provides owners with an added benefit – a modest interest rate and warrants. These warrants represent stock options, affording owners the opportunity to acquire some of the company's stock in the future.

The ESOP concept aims to democratize capitalism by allowing employees to purchase company stocks and become stakeholders. To incentivize business owners to sell stocks to employees without immediate payment, tax incentives play a pivotal role.

MyCannabis: How will this ESOP structure help defang Tax Code 280E?

Darren: Here is a notable benefit of the ESOP structure: Consider Company A, with an EBITDA of $20 million and a total company valuation of $100 million. In the traditional scenario of selling to a private equity firm or a strategic buyer, one would be subject to a hefty capital gains tax of 30%, totaling approximately $30 million. This is a substantial amount.

However, opting to sell the same company to employees through the ESOP structure provides a distinct advantage. In the scenario where you sell 100% of your company to employees through an ESOP, you would incur zero taxes. ESOPs stand as the sole entities in the US that enjoy this tax-free status, a provision introduced in 1998. This exemption encompasses federal, state, and unrelated business income tax (UBIT). When operating in a tax-free environment, the restriction on deductions for business expenses becomes inconsequential. In this context, Section 280E becomes irrelevant. It's crucial to highlight that for an ESOP to be effective in the cannabis industry, owners must relinquish 100% ownership to employees through the ESOP structure.

MyCannabis: Which kind of cannabis  businesses will benefit most from ESOPs?

Darren: ESOPs may not be suitable for companies with exceptionally high valuations. Consider, for instance, an AI or robotics company that, while possessing substantial value, isn't generating significant revenue. In such cases, undertaking an ESOP might not be feasible. Notably, an ESOP is typically transacted at fair market value or the amount a financial buyer would pay to settle outstanding debt.

Ideal candidates for ESOPs are companies in mature markets with a fair market value. Conversely, highly profitable companies or those anticipating rapid growth in the near future may not find ESOPs to be the most advantageous option. Similarly, smaller companies might not realize substantial benefits from pursuing ESOPs.

It's crucial to recognize that the threshold for effective ESOP implementation tends to be around $2.5 million in EBITDA. Waiting until the company reaches a more optimal financial position is often a prudent strategy, allowing owners to maximize the benefits of an ESOP when they are better positioned to do so.

MyCannabis: Parting Shot?

Darren: Employee ownership is also good for the company because it guarantees commitment. Employees are owners and hence will not waste company resources and talent will be retained as well.

The biggest need in the industry now is education. Many people believe that they know what an ESOP is but in reality they do not.

It was a pleasure to have this conversation with  Darren Gleeman, Managing Partner at MBO Ventures. Readers wishing to learn more about MBO Ventures are encouraged to check out their website.

 

Lydia K. (Bsc. RN) is a cannabis writer, which, considering where you’re reading this, makes perfect sense. Currently, she is a regular writer for Mace Media. In the past, she has written for MyBud, RX Leaf & Dine Magazine (Canada), CBDShopy (UK) and Cannavalate & Pharmadiol (Australia). She is best known for writing epic news articles and medical pieces. Occasionally, she deviates from news and science and creates humorous articles. And boy doesn't she love that! She equally enjoys ice cream, as should all right-thinking people.


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