California's Cannabis Market at a Crossroads

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Cannabis operators across the state say lawmakers and regulators must address several key issues for the market to prosper. Government officials are proposing changes, but will they be enough?

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Marie Montmarquet and Allen Hackett, founders of MD Numbers
Photos By Jennifer Skog

The plan to create a business based on a shared love of cannabis drove Marie Montmarquet and Allen Hackett from east of the Mississippi to the West Coast.

“I always wanted to move to a compliant state and take this to a real business, and not be somewhere that it was criminalized and have to worry about jail time or being prosecuted for doing something that we love,” says Montmarquet, who was born and raised in Nashville, Tenn. “We were just so passionate about the plant that we wanted to be able to do this for our entire life.”

But out in California, following Montmarquet’s and Hackett’s respective moves there in 2010 and 2015, and their launch of four business segments under their Monterey County-based parent company MD Numbers, they’re battling headwinds.

Montmarquet says everything came crashing down for California’s cannabis market around May 2021. High taxes throughout the supply chain, oversupply of product, a lack of retail across the state, and competition with a strong illicit market are all mounting issues that are complicating California cannabis operators’ livelihoods, and in some cases, driving them to move away or find new work.

Given these compounding issues, many in the industry have united around the slogan “Less taxes, more retail” in a push to lessen obstacles and create more opportunities for operators.

“The way the market has shifted, that leg up is definitely not there anymore.” Allen Hackett, Founder, MD Numbers

“We’re all juggling 50 different balls right now,” Montmarquet says. “Everyone was expanding and then immediately had to stop expanding. If you were doing well and you’re like, ‘Oh, let’s take on more territory; let’s add to our portfolio’—then the next thing you know, prices drop 40%—who wants to invest in cultivation, or who wants to dive into cannabis like they wanted to in 2018?”

Though California prices have been volatile for a long time, Montmarquet says she and Hackett, who consider each other siblings and refer to each other as such, didn’t expect prices to stay down.

Hackett, who originally hails from Roanoke, Va., and now works daily overseeing MD Farms’ greenhouse cultivation facility in Salinas, says cultivators did well in 2020 during the height of COVID. So did delivery services, like the duo’s Marie’s Deliverables, the business that started their West Coast cannabis journey five years prior. Then, Hackett says, when growers in the northern part of the state harvested their cycles of crops in early spring 2021, cannabis was selling for less than expected compared to past years because there was an oversupply.

“Then, you fast-forward to the fall last year, when the first crops would come down—Croptober—and then you see how desperate it got for some outdoor farmers,” Hackett says. “They really couldn’t get rid of their product, and the pricing was really low, where they couldn’t sustain it. So, it was really telling and eye-opening for the entire industry.”

MD Numbers is somewhat insulated from seasonal swings in supply and pricing because it has the controlled environment of a greenhouse with heat, and supplemental HPS and LED lights, Hackett says.

“We are a mixed-light facility, but the main success for our greenhouse is the sun,” Hackett says. “So, even in the wintertime, we’re supplementing that with lights. It’s still not quite the same, so our yields do decrease by about 35%.”

MD Numbers’ facility in Salinas, Calif.

Because light and humidity levels are variable in the greenhouse environment, Hackett says the business selects which cultivars it grows during a given season based on how each one performs under certain environmental conditions.

“Some things we like to grow in the summertime that get big and are light-dominant—they like sunlight,” Hackett says. “Some strains don’t like as much as sun, so when it gets really bright and really hot, they don’t produce as well. Those are strains that you know you can do well in the wintertime.”

Hackett says MD Numbers is able to perform hands-on cultivation methods—and achieve top-shelf quality and pricing. That’s opposed to cultivating lower-grade product and participating in a race to the bottom, which Montmarquet says other California businesses have done.

The company’s cultivation techniques include powdered molasses and microbial tea inputs, as well as a pheno-hunting process that the company will revamp as it plans to bring an R&D nursery and tissue culture lab online later this year. Hackett says the lab will free up space that mother plants are currently utilizing and ensure vitality among plant material that will serve as future mothers.

