Years ago, long before big business and politics changed the California cannabis landscape forever, Casey O’Neill and his family began tilling the earth in northern Mendocino County.
It was simple and good work, but it wasn’t easy. With time and sweat, the family took 20 acres of marginal land on a sloping grade and turned their home into three small sustainable grows, called HappyDay Farms.
“We’ve had to fight for every garden bed we’ve got,” O’Neill says. “We started with rock and clay, and we subtracted the rock very laboriously through hand labor. And we’ve slowly, but surely been working toward building soil with compost. Our soil has become pretty rich and nice at this point. We’re really happy about that, but it’s been a very difficult process. I don’t really have the ability to scale up, and I also don’t want to.”
Only in the past year has O’Neill felt the sudden, pressing need to scale up at all. In 2016, Proposition 64 teed up a taxed and regulated marketplace for cannabis cultivation and distribution in California. As with most things in the state’s cultural and political history, the story is complicated.
O’Neill says the costs and structure of state and local regulations have pushed him—and tens of thousands of other small cannabis farmers—onto a learning curve far steeper than the rolling hills of Mendocino County.
He’s been watching the legalization process closely, serving since 2015 as a vice chair of the California Growers Association (CGA). With an estimated 68,150 cannabis farmers working in California today, the CGA is concerned with the open question of how many of them will end up licensed in the legal market.
“Essentially every step of the process is just thousands and thousands of dollars on businesses that have been for the most part operating at a subsistence level,” O’Neill says. “I’ve been able to spread it over the last three years because I’ve been working on it for a long time, but for a lot of people who are just getting involved, these costs are being assessed right now. It’s a massive burden. And we can’t get bank accounts, we can’t get financing; the only money we can get is either growth-oriented venture capital, which comes with a whole set of dangers, or really high-interest hard money loans. People are being asked to do things [that] are pushing them into bad situations with really little recourse.”
As of March 19, the California Department of Food and Agriculture (CDFA) had issued only 2,477 temporary cultivation licenses. O’Neill says that the path to legitimacy in California is too much to bear for many farmers; a lot of them aren’t even applying for licenses. The CDFA has received 4,451 applications; that’s a 6.5-percent application rate in the first three months of the year.
It’s in that context that the CGA authored a report titled, “An Emerging Crisis: Barriers to Entry in California Cannabis” earlier this year. In 38 pages, the organization laid out a case that state regulations were actually achieving the opposite of what many voters had anticipated at the ballot box in 2016. Growers with deep pockets can now waltz into the marketplace with ease, and small farmers like O’Neill are draining their balance sheets just to have a shot at the fringes of commerce. Legacy farmers who laid the groundwork for the industry over decades—even before Prop. 215’s inception—are left on the outside looking in.
“In regulating cannabis for the first time, California was forced to deal with a question that is too often ignored in drug policy discussions: Yes, prohibition is a failure; and yes, cannabis should be legal; but how?” the report posited. “Policymakers don’t often have the opportunity to shape the structure of a $7-billion market. How should the wealth generated by newly regulated cannabis be distributed? And who should have a chance to participate?”
O’Neill drove three hours to Sacramento to help answer those questions.
In a stately gray committee room at the Capitol building, O’Neill explained that the new regulatory framework was damning California farmers in its costly web. Voters had approved Prop. 64 by a 57-43 margin, but the Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA)—the resulting law that designed the regulatory framework for the cannabis marketplace—took a sharp left turn from the original intent, O’Neill argued.
“I’m here today under grave circumstances,” he told the lawmakers in the room. “The impact of these regulations on our communities and our economies is drastic. There’s not a lot of off-farm jobs in our community; a lot of people I know have no idea what they will do if they can’t get a license—and they can’t get a license. We are in a crisis. This emergency is caused by a thousand paper cuts, not by a single wound. As such, it will be especially difficult to correct.”
The MAUCRSA regulations are only temporary for now. Licenses issued by the state of California—for cultivation, manufacturing, distribution, retail—are good for only four months. The state is expected to deliver more permanent regulations this summer. Farmers like O’Neill are hoping that some changes are in store, that the state relents on both the financial and temporal costs of these new regulations.
