Neglecting Legacy Cannabis Operators is Costing California Billions a Year
Excessive regulation and a lack of consultation has left the state's original weed entrepreneurs, and up to 75% of potential revenues, behind.
In December, the panel advising California’s cannabis regulators recommended the state loosen regulations on legal businesses as part of the Bureau of Cannabis Control’s (BCC) annual report.
It’s a stark change in tone for the state with the most expensive and bureaucratic recreational cannabis regulations in the U.S. In a statement, the bureau’s Cannabis Advisory Committee (CAC) said they recommended changes to give legal businesses a leg up because of the “additional pressures the cannabis industry faces during this challenging time.”
But for many in the industry, life in the weed business has been challenging since the state legalized adult-use in 2016, especially for those with less or no access to the tools needed to break into the heavily red-taped sector.
Experts on the state’s weed industry advisory committee say California’s recreational regulations weren’t designed to have all operators succeed. While high barriers to entry favour big players, compliance costs and requirements that force potential operators to pay significant rent before getting licensed are keeping swathes of legacy folks on the fringe.
And that’s losing the state a ton of cash. For one of the world’s longest running regulated weed economies, data firms estimate that less than a third of California’s US$11.5 billion in annual cannabis sales comes from legal sources.
The state could be distancing itself from more than US$7.5 billion in revenue a year.
While a notorious 2020 exposed overcapitalization in the state’s industry and legal weed at large, more resources and education are required if California wants to include the knowledge and untapped economic opportunity stuck in the shadows. It will also need to chip away at overwrought state-level regulatory processes that hamper applications.
California’s adult-use legislation wasn’t written for everyone to succeed
In 1996, California became the first U.S. state to pass legislation for medical cannabis with Proposition 215. But when California voters passed Proposition 64 in 2016, legalizing recreational cannabis, many businesses operating concurrent with the original medical regime shut down.
But those operators weren’t state-sanctioned to begin with. Proposition 215 only permitted the use of medical cannabis. Cannabis businesses at the time operated in a legal grey area, running dispensaries, farms and delivery services. When the adult-use market came online, many couldn’t afford to continue operating.
California is the only state where legalizing recreational sales shrunk the market, falling from US$3 billion in 2017 consumer spending to US$2.5 billion in 2018 according to BDS Analytics and Arcview Market Research. In their report, analysts attribute the downturn to the bureaucratic nature and high cost of Proposition 64 compliance.
In September 2019, the United Cannabis Business Association reported non-compliant outnumbered licensed operators three-to-one. BDS Analytics estimates 70–75 per cent of California’s US$11.5 billion 2020 weed market came from illicit activity, and expects the sector to be evenly split by 2025.
While accounting for unregulated sales remains educated guesswork, in two years Canada’s legal market accounts for at least a third of gross revenue. Hurdles are still in place north of the border, but regulators and governments have been more agile when it comes to opening the market and encouraging new entrants.
Keith Stephenson, CEO of Purple Heart Patient Center and an industry representative on the CAC, says there’s more to the story. Because most cannabis crimes are now considered misdemeanors, many operators have decided to break the law, he says.
But according to Stephenson, California’s adult-use regulations make it so only operators running a “fiscally balanced business” can comply.
“[Proposition] 64 was definitely not written with the intent for everyone to succeed,” he says.
When the legislation was proposed, many cannabis advocates encouraged people to vote “no” based on concerns that the bill would overregulate the industry and make it difficult to compete without large sums of capital and corporate experience.
A lack of consultation at the root of today’s problems
Advocates knew the bill would also force a culture shift. The industry would quickly develop a bigger focus on profit than it ever had. So-called legacy operators, those who started their businesses before Proposition 64 and closer-tied to California’s weed history, would get pushed out as a result.
This is why many believe The Golden State’s illicit market is still so large: Thousands of entrepreneurs, unable to compete in the regulated space, work in the shadows instead.
Another group, made up of former legacy businesses that have gone legal, is trying to help others transition to the regulated space.
“We’re not necessarily part of the new cannabis world — we’re part of the old cannabis world, and they’re two completely different lands,” says Marie Montmarquet, co-founder of MD Numbers, a family of weed brands from cultivation to retail that previously operated a delivery business in the pre-recreational space. “One is done on a handshake and a lot of loyalty, and one is done in court.”
Now, in addition to running her delivery company and farm with business partner Allen Hackett, Montmarquet advises legacy operators trying to get Proposition-64 compliant. At the San Francisco non-profit Success Centers, she works pro-bono under Angela White, who heads an educational training program for cannabis entrepreneurs impacted by the war on drugs. And through her cannabis advisory firm Legacy Coterie, Montmarquet consults with legacy operators to build out their delivery, cultivation and sales strategies.
To her, the root cause of California’s cannabis problems is a lack of consultation.
“[State officials] never reached out to all the people who were participating in this industry first and foremost and said ‘Hey, do you want to participate legally?’” she says.
As a result, legacy players have been excluded, and industry profiteers aren’t producing cannabis products that meet the California legacy standard.
Progress stifled by state- and local-level regulation
When the adult-use bill passed, local governments were allowed to zone specific areas for cultivation, distribution, retail and other types of weed operations, while excluding them from other zones. By the end of 2020, only a minority of California counties and cities permit cannabis businesses to operate in any capacity.
To comply with Proposition 64, existing businesses had to move to a select set of jurisdictions, where rent and operational expenses increased due to the high demand. Many continued to operate illegally against local regulations, while others simply went out of business.
“We voted for a law, and we are blocked at the local level,” says Andrew DeAngelo, a long-time California cannabis activist, industry consultant, and co-founder of legacy dispensary chain Harborside. “There are big counties that are known for growing weed where it’s banned,” he adds.
Second, Montmarquet says the high cost of compliance created huge barriers. California taxes cannabis businesses and sales than any other state, resulting in an additional 18–30 per cent in taxes being passed down to consumers depending on local regulations.
But the largest expense for most cannabis businesses is rent. Proposition 64 requires potential operators to secure a facility or storefront and pay rent on that space prior to licensing. Many spend close to US$100,000 on rent before receiving a licence.
“It is common for the licensing process to extend 12–18 months or more,” Montmarquet says. “Throughout this time, the applicant is normally paying rent on a space that is not bringing in any income.”
Founder and executive director of the International Cannabis Farmers Association (ICFA) Kristin Nevedal notes that many of these issues are part of entering any regulated market in California.
The California Environmental Quality Act (CEQA), for example, “requires state and local governments to inform decision makers and the public about potential environmental impacts of proposed projects” according to an internal ICFA document shared with Mugglehead. Nevedal says Going through the CEQA process is often long and bureaucratic, and is tailored to the environment of region and its local government’s specific rules.
“I think there’s a lot of confusion about what has been implemented today and the source of those statutes: Are those statutes truly in relationship to Prop. 64, or do they predate Prop. 64?” she encourages critics to ask.
Nevedal looks to streamlining the CEQA process as one definitive way to improve legacy operators’ plights. She also thinks extending