New states continue to come online with medical cannabis programs. As a by-product, teams of potential and current cannabis entrepreneurs flock to each location to secure licenses. Is the new state-by-state cannabis licensing game a true gold rush? Is it even profitable?
Currently Washington, Colorado and California receive much of the attention pertaining to the cannabis market. This article, however, will focus attention on many of the new states with medical cannabis programs that are either in their infancies or still in licensing phases. Looking at the challenges and potential benefits of being in these emerging, but more restrictive markets, should provide a more realistic view of the business landscape and provide guidance on how to avoid some of the pitfalls to which many fall prey.
A Basic Overview of Business Challenges
Cannabis businesses are unique and challenging. Any new cannabis cultivation enterprise is going to be particularly unique due to the nature of the product being produced (unless, of course, you have been cultivating indoor cannabis on an industrial scale for the last X decades … but few fall in that category). But beyond that, these businesses also are challenged with a variety of hurdles that “normal” businesses simply do not have to accommodate for: limited banking/no financing, few insurance providers, obscene tax implications, no interstate commerce, evolving controls, prohibitive legislative changes and vendors hesitant to engage the industry.
New (Restrictive) Markets
New states with legal cannabis programs present their own unique challenges as the various regulatory bodies (both state and county) implement their own legislation and ever-evolving regulatory controls. Many states build untenable barriers to entry and/or executing business in any type of profitable manner, or implement barriers to patients’ ability to qualify and register to legally purchase the products.
States intent on implementing successful programs frequently limit the number of licenses available and utilize a competitive application process through public posting of a Request for Application (RFA). Applicants have a limited time to document their ability to meet or exceed the controls defined by the state in the RFA.
The application process frequently costs the applicants tens of thousands in cash outlay (usually nonrefundable) to the state simply to submit the application, and third-party expertise to consult and prepare the necessary documentation can easily double and quadruple those costs.
Before chasing after a license in a newly legislated cannabis program, consider some of the unique requirements of the programs being implemented. Every new state’s cannabis program borrows from a previous state’s controls and regulations, while adding its own unique circumstances or culture. Therefore, controls and requirements vary widely from state to state. The list below gives an overview of some of the unique mosaic of state controls:
- Cannabinoid Restrictions While many states have full spectrum (THC, CBD, flowers, concentrates, etc.) medical cannabis programs in place, others restrict all products to specific non-psychotropic cannabinoids — primarily CBD. Some states, like Virginia, also theoretically allow THCA (tetrahydrocannabinolic acid); you can’t purchase it, cultivate or produce it, but you won’t go to jail if caught with it — provided you have intractable epilepsy.
Restrictions within these limited-cannabinoid programs require producers (if production is allowed) to keep THC concentrations below certain thresholds — in some cases as low as what is recognized federally as ‘hemp’ — while also requiring costly environmental and security controls similar to those used for cultivating THC-rich cannabis. At best, this scenario makes the costs of good sold (COGS) equal to that of a high-THC product, while having less revenue potential. That is, if the business can survive at all in such a climate.
- Production and Manufacturing Requirements Between restrictions on locations, a myriad of environmental controls are relevant for any new operation. State legislators expect advanced security controls to be in place and, as such, most allow indoor cultivation only, which has a significantly higher build-out cost associated with it, as well as significantly higher ongoing costs (as compared to greenhouse or outdoor cultivation).
Many states also restrict the product types that can be produced and sold — such as, in New York, the lack of botanical inflorescence and largely restricting the market to concentrated cannabis extracts, or, in Maryland, the restriction against all edibles. Obtaining a license is just the starting line.
- Approved Medical Conditions The medical conditions the state approves is one of the most important factors for new businesses in an immature medical cannabis market. Those conditions and a patient’s ability to become registered to purchase the product dictate the number of potential customers for a new business entity. In states with very restrictive conditions, the market potential is very limited. Following potentially several million dollars in start-up expenses, many organizations find that the limited patient base is inadequate to support their bottom line.
- Vertical Integration States such as Colorado have wavered back and forth between requiring separate manufacturing and distribution models and vertical integration to a point where the current market is a blend of both. Most Eastern states have leveraged a distributed model in which producers are separate entities from retailers, and the number of producers/manufacturers is significantly limited; for example: four in Connecticut, five in New York, 22 in Illinois, five in Florida, 15 planned for Maryland.
- Limited Marketing While regulations may vary by state or locale, marketing is controlled tightly in nearly all markets. Once/if state or regional challenges are overcome, outside of a handful of print publications and social media, there are few national advertising or marketing options available to any cannabis enterprise.
- Limited Expansion Frequently, very restrictive controls exist with regards to canopy size and product scope. Once facilities are identified and secured, licenses are obtained, and the business is in production and the market matures, if you want to expand or move, a variety of unforeseen challenges both from the regulators and local communities (for example, new licenses required, zoning regulations, and limits, again, on size) can develop.
- Buy-In and Production Costs While not all states are relevant for these issues, in many states (e.g., Connecticut, Illinois, Florida, Maryland) potential applicants must have several million dollars in liquid assets to even participate in the qualification process. Additionally, components such as build-out costs, personnel, security, power and ongoing compliance increase COGS exponentially. When you consider competition from not only other licensed businesses, but also the black market, you can quickly see that exceedingly high COGS can cause a serious issue for a return on investment and profitability.
- Nonprofit vs. For-Profit Several states (e.g., California, New Mexico, etc.) also have a requirement that any licensed cannabis entity be a non-profit.
Despite the many challenges associated with these competitive licensing processes, each state’s application-submission process is deluged with thousands of applicants — by both local entities, as well as out-of-state interests (where permitted). These teams rush to engage consulting services from a variety of experts (such as attorneys, compliance resources and architects) and would-be experts (everyone and his brother suddenly is an expert offering consulting advice to those who know even less), and frequently acquire properties well in advance of the RFA release.
A persistent mentality around the industry is that cannabis equals easy money. There is, however, no replacement for comprehensive business planning and efficient operations. If your current business plan resembles: “get license -> grow lots of weed -> make lots of money,” then perhaps the drawing board should be revisited.
The thought that you can take a mediocre business model and make it thrive in a new market simply because a competitive license was obtained is a fallacy.
I have witnessed organizations that are B and C players in a mature and relatively free(er) market environment clamor for licenses in a new state as if it is the best business idea they have ever had. It is important to remember that even if mediocrity can shine temporarily in a restrictive and monopolized environment, it is a big fish in a small pond scenario, artificially created by the regulatory controls in place. Mediocrity is simply mediocre and will not survive in a competitive environment.
The longer-term business climates in which many restrictive regulatory controls are eased and the competitive state landscapes become more robust will see premium quality, comprehensive product sets, competitive pricing and efficient operations win the day.
While there is no doubt that the product in question benefits (currently) from artificially high market prices, that is largely due to the prohibition implemented by the government vs. an appropriately profitable model (e.g., earnings vs. cost of goods sold).
If a new organization isn’t planning for the longer term and treating the environment like an operational challenge focused on an indoor-cultivated agricultural commodity, there will soon be (unfortunate) surprises around every corner.