“Right now, the program’s not working for a lot of people,” O’Neill tells Cannabis Business Times. “I’m a big believer in community. I’m a big believer in local food security, and I’m also a very big believer in diversified farms. I think that a monocrop farm portfolio is an inherently unstable organism and a bad idea.”
Increasingly, though, and quite rapidly in this new marketplace, California’s regulatory costs favor well-financed businesses that focus solely on cultivating and manufacturing cannabis as a monocrop—businesses that can weather a few years of losses while the marketplace settles. Where subsistence farmers were once able to maintain their own financial pace, the market is insisting that those smaller operators boost their revenues (and, invariably, their expenses) enough to cover the baseline entrance fees of this new industry.
This is what the CGA fears in these early months of legalization, according to its report: “It is not operational inefficiencies that are hurting small growers. Rather, it is the one-time costs of regulations or the inability to comply with regulations because of local land-use policy.”
As to the question of scaling up, O’Neill is not alone in weighing the influence of California’s new cannabis regulations. Through one-time application costs, annual licensing fees, hefty new tax codes, land-use modifications, ecological remediation expenses, building infrastructure improvements, water storage requirements—to say nothing of the stiff competition of well-heeled agricultural businesses entering the so-called “Green Rush”—the price of running a farm that’s survived for decades has suddenly become overwhelming.
“Enforcement without opportunity is a broken paradigm,” O’Neill told state legislators in Sacramento. Later, a woman repeated his line during the public comment portion of the hearing.
“I wrote it down because it was so good,” she said, scanning the notes she was holding. “‘Enforcement without opportunity is a broken paradigm.’"
The regulatory landscape in California is nothing if not in flux. In these early months, though, the driving narrative has been one of large-vs.-small—or the benefits of economies of scale pitted against subsistence. With more than 2,000 farmers operating with a state license today—and untold numbers waiting to earn their own—the purported $7-billion market is pushing operators of all stripes into a race against time. It’s a mad, mad, mad, mad market.
Three state agencies govern the new cannabis landscape: The California Department of Food and Agriculture (whose CalCannabis division oversees cultivation licensing), the Department of Public Health (which oversees manufacturing licenses) and the Bureau of Cannabis Control (BCC, which oversees retail, distribution, testing and microbusiness licenses). All cannabis operators will inevitably have to interact with other licensed businesses, meaning that the intersection of these three regulatory agencies’ powers is a critical space for everyone in the industry.
For those 2,477 licensed farmers in early March, only 300 adult-use retail licenses had been issued by the BCC (for dispensary owners). So, even for those who’ve earned a license from the state, distribution is bottlenecked. Pair that with falling wholesale prices, and the process of getting flower from the farm to the consumer is rocky at best. (Wholesale prices have hovered around $1,000 per pound statewide, between December and March, according to North American financial data provider Cannabis Benchmarks.)
A cadre of curious cannabis farmers from across California attended the regulations hearing in February, and they listened intently as O’Neill stated his case. In the audience, Wendy Kornberg was hearing a familiar refrain.
Kornberg runs Sunnabis: Humboldt’s Full Sun Farms in the sparsely populated southern hemline of Humboldt County. There, the cultural legacy of cannabis is strong. As part of the Emerald Triangle, Humboldt County (along with Mendocino and Trinity counties) is almost synonymous with outdoor grows and delicately tailored cannabis varieties. Now, rural farmers eligible for a small cultivation license, in many instances, are the ones raising the loudest criticisms of the new system. Their balance sheets simply aren’t a match for the new state costs.
“Here’s the thing,” Kornberg says. “Without the cannabis farmer, there is no cannabis industry.”
She paints a picture of incongruous local policies that draw financial costs from cannabis farmers—while delivering no tangible returns.
This is one of the more glaring dynamics in California right now: Local regulations vary across municipal and county lines, creating even more fragmented access points into the industry. And farmers (and distributors, manufacturers and dispensary owners) can’t apply for state licenses without first harmonizing their businesses with local agencies.