Following harvest, all of MD Numbers’ product is hand-trimmed, Montmarquet says.

“We came from the retail side and understanding what we wanted the finished product to always look like,” she says. “So, because of that standpoint, it just allowed us to have a little bit more of an open mindset going into different processes and beta testing a lot of things. Some cultivators are stuck in their ways—Allen is not. We always want to constantly evolve.”

And it’s by necessity. Hackett says that MD Numbers, being grandfathered in from California’s Proposition 215 medical days, had the advantage of being among its first cultivators when the state’s adult-use market opened at the start of 2018. Now, he says, “The way the market has shifted, that leg up is definitely not there anymore.”

Others have fared worse. Montmarquet says some outdoor growers have only been receiving $200 per pound for their wholesale flower—trying to keep their head above water as the cultivation flat tax of $161 per pound nearly drowns them.

Cannabis businesses, large and small, have shut their doors, not just because of the taxes but also because two-thirds of the state’s cities and counties have opted out of allowing brick-and-mortar cannabis retail, and the illicit market is undercutting legal pricing and access by often more than 60%. For social equity applicants and operators, additional hurdles take the shape of limited access to licenses and capital.

“You work so hard to get a business off the ground,” says Whitney Beatty, founder and CEO of Josephine & Billie’s, a social equity dispensary in Los Angeles. “It took us years to get this business off the ground, and you come into a market, and it is like it’s the Hindenburg effect going on; I keep on saying it, but it is, it’s like fire, fires everywhere. Some things are changing rapidly on an everyday basis where you’re constantly having to pivot, but there are so many issues going on and it becomes hard to find stability.”

Tax Relief Required

Farther up north, cultivator and manufacturer CannaCraft runs roughly 10 acres of cultivation in Lake County, 15,000 square feet of fresh concentrate production in Humboldt County, and 50,000 square feet of manufacturing and processing in Santa Rosa.

CannaCraft’s house of brands include, among others, Farmer and the Felon, a partnership with the Last Prisoner Project; Care By Design, a CBD and THC wellness line; and Lagunitas Hi-Fi Sessions, a partnership with the craft brewer.

In addition to producing and selling a variety of product and advocating for social justice for cannabis prisoners, the company has been closely following the legal and regulatory landscape in California.

Tiffany Devitt, the company’s chief of regulatory affairs, states that one of the main issues is the cultivation tax. It’s harmful to California’s entire cannabis industry because it occurs at the beginning of the supply chain, she says, adding that this is uncommon for agricultural commodities.

What’s more, because it’s a flat tax, it becomes more of an obstacle when prices are depressed, she says.

“It goes up proportionately [as a portion of your costs] as your prices go down,” Devitt says. “Then, what happens is, as that mature biomass moves through the supply chain, it gets hit again and again by other taxes, and those end up compounding.”

One of those taxes, the 15% excise tax, is paid by end consumers to retailers, but the state requires that it’s collected and remitted to the state by distributors, Devitt says, adding: “So, another part of this tax question is sort of the lunacy of distributors essentially having to act as tax collectors and tax enforcement agents.

“All of the big distributors have a problem, which is, everybody ... is basically using that excise tax to kind of float the business, and it’s very hard for distributors to actually collect the excise tax,” Devitt says.

Josephine & Billie’s Chief Operating Officer Ebony Andersen also highlights that some operators are doing that, but not all are able to.

“You actually have to pay more in taxes than you’re actually making,” Andersen says. “And the only people able to do that are people who are wealthy enough to float the business until it becomes profitable.”

In the May revision of California Gov. Gavin Newsom’s proposed 2022-2023 state budget, for the fiscal year beginning July 1, 2022, Newsom proposes tax reform in cannabis, including setting the cultivation tax rate at zero beginning that day.

