Part I of a two-part series.
The legal, regulated cannabis industry is expanding at an explosive rate, creating opportunity for large-scale cultivation businesses. Prior to state-level legalization initiatives, cultivation was performed clandestinely and on a relatively small scale (at least compared to traditional agriculture). Also, many medical growers are faced with the opportunity to expand significantly to serve developing recreational markets. Consequently, one of the most frequent and challenging hurdles faced by cultivators is the prospect of developing and operating a large-scale facility or site devoted to commercial production. This column will explore considerations that need to be taken into account by existing operations looking to scale up and capture a larger portion of the market.
Much of the information also is applicable to those attempting to use cultivation knowledge gained in a small-scale or home-grow setting to enter the regulated industry.
One note: Bigger doesn't always mean better; large operations present myriad difficulties not faced by smaller grows, including coordinating more staff, managing a larger plant inventory (as well as greater amounts of supplies and throughputs needed for cultivation), and increased security concerns, just to name a few. Scaling up hastily and improperly can result in an inefficient, fractured operation with a slimmer profit margin than it had previously, or possibly even a business falling into the red.
In today’s highly competitive and frequently shifting cannabis market, where everyone is trying to get a piece of the pie, methodical and meticulous evaluation, preparation and execution are required if you wish to grow your cultivation operation into a well-designed, compliant and productive enterprise for years to come.
Before You Begin: Should You Scale Up?
As one of the fastest-growing industries in the country, the question about whether or not to upscale your grow seems like a no-brainer. However, because of the many difficulties and challenges unique to cannabis businesses, rigorous assessment of market conditions and the local regulatory environment is essential to determine whether an expanded operation will result in greater profitability, or simply a bigger headache. Some items to consider include the following:
- In most legal states, markets are not entirely free, but are controlled to some extent by legislation and regulation. A simple example would be a state or municipality limiting the allowable number of licenses. Canopy size limits can exist as well. It is imperative to engage with state and local regulators to determine if expansion is even feasible, in addition to feeling out what impending regulatory shifts could affect your investment.
- Is there market demand in your state or, for existing businesses, in your current distribution network? Or will new buyers have to be identified and new relationships formed? If there is demand, where is it? Is there opportunity in the medical market, recreational market, infused-products manufacturing, or all of the above? For example, maybe new qualifying conditions are being added to a state’s medical cannabis program that will swell the patient registry and create more demand. Or, as in Oregon, perhaps the medical market is saturated, but the implementation of licensing for recreational businesses is imminent.
- If the legal and market environments are favorable, how will the expansion or establishment of a larger operation be financed? Banks are still wary of providing loans to cannabis businesses, meaning that, barring an already strong revenue stream or having a few million dollars lying around, an operator will likely be forced to seek private investment. This raises more considerations, and leads to the next consideration.
- Be sure to play by the rules regarding outside funding. Some states limit the investment types and sources, including banning out-of-state investments, that can be made in cannabis businesses. Consult your attorney to ensure you are not running afoul of local regulations or more far-reaching investment laws, such as those dictated by the SEC. On that note, focus on accredited investors, as regulations in certain areas for specific investment types can necessitate background checks on those providing capital or receiving equity.
- Make sure your funding documents are accurate, in order and can realistically demonstrate a return on investment (ROI). As the cannabis industry matures and becomes more competitive, more people are willing to invest. However, those people are often business-savvy individuals who want the proper assurances that they will be getting their money back, and then some. Detailed, well-prepared budgets, business plans, pro formas, and profit and loss statements will go a long way toward gaining credibility with legitimate investors and securing the financing you need to expand your operation.
It also must be noted that due to cannabis’ continued federal illegality, section 280E of the IRS tax code prevents operations from deducting normal business expenses, which will, of course, increase with expansion and cut into your bottom line. Consult someone well-versed in tax law to make sure that projected profits accurately take into account the additional tax burden that will be placed on your business.
Areas to Consider When Upscaling
Assuming all legal and market considerations look good, you’ve gauged a profitable new production target, and you have or are able to raise sufficient capital, it’s time to get to work on expansion. Here are two important areas to consider when scaling up an operation.
Planning and Design
An important question at this juncture in the cannabis industry’s development is whether greenhouse or outdoor production is legally feasible in your state. If so, these options must be strongly considered, as they can provide a significant competitive edge over conventional indoor facilities in terms of production costs. Hybrid indoor-greenhouse facilities could be an option as well.
As production volume increases around the country, prices will eventually fall well below current market rates, necessitating that producers keep costs down if they are to survive the industry’s future landscape.
Another expansion avenue to consider is the addition of extraction or infused-product manufacturing to your business model. Demand for concentrates and edibles continues to rise in most markets, making those value-added products a strong investment. However, the focus here is primarily on expanding cultivation operations.