In Humboldt County, for example, Measure S enacted land taxes on each square foot of farmland. That comes on top of the state’s $148 per pound in excise tax on flower at harvest (or $45 to $50 per pound on trim). In the event of crop failure—due to flooding or fire, for instance—farmers are often out of luck. While some crop insurance policies are extended to cannabis farmers, the U.S. Department of Food and Agriculture restricts its Federal Crop Insurance Corporation subsidization program. Whether insured or not, at the end of the day, farmers in Humboldt County are expected to pay their Measure S taxes. That tax revenue then is distributed according to population; southern Humboldt County, which grows most of the local cannabis, sees the smallest share of its cultivation tax dollars, a point of conflict for cannabis farmers.
Doubling down on the small farmer’s bind is an overarching issue in California and elsewhere: For now, cannabis business operators have limited access to banks and other financial institutions. They are barred from resources like traditional small-business loans. Nor can they claim standard business deductions, due to IRS Code 280E.
As CBT partner Cannabiz Media reported in March, “The barriers to entry are high in California, and those companies with strong regulatory expertise, lawyers, and consultants (i.e., companies that have money to pay for this expertise) will likely fare best under this scheme.”
The money to pay for that expertise is the critical variable in California these days. Not only are the regulations costly at face value, but the very notion of navigating legal documents and state policy language is something that legacy cannabis farmers simply haven’t had to do in the past. The fine art of bookkeeping is unknown territory for many. Lawyers and consultants, then, become a crucial part of the licensing process for cannabis operators.
“I hope this doesn’t sound too self-serving, but we are finding that … they’re either trying to do it themselves or they’re seeking advice from a local attorney or an attorney whose expertise, for example, is more in licensing,” says land-use and real estate attorney Thomas Casparian. At the firm Cozen O’Connor, he works with cannabis operators of all stripes in obtaining their proper local permits. “It is critical that any grower or operation consult with an experienced land-use attorney, because it is a specialized field. … To try to navigate that process with somebody who isn’t experienced in obtaining land-use entitlements is going to cause you to at best lose valuable time and at worst to see your entitlements rejected.”
The key, Casparian advises, is due diligence prior to applying for any local or state license. Knowing the various land-use policies of a municipality is vital. Once a business is fully prepared, then it may enter the application process.
Of note is the state’s “microbusiness” license, which is meant for growers with less than 10,000 square feet of canopy who also distribute, manufacture and sell in a retail setting. It’s California’s answer to small vertically integrated business models in other states.
So far, only 61 microbusiness licenses have been awarded.
“This license is particularly grievous to those of us who farm in rural areas, because it seems that the license was created to lower the barriers to entry for small businesses, but it is impossible for rural farmers to actually obtain,” Kornberg says. “Most of us that live on our ranch or agricultural lands do not have the proper zoning or infrastructure to get a microlicense. Ten thousand square feet is a huge cultivation area for an indoor [grow] and could probably supply a decent percentage of the flower needed for a dispensary, so all the micro[business] license actually does is allow for more vertical integration for dispensaries and cut the farmers out even further. Policy has been written with industry in mind rather than agriculture, and it’s a huge misstep in our path to legality.”
To counter the burden of regulatory costs, Kornberg says that successful cannabis cultivators are building off an engaging, standout brand. As the market settles in California, consumers will shift into the industry’s substrata: The “craft cannabis” segment will grow distinct from more mainstream cultivation.
“We’ve been for ... three years now [trying] get our permits and ... get our compliance all in a row and everything,” Kornberg says. “I’m glad that we started when we did, for sure. It gave us a lot of foresight into where we wanted to go and how we needed to get there, and we were able to start marketing and branding in 2016. That was really, really key for our company, because we are a small company.” For Sunnabis, what a small business lacks in thousands of pounds of annual cultivation can be made up by customer interaction and brand loyalty.
She laments the now-banned cannabis events in California that used to give her face-time with customers across the state. Marketing opportunities are vital tools in the belts of small farmers. (Assembly Bill 2020 could bring those events back in the future, allowing open cannabis use at permitted event spaces.)