Newsom’s revised May budget also includes a proposal to change the method of excise tax collection and remittance so it no longer falls on distributors, but rather shifts to retailers, beginning Jan. 1, 2023. The excise tax would remain at 15%.

The 15% excise tax is difficult for cannabis businesses to work with, though, Montmarquet says, pointing out that it’s actually higher because of retail markup.

“It’s 15% at an arm’s length of an 80% markup, which brings it to a 27% tax,” she says. “That is an unlivable tax for retailers, supply chain, all the like in the supply chain—distributors—no one can have a 27% tax.”

Professor and economist Daniel A. Sumner and project scientists from University of California, Davis confirm in the book “California Agriculture: Dimensions and Issues, 2nd Edition” that the percentage after markup comes out to 27%.

During Newsom’s budget revision announcement May 13, the governor thanked state Sen. Steven Bradford, who introduced cannabis tax reform Senate Bill 1281 in February. According to California NORML, “Bradford’s bill SB 1281 was the only legislative proposal this year to end the cultivation tax without raising excise taxes.”

As of press time, the latest version of SB 1281, amended May 9, proposed eliminating the cultivation tax beginning Jan. 1, 2023. The bill, if adopted in its current form, would reduce the state excise tax to 5% “of the gross receipts of any retail sale by a cannabis retailer” beginning on the same date. The amended bill also acknowledged that cannabis industry members wrote a letter to state government officials in late 2020, calling California’s cannabis industry “‘a nationwide mockery’” and a “‘public policy lesson in what not to do,’” while stating that, even then, they faced the risk of their businesses closing.

The California constitution requires that its Assembly and Senate both introduce the governor’s proposed budget as identical bills, and the California State Legislature has until June 15 to pass a budget for the next fiscal year. It remains to be seen for certain what the tax structure for California cannabis businesses will look like for the remainder of 2022 and heading into 2023.

Nicole Elliott, director of the state’s Department of Cannabis Control (DCC), its cannabis licensing and regulation agency, spoke with Cannabis Business Times about various ongoing issues in the state. She says her department doesn’t directly handle tax issues, but has been liaising with the industry on the issue.

“We’ve participated in a number of public discussions with our policy makers in the legislature who really own tax reform to help convey what we know and hear from our licensees,” Elliott says.

Addressing concerns that some people have brought forth about the reduction and elimination of taxes hurting social programs, Devitt summed her and her colleagues’ thoughts the following way: “We are perfectly happy to see cannabis tax revenue going to social programs. Our point is simply that, in order for cannabis to be a sustainable source of revenue for the state, it has to be a sustainable industry.”

MD Numbers performs hands-on cultivation methods and achieves top-shelf quality and pricing, rather than racing to the bottom on price.

Reeling Retail

The latter half of California’s “Less taxes, more retail” slogan is, like many of the industry’s challenges, a multi-pronged issue.

While outsiders might imagine California as having a dispensary on every corner, that’s not entirely the case. California has only 2.4 dispensaries per 100,000 residents, according to previous reports by CBT. For comparison, Oregon, another relatively mature, West Coast market, has 18.3 dispensaries per 100,000 residents. Oregon, however, issued a cannabis licensing moratorium in April due to a crowded marketplace, the inverse of California’s conundrum.

One factor causing California’s retail shortage is that a whopping 67% (363 of 539) of California’s total local jurisdictions do not allow for cannabis storefront retail, according to the DCC.

“It’s a huge issue. There’s still dry counties,” Montmarquet says. “There’s still bans where [there’s] not any legislation being created in a lot of cities and municipalities and unincorporated places throughout California. And I don’t necessarily think that retail is going to catch up to the amount of cultivation that we have licensed anytime soon.”

This, in turn, creates clusters throughout the state where legal retail operations exist, and deserts where they do not.

“It’s not just more retail shops; it’s better distribution of retail shops,” Devitt says. “... The market hasn’t grown, even with additional retail licenses, they’ve simply taken a small part of the pie, which is cannabis-friendly jurisdictions, and chopped that up into tinier pieces among more retailers, as opposed to expanding that and getting better coverage and better access across the state.”