Compliance also is essential to success. Currently, many cultivation facilities would not pass muster in regard to federal standards such as those of the Occupational Health and Safety Administration (OSHA) or the Americans with Disabilities Act (ADA). Once cannabis is legal federally, those operations could be subject to big fines and may have to perform extensive renovations to achieve compliance. Employ an architect that is familiar with all pertinent building and safety codes, in addition to the particular cultivation requirements.
Some general items to be sure to address include adequate egress routes, emergency exits and properly rated fire doors at appropriate junctures. Some fertilizers and agricultural chemicals also require that safety features such as eyewash stations and lockable, fire-resistant storage cabinets be available throughout a facility.
In terms of design, consider workflow and lean manufacturing principles to maximize efficiencies, while also minimizing the possibility of cross-contamination between different garden areas. (For more on lean manufacturing and efficiency, see “7 Ways to Increase Efficiency and Cut Costs on page 76.) Some guidelines:
- Map your site according to how staff would ideally travel throughout the workday, as well as how plants would move through the facility. Eliminate extraneous movement and backtracking. If building onto an existing facility, make sure that new production space can be integrated smoothly into the existing space. For example, your staff will be unhappy (not to mention wasting time) if your new 300-plant flower room is a half-mile and two flights of stairs away from the vegetative area, with no way to fill it other than carrying the plants there by hand.
- Ensure that each clone, veg, flower, dry, cure and processing area can be accessed independently of the others to mitigate the spread of pests and reduce possible diversion.
- Flowering plants are the most eye-catching, but don’t let that blind you to the need for more space in other departments, such as clone, veg, drying, supply storage, and staff facilities and common areas. (Having adequate common areas and facilities for staff is incredibly important to keep up morale and productivity; this will be addressed further in the Part II of this column in the March/April issue.) More flower rooms means more plants in veg, and those plants need space if they are to emerge pest-free with productive structures. Racks for newly rooted clones and smaller plants can maximize square footage in a veg area.
- If you are going to grow twice as many plants after your expansion, you will need twice as much soil, fertilizer, and other supplies on hand. The ability to receive and store bulk shipments of supplies will save money and hassle, as opposed to making frequent, smaller supply purchases at a higher per-unit cost. Also, be aware that you will have twice as much waste and plant material to dispose of compliantly.
Permitting, Compliance, Licensing
Often, the state regulatory body overseeing cannabis must be informed of changes to a cultivation facility, especially when production capacity is being increased. For example, the Colorado Marijuana Enforcement Division (MED) requires various types of “material changes” to be reported and approved prior to undertaking them. A related consideration is whether expansion will require a new license type or tier. Depending on the state, licenses are generally split into different tiers according to either plant or patient count, or the square footage of your plant canopy. Be sure to start the process to update your license tier before construction is complete.
On the local level, obtain all pertinent permits and approval for your plans. If you do not, you will likely fail post-construction inspections, resulting in more construction and higher costs. Alert your utility companies as well, especially the power company if you grow indoors, so that they can make necessary upgrades to infrastructure. Indoor cultivation is straining electric grids in areas such as Denver and Portland, and a blown transformer could leave your entire warehouse in the dark.
Security is another high priority to protect your investment and to meet compliance standards. If altering existing spaces, evaluate your security cameras to make sure they remain adequate and in proper positions. Construction can present unique security challenges overall, such as how to deal with a huge hole in an exterior wall that can't be sealed immediately. Open and frequent communication between your security provider and general contractor is essential to address unavoidable threats to security, as well as to ensure that existing security measures and equipment are not compromised.
As you can see, many considerations exist in the pre-construction phase of expansion. But it doesn’t end there. In the March/April issue, this column will explore essential considerations raised by the construction process, preparing and managing a larger staff, and strategies to successfully propagate additional healthy plants to fill your new expanded operation.
About the Authors: Nic Easley is the founder and CEO of Comprehensive Cannabis Consulting (3C). A decorated veteran of the U.S. Air Force, Easley established a 35-acre organic farm in Colorado after completing his military service, and has degrees in biology and environmental studies. Over the past eight years, Easley has consulted with more than 60 clients in Colorado and formed 3C to bring organic, sustainable cultivation solutions to the world. Adam Koh is the Chief Cultivation Officer for 3C. Previously, he served as cultivation manager of a Denver-area medical cannabis facility that was awarded the High Times Cannabis Cup for Best Medical Hybrid in 2014. Koh has experience cultivating more than 100 different strains, including numerous high-CBD varieties, and in his previous position oversaw the care of roughly 3,000 plants at any one time.