Those events, in turn, would coincide with tourism revenue for local businesses and for the state at large—a minor undercurrent in the legalization debate.
While small farmers rush to catch up with new regulations, larger operations in the state are gaining ground. Bigger budgets translate to keener compliance ability—and to greater cash flow. In the end, that means quicker response times for customer demand and more nuanced innovation in the R&D office.
But is the debate in California really a large-vs.-small dynamic?
If so, what’s the score? What’s next?
When Adrian Sedlin answers the phone, he’s got good news. The California Department of Food and Agriculture (CDFA) had just sent its CalCannabis reps to his cultivation facility in Desert Hot Springs, and Sedlin’s Canndescent, a 75,000-square-foot indoor operation, passed with flying colors.
Canndescent has quickly become a recognizable luxury cannabis brand. In a high-profile interview on a CNBC program, Sedlin remarked, “Call us the Courvoisier of cannabis or Hermès of cannabis. We’re going after that high-end adult use.”
Desert Hot Springs is an inviting relic of mid-century architecture and boutique tourism, located right off I-10 in Riverside County, east of Los Angeles. It was the first municipality in southern California to allow industrial-scale cannabis cultivation in 2014. (“When it comes to cannabis, all politics is local,” attorney Omar Figueroa says, pointing to local regulations as the entryway to the expanding state market. “That’s where the potential of MAUCRSA is unlocked.”)
If the name of the real estate game is “location, location, location,” then that goes triple for the movers and shakers of cannabis. Sedlin’s investment in Desert Hot Springs is an important note: Many jurisdictions in southern California have implemented bans or temporary moratoriums on cannabis cultivation, distribution or retail sales.
All told, 39 of California’s 58 counties have bans on cannabis cultivation, as of mid-March 2018. Now, within those counties, individual municipalities maintain the right to approve cultivation within their boundaries—which is how Desert Hot Springs opened the door to businesses like Canndescent while Riverside County and its unincorporated areas did not.
And among those that do allow commercial cannabis activity, tax rates on land and product vary from Mendocino County’s 2.5 percent to 10 percent on growers to Inyo County’s 5 percent to 12.5 percent on growers—and a smattering of other variable rates. In some counties, different municipalities and unincorporated areas levy varying tax rates, and, in other cases, tax rates are set to increase over time.
“Mostly what we’re finding is operations steering away from locales where the tax burden is too high,” Casparian says. “From my view, the businesses are able at this point, within some limits, to choose where to start their operations or move their operations. That’s how we’re finding most growers and operations dealing with taxation. What I think we’re going to see is localities reexamining their taxation systems when they find that they’re discouraging this economic development opportunity in their locale.”
And economic development is a primary undergirding of the legalization measure in California and any other state.
For the California Growers Association, that concern—how economic development is allocated on a broad scale—is also the central argument in a lawsuit the organization filed against the CDFA in January: that the MAUCRSA language itself contradicts the promises made to growers in 2017.
The law, indeed, prohibits the state from issuing any “large” cultivator licenses prior to Jan. 1, 2023. The fine print bars any large-scale producer from obtaining multiple “medium” cultivator licenses, which allow for one acre of canopy size.
But regulations issued in November 2017 suddenly diverted from the Prop. 64 language: There was no longer any limit on “small” cultivator licenses, which allow for one-quarter of an acre in canopy size (or 10,000 square feet). Companies can “stack” those small licenses and essentially put a large cultivation operation before the CDFA.
Companies can also stack their licenses across the state’s three regulatory agencies: the Department of Food and Agriculture, the Department of Public Health and the Bureau of Cannabis Control. As of mid-January, just 15 companies held 10 percent of the state’s 1,273 cannabis licenses, according to Cannabiz Media. CA Systematize, for example, held eight licenses from all three agencies (small medical and adult cultivation, extraction, retailer and dispensary licenses). It’s another semblance of vertical integration in a state that doesn’t explicitly address that business model.