And existing retailers have taken notice of the increasingly crowded market.

So while retailers, and the industry at large, is united in the push for “Less taxes,” some are wary of “more retail,” including Rhavin L, co-owner-operator of the Melrose District location of Sixty-Four & Hope, a social equity dispensary chain in Los Angeles.

“I’m between two really close dispensaries, and we’re all different, but as a consumer, a lot of times you’re just going to go to what’s close,” Rhavin says. “… So having more and more dispensaries, that sounds great as a consumer, [but] as an actual employer, I’m just wondering, how are we all going to get a piece of the pie when there are so many mouths to feed?”

While Newsom’s revised 2022-23 budget proposal includes $20.5 million to “establish a cannabis local jurisdiction retail access grant program,” providing funding is only half the battle. Convincing those 67% of jurisdictions to change their tune, on the other hand, is a whole other challenge.

Director Elliott says one of DCC’s goals is “really engaging with the local jurisdictions to help them find pathways to support licensure in their jurisdiction and access to their consumers,” but also notes “it’s just a longer process.”

Those jurisdictions prohibiting cannabis retail not only stifle the legal industry’s growth, but they also sustain the illicit market, Elliott says.

“We have a significant amount of the state of California that does not participate in the legal market. They continue to perpetuate prohibition in some form or fashion by not allowing licensees to operate in their jurisdiction,” Elliott says. “We know that there are consumers that exist across the state of California, and they will find their product somewhere, and we would like for them to find their product in a licensed location.”

Post-harvest processing at MD Numbers.

Illicit Market Competition

While the illicit cannabis market exists in every state and every region of the country, California’s illicit market has long supplied the rest of the country’s cannabis demand.

While California’s legal market has made strides in the four-plus years since adult-use sales began on Jan. 1, 2018, the illicit market still holds the large majority of market share by almost all estimates.

For example, according to New Frontier Data, in 2021, California’s legal market totaled $5.9 billion in sales—$5 billion in adult-use sales and $866 million in medical sales. But that still falls short of the state’s illicit market, which had an estimated market size of $8 billion in 2021.

While retail deserts are one factor perpetuating the illicit market, Devitt says that’s just one piece of the puzzle, noting that product pricing plays a role in consumer consideration.

“An illicit vape might be one-third the price of one on the regulated market. And what’s interesting is some people who buy it in the illicit market, it’s simply a matter of the price; they don’t care about testing,” Devitt says.

Illicit operators can sell those products at a lower price point because they avoid all the added taxation, again signaling the uneven playing fields between the legal and illicit cannabis markets.

“We know that there are consumers that exist across the state of California and they will find their product somewhere, and we would like for them to find their product in a licensed location.” Nicole Elliott, Director, California Department of Cannabis Control

Beatty says that all the various taxes, including state excise and city taxes, create added challenges for legal operators and dissuade illicit operators.

How can the legal market win out over the illicit one? “That does not happen unless we lower barriers to entry and make it attractive for people to come over and be in this regulated market,” Beatty says. “And we have not done that.”

One opportunity for illicit operators in the Bay Area, specifically, to join the legal market is through San Francisco’s Amnesty Program, supported by the city’s Office of Cannabis (OOC). The Amnesty Program “establishes the process by which an applicant may apply for and receive a temporary cannabis business permit to engage in commercial cannabis activities other than storefront cannabis retail sales,” according to Section 1605 of the San Francisco Police Code.

Currently, there are 142 temporary permits, according to San Francisco’s OOC.

“Through the Amnesty Program, unregulated operators were provided an opportunity to enter the regulated market,” says Jeremy Schwartz, OOC spokesperson. “The operators that came forward either operate the supply chain, delivery, or a laboratory via a temporary permit. They will continue to do so until the OOC issues their permanent permits, after the social equity tiers are processed.”

When considering the challenge of addressing the illicit market, Elliott, who previously served as director of San Francisco’s OOC before being confirmed as DCC Director in a Senate Rules Committee hearing March 30, acknowledges there’s much work to be done, but notes the right people have to be in place for DCC to achieve its goals. She says when DCC was formed in July 2021, the agency had a 43% vacancy rate that has since been trimmed to 35%, with the goal of reaching 30% by the end of this year, and 15% by the end of 2023.

“We’ve really worked with intention on this division, in particular, and have really cut down vacancies in this division significantly over the last 10 months,” Elliott said in a May interview. “We’ve expanded those teams. They’re in Fresno, we’re placing two more in LA, so in areas where we do experience a lot of challenges, [but] not all areas where we’re challenged.”

And when considering enforcement options to curtail the illicit market, Elliott admits “there is not an appetite to repeat what has been really just an absolute failure of enforcement through this war on drugs construct.”

MD Numbers’ facility in Salinas, Calif.

“Where we’re challenged is seeing the entire life-cycle of an enforcement operation and what is most effective,” she says. “We’re seeing the enforcement aspects and the consequences of that, whether that be through prosecutions or civil or administrative penalties, [and we’re] really trying to hone in on what is most effective in a variety of circumstances and use those tools more diligently and do more than just take off the edges of the illegal market.”

Elliott says those “tools” include notifying landlords they may be aiding and abetting illegal activity, engaging with industry licensees and stakeholders, and collaborating on state and local levels to share data on what solutions are most effective.

New Frontier Data projects 2024 will be the first year where California’s legal market size reaches and surpasses the illicit market, projecting $7 billion adult-use and medical sales combined in 2024, compared to $6.92 billion in illicit market sales.

And for those hoping federal legalization would alleviate many of California’s issues, Elliott warns there’s two sides to that coin.

While Elliott welcomes the idea of interstate commerce, saying “we would like to see pathways for our farmers to legally transport their product across state lines,” she expresses concern about a federal tax piling on to an already burdensome tax structure.

“We don’t want to see a tax burden so onerous that we continue to perpetuate illegal market activity,” she says. “Making this accessible to existing consumers is really important.”

What’s more, Montmarquet says any cannabis business hinging its success on federal legalization is already in trouble.

“None of us can wait on federal [legalization],” she says. “If any business model is to wait on federal legalization so we can then export nationally, your business will be completely defunct far before that happens.”

Aiming for True Social Equity

The illegal market is difficult to compete with, but at the same time, Montmarquet says MD Numbers does not want to see people face criminal penalties for engaging in illicit cannabis activity.

“What we don’t want to do is have the drug war 2.0 and recriminalize the plant,” Montmarquet says. “Allen and I, … just being that, of course, we’re compliant cultivators, we would like to compete with compliant cultivators. But I would never agree with putting anybody behind bars for growing this plant.”

Certain people and communities, including Black, Indigenous, and People of Color (BIPOC) and legacy cannabis operators who have borne the brunt of enforcement, are sometimes able to enter the legal cannabis space through social equity programs. Different government arms throughout California have, as part of these programs, implemented efforts to increase representation and diversity in ownership.

The city of Los Angeles has issued 1,440 temporary approval licenses, including 409 social equity licenses, a spokesperson for the city’s Department of Cannabis Regulation (DCR) told CBT May 18.

Additionally, 692 cannabis businesses in the city have approved licenses, and 243 of those licenses are for verified social equity applicants, the spokesperson said.

San Francisco’s population is roughly 4.8 times smaller than Los Angeles’. That city has issued 44 equity permits (licenses) and has an additional 28 applicants working through buildout prior to receiving their permits as of May 16, according to Schwartz.

MD Numbers’ facility in Salinas, Calif.

Proponents of social equity in California say there’s room for improvement in terms of licensure and the ability to raise capital.

As of mid-February, 14 California jurisdictions had implemented equity programs, and at that time, another 22 jurisdictions had funded equity assessments, according to a document DCC provided to CBT.

