How Cannabis Companies Use ESOPs for Tax Savings and Ownership Transition

By Charles Alovisetti, Jack Crain

Aug 7, 2025

What Are ESOPs and Why Do They Matter for Cannabis Operators

Employee Stock Ownership Plans (ESOPs) are federally authorized retirement benefit structures designed to hold company stock in a trust on behalf of employees. These plans offer workers an indirect ownership stake in the business and serve two main purposes:

Aligning employee incentives with company performance
Providing a tax-advantaged mechanism for owners to sell their companies.

Although employees are not direct shareholders, their accounts within the ESOP trust receive allocations of company stock, typically based on annual compensation. Over time, as the ESOP repays its acquisition debt, stock is gradually allocated to employee accounts. These shares are subject to vesting and may be repurchased by the trust when an employee departs.

In the cannabis industry, ESOP deals offer an additional and unique advantage: they can help mitigate the impact of Section 280E, which limits tax deductions for cannabis operators.

How ESOP Transactions Work for Cannabis Operators

To initiate an ESOP transaction, a cannabis company (referred to as the ESOP sponsor) engages a third-party trustee to represent the interests of employee beneficiaries. The ESOP trust then acquires company stock from existing shareholders, often through a combination of seller financing and internal loans. While external financing is common in other industries, it remains rare in cannabis due to limited access to traditional lenders.

Selling to an ESOP allows cannabis business owners can transition their equity over time while preserving company continuity. The trust pays for the shares over time using company profits, which are typically tax-deductible contributions. (Alternatively, a third party can lend money to the ESOP and finance the transaction, however this is difficult in the cannabis context due to financing shortages.)

Importantly, ESOP transactions are required to be conducted at fair market value, and the trustee has a fiduciary duty to ensure the deal terms are in the best interest of employee participants.

In addition to receiving payment for their shares, selling shareholders are often granted warrants in the trust. The warrants allow the shareholders to capture additional upside when the ESOP trust is sold to a third party.

An ESOP does not require changes in day-to-day management. Existing owners and executives can remain in operational control after the transaction closes. The ESOP trustee does not manage the business but serves as a fiduciary responsible for ensuring that the transaction is fair to employee participants and that the plan is administered properly. Post-closing, the trustee typically has limited involvement unless major corporate actions (e.g., a sale or recapitalization) require their approval.

Tax Advantages of ESOPs for Cannabis Businesses

A properly structured ESOP can deliver meaningful tax benefits, both for selling shareholders and the company itself:

Potential Capital Gains Deferral: Sellers to an ESOP may defer or eliminate capital gains taxes by reinvesting proceeds into qualified replacement property, as allowed under IRC § 1042. This benefit is only available in C Corporation structures.
Tax-Deductible Contributions: Corporate contributions used to repay ESOP acquisition loans or allocate shares are generally tax-deductible. However, this deduction may be limited for cannabis operators due to the restrictions of IRC § 280E.
Potential Tax-Free Income for S Corporations: If the ESOP becomes the sole shareholder of an S Corporation, the company’s income flows through to the ESOP, which is a tax-exempt entity. This eliminates federal (and in most states, state) income tax liability, and for cannabis companies, may effectively neutralize the impact of Section 280E.

States that conform to federal S Corporation treatment can provide significant additional tax savings under this structure. However, a handful of jurisdictions (including D.C., Tennessee, and New Hampshire) continue to impose entity-level taxes, which may reduce the benefit. In the absence of federal rescheduling, a fully ESOP-owned S Corporation may be the most effective way for cannabis operators to mitigate the effects of Section 280E.

Comparing C Corp vs. S Corp ESOP Strategies in Cannabis

While both C and S Corporation structures can provide benefits (deductible dividends and § 1042 deferral for C Corps, versus income tax exemption for S Corps) companies must choose between them. These benefits are mutually exclusive, and sellers must prioritize either long-term tax exemption (S Corp) or upfront capital gains deferral (C Corp with § 1042 rollover). This may be a moot point for cannabis companies since taking advantage of a § 1042 rollover is not possible in a deal using a seller note (i.e., seller financing).