“For what it’s worth,” Sedlin says, “as we were doing our planning long-term, I flew up to Sacramento and asked exactly this question to Amber Morris, the head of the CDFA for cannabis at the time. Literally asking her, ‘So what’s the deal? Can you have multiple? And what’s the state’s perspective on that?’ And the answer was: Yes, you’ll be able to. But they will have to be separate premises. That information has been out there since 2015.”
According to the November 2017 MAUCRSA regulations language, indeed, each license must be attached to its own designated premises. But those addresses no longer need to be “separate and distinct.”
“This is where you can get into a philosophical conversation, which is, it really depends on what kind of social engineering you see as government’s role,” Sedlin continues. “Is government’s role to underwrite and subsidize the small farmer? I don’t know. Is government’s role to make sure or try to create an environment where consumers get the highest-quality product at the lowest price? I don’t know. Some people might consider that a good thing.”
The CDFA elected to hand that discretion off to local municipalities. A spokesperson tells Cannabis Business Times: “A one-acre canopy limit ... was not included in the [November 2017] regulations due to the fact that Proposition 64, the law guiding the process, did not provide authority to include it. However, local jurisdictions may impose that limitation on their own if it meets the needs of their constituents.”
The California Growers Association countered with its lawsuit: “Authorizing large cultivation operations prior to 2023 will have a devastating effect on small and medium cannabis businesses, local economies throughout the state, and the environment.”
The argument in both CGA’s lawsuit and its “Emerging Crisis” report is that the state has already cut straight to that end game of allowing large-scale operations. It’s happening.
“The stacking makes the barriers less attractive to get over,” CGA executive director Hezekiah Allen tells Cannabis Business Times. “If there’s this tremendous opportunity in the regulated marketplace, people are going to get there. If the regulated marketplace is saturated ... many are probably going to do something else.”
Baked into the fine print of MAUCRSA is a mandate by the state Department of Fish and Wildlife for cannabis farmers to help pay for the environmental remediation of lands devastated by commercial fishing along the coast and the once-prominent timber industry. These costs are assessed on a per-property basis, clustered particularly in northern California.
“There is great unfairness to the costs,” O’Neill said at the February hearing. “It’s as though the regulations are trying to address the impacts of a past timber boom on the backs of small cannabis farmers. Providing multi-year timelines for remediation would help ensure that farmers are able to make the transition to the regulated marketplace while also ensuring that restoration work is completed.”
The problem—the “emerging crisis”—is that those costs are great enough that most farmers’ only option is to scale up, O’Neill said. He tells Cannabis Business Times: “If we’re not able to have time to bring these processes into practice, then it’s kind of a moot point. There’s a certain sense that the regulations have been crafted in a way that it’s just going to drive people out of business, rather than actually creating environmental compliance.”
On one hand, the campaign to legalize adult-use marijuana regulations in California came with a vocal show of support for the small farmer. The initiative’s original language that barred business owners from operating a cannabis farm any larger than one acre until 2023 was meant to allow smaller farmers like O’Neill a chance to recoup the up-front compliance costs and to grow a profit margin healthy enough to compete against bigger players in five years. The 11th-hour regulations flouted that “promise,” as the Los Angeles Times called it, and gave larger operators the license-”stacking” provision that the market is seeing now.
According to Lt. Gov. Gavin Newsom’s Blue Ribbon Commission on Marijuana Policy, “the goal should be to prevent the growth of a large, corporate marijuana industry dominated by a small number of players, as we see with Big Tobacco or the alcohol industry.”
Whether small farmers would be in a better position in 2023 than they are in 2018 is a speculative hypothetical; many industry observers express doubt. The original Prop. 64 small-farmer “promise” may have only delayed the reality of commercial cannabis and of any other nationally scaled industry.
Now, though, the competitive field may keep many small farmers from ever leaving the black market.
The central question is time, and yet the bulk of the newly regulated cannabis industry in California is moving very quickly. There’s a sense that operators have waited so long to come out of the shadows and work in a legal setting that, now, all of a sudden, everything needs to happen at once. Brands are establishing themselves broadly in the marketplace, and product innovation is occurring as fast as the state’s few testing labs can process raw material. The final rules are months away from being written and approved, and already the industry is driven by the businesses that move quickly, that step out in front of the wave of regulation.