Montmarquet notes this lack of equity programs in the California cities where cannabis businesses operate. She also points out that local governments with equity application criteria including low income aren’t setting applicants up for success; the applicants will end up requiring large amounts of capital to pay rent for months or years at a time before their licenses are even approved, then will need to operate capital-intensive businesses under strict regulations.

For social equity programs to work, there needs to be funding attached, Beatty says, “... or else we’re putting programs in place that say they are intended to allow people who are disproportionately disenfranchised to have an opportunity to own and operate businesses within this industry, but you’re not giving them opportunity to fund [the business] and we’re not really letting them own and operate businesses. So, we have to give opportunities for that funding.”

When it comes to private funding, women-led startups received 2.3% of global venture capital (VC) funding in 2020, according to Crunchbase. In 2021, Black women-led startups received 0.34% of U.S. VC funding, per the site.

“As more and more VC dollars pour into this space, that’s the only money that we can get,” Beatty says. “We can’t go down to the Bank of America and get a loan. That allows those people to shape who gets to survive and thrive within this space, full stop. And it defeats the purpose [of social equity].”

Aja Allen, owner-operator of social equity dispensary Sixty-Four & Hope’s Mid-City location in Los Angeles, says finding private investment and resources is proving difficult for cannabis operators because potential investors and resource providers know there are issues in California’s cannabis market, so they are intentionally shying away.

“That’s why it’s really important for us to enroll people in us as people and ourselves and our stories and where we come from and where we’re going and what we’re willing to put in to this to make sure that it works out in our favors,” Allen says, “so we can make sure the people still sitting in jail for cannabis right now are feeling some sort of hope and some sort of relief that maybe one day they’ll be able to get out of jail because they decided to sell weed.”

“Some things are changing rapidly on an everyday basis where you’re constantly having to pivot, but there are so many issues going on and it becomes hard to find stability.” Whitney Beatty, founder and CEO, Josephine & Billie’s

Beatty of Josephine & Billie’s sits on the board of Supernova Women, a non-profit organization that encourages women of color to become stakeholders in cannabis. In 2022, Supernova Women released its Social Equity Impact Report, which states that there is a projected social return on investment (SROI) of $1.20 for every $1 invested in social equity programs; additionally, per a report summary, the SROI increases to $4.56 for every $1 invested when “reinvestment funds are specifically earmarked to the community’s education programs, health assistance, employment training and expungement assistance.”

DCC says it’s working to address hurdles with social equity. On Jan. 1, 2022, the department launched an equity fee waiver program. “That has provided millions of dollars’ worth of fee waivers to equity applicants, both within local programs, as well as what we call ‘statewide equity applicants’ or licensees because their jurisdiction has not created a local program, but they meet certain criteria,” Elliott says.

She continues: “We will be developing a deferral program. There’s, I think, less enthusiasm from stakeholders about the concepts of deferrals over waivers, but we like to think of it as more tools in the toolbox to support equity businesses. And then we have a licensing unit that specifically focuses on working with equity applicants through the licensing process, really trying to case manage them all the way to licensure.”

California’s cannabis industry continues to exert pressure on Newsom and the state government to alleviate various issues, and that’s needed, Montmarquet says.

“As a farmer in the industry, as a cultivator, I can guarantee most cultivators feel that the only person making money is the government throughout this process,” she says. “And we all feel that our hands are tied until Uncle Sam can alleviate some of this burden for us. We’re doing all we can to be compliant and remain compliant and exist in this market, but we definitely need our legislators and our regulators to help the community and not hurt the community.”

Hackett adds: “We’ve reevaluated things and took things from the ground up and were like, ‘Hey, we’re still in the fight. We’re still fighting the good fight. Let’s make sure we’re here for the long term.’”

Zach Mentz is senior editor for Cannabis Business Times.

Patrick Williams is managing editor for Cannabis Business Times.