Both C Corp and S Corp ESOP structures offer advantages:

C Corps allow for § 1042 capital gains deferral
S Corps offer ongoing income tax exemption

However, these benefits are mutually exclusive. Cannabis owners must prioritize either:

Upfront tax deferral (C Corp) or
Long-term tax elimination (S Corp).

This may be a moot point in cannabis, where seller-financed ESOPs (which are common due to limited access to capital) are generally ineligible for § 1042 treatment.

What Employees Gain from Cannabis ESOPs

From the employee’s perspective, stock is allocated gradually over time as the ESOP repays internal loans. Allocations are typically proportional to compensation and subject to vesting schedules. Upon departure, vested shares are bought back by the ESOP trust, while unvested shares are forfeited.

In the event of a company sale, employees participate in transaction proceeds based on their vested holdings. In some high-profile cases, employee payouts have reached seven figures, underscoring the potential upside. Although, this has yet to occur in the cannabis industry.

Cannabis Licensing and Regulatory Considerations for ESOPs

Implementing an ESOP in the cannabis sector involves navigating both tax code restrictions and licensing complexities. Financing constraints often necessitate seller-financed structures, as third-party lenders are wary of federal cannabis restrictions. Additionally, state ownership requirements can complicate ESOP approvals. Some jurisdictions, like Washington, require all license holders and owners to be state residents. Due to their diffuse and trust-based structure, ESOPs don’t always fit neatly into existing definitions of "ownership."

Maryland has taken a proactive stance by enacting legislation in 2025 (SB 215) expressly allowing ESOP transactions, even amid a broader moratorium on license transfers. Other states are beginning to follow suit: Maine includes ESOPs in its cannabis regulations, and Massachusetts has advanced legislation to exempt ESOP trustees from license caps. As of the date of publication, both Massachusetts and Minnesota are contemplating legislation that would directly address ESOP transactions.

Even in states without clear ESOP guidance, deals may still proceed by educating regulators and demonstrating compliance with ownership and control requirements. Successful transactions have been completed in Massachusetts and Illinois under this approach.

Execution of ESOP Transactions: What to Expect in a Cannabis ESOP Deal

Closing an ESOP transaction in the cannabis industry is a complex process that requires careful planning and regulatory coordination. Owners should expect the process to take at least six months and should engage experienced ESOP advisors and cannabis regulatory counsel early.

The first step is a feasibility study, which will assess whether an ESOP transaction is viable given the company’s financial profile and applicable state regulations. With the right legal, tax, and regulatory support, however, ESOPs can offer a path to long-term stability, tax efficiency, and employee engagement for cannabis operators.

Final Thoughts: Are ESOPs a Smart Exit Strategy for Cannabis Operators?

As the cannabis industry matures, business owners are exploring new ways to exit while protecting their legacy. ESOPs offer a rare combination of tax benefits, cultural continuity, and employee investment.

In a sector constrained by Section 280E and limited access to capital, ESOPs may be the most viable alternative to a traditional sale or merger.

Want to Learn More About Cannabis ESOPs?

ESOPs offer cannabis companies a powerful tool to eliminate the impact of 280E, create tax-deferred exit strategies, provide future upside to founders through warrants, and enable employee ownership without personal investment.

Watch this pre-recorded session where Vicente LLP corporate attorneys Charles Alovisetti and Jeremy Shaw break down the mechanics, benefits, and real-world applications of ESOPs in the cannabis industry with special guest Darren Gleeman, Managing Partner at MBO Ventures.

Vicente LLP is uniquely positioned to guide operators, investors, and advisors through the strategic and regulatory considerations of implementing an Employee Stock Ownership Plan.

Need help evaluating whether an ESOP fits your goals? Contact us or visit our Corporate & Business Services page to learn more.