The consequences of legalization aren’t coming undone; there is no plan to return to the old practices of a younger cannabis industry. California is in a unique position, and, as such, its legal market will look much different than what Colorado or Oregon businesses face.
“California is an outlier,” the CGA report states. “Our state has the most robust and productive cannabis industry of any state. Other states replaced an illicit import-based market with domestic production whereas California must transition an existing unregulated marketplace.”
More than 90 percent of California cannabis farmers have elected not to apply for a state license, as of yet (mid-March)—an early sign that the unregulated marketplace may continue to thrive to some extent.
And those unlicensed operations will throw off the market, no doubt; prices will be drawn downward and licensed businesses will be forced to contend with competition that can’t be easily identified. The best offense, then, is a good defense: money.
At Canndescent, which closed a $10-million Series B financing deal in January, Sedlin says that the marketplace will dictate how California’s legal cannabis business is shaped.
“My grandma used to always tell me, ‘You get what you want and want what you get,’ ” Sedlin says. “Part of that I always viewed as: Be careful what you wish for. And, surprise, it’s legal! Guess what: Because it’s legal now, people who are very, very serious about their professional environment are coming in.”
Actors from across the agricultural business community will be watching the market play out closely. The CGA, according to Allen, is monitoring more than 100 cannabis-related bills in the State Assembly.
On March 15, Assembly members Tom Lackey (R-Palmdale) and Rob Bonta (D-Oakland) introduced a bill that would suspend the state’s cultivation tax of $148 per pound of flower and cut the state’s cannabis excise tax from 15 percent to 11 percent. The intent of AB 3157, they said, was to reduce the price differential between the regulated and black markets. Consumers would see lower prices, and, in turn, cultivators would see lower costs built into production.
Both tax reductions would end in June 2021.
It’s a measure, though, that lawmakers brought up in the cannabis regulations hearing at the State Capitol in February. The steep excise tax, in particular, has been an active discussion since the start of the year.
“Does the industry have a perspective on what that number should be?” Assembly member Jim Wood (D-Healdsburg) asked during the hearing.
“From the farm perspective, anything lower is going to help,” O’Neill replied. “It’s really hard right now. Especially, Mendocino County is traditionally a very small cultivation size. We are capped at 10,000 square feet, and people are getting buried right now by the costs.”
“Right now” is the key phrase embedded in most cannabis conversations in California. The industry is buzzing along a warp speed right now, and, yet, business owners of all stripes are looking eagerly to Sacramento and to their local county boards for any inkling of what’s to come.
“Cannabis is the economic mainstay of a lot of rural communities, and people are trying to figure out what’s going to happen,” O’Neill says. “The big concern is that cannabis dollars—you know, local farm dollars—recirculate within the local economy a number of times. We’re seeing the fallout in the traditional business sector as well. Revenues are down, there’s not as much spending going on. This is rapidly approaching an economic crisis for a lot of rural communities, while large, well-capitalized businesses are essentially able to run away with the show.”
These days, in pastoral Humboldt County, Wendy Kornberg is in the process of expanding her cannabis cultivation down the hill from where she lives. (The county’s Retirement, Remediation, and Relocation program allows farmers to move production from marginal land to more appropriate parcels, without facing any additional taxes or fees. It’s a silver lining, Kornberg says, among the cannabis industry’s zoning and regulatory obligations.) She’s scaling up the garden this year from 8,000 square feet to 20,000 square feet, all nestled between breezy mountaintops.
“When we started down this road three years ago, I was like, ‘You know, we need to be prepared for three to five—maybe six—really hard years,” she says. “And we have seen it climbing toward that more and more difficult [state]. I think that this year and next year are still going to be difficult financially, but I think it’s going to be settling. If you make it through the next couple years—if you make it to 2020 and you’re still in business—I think it’s going to be good. I think that for the craft cannabis farmer, we’re going to find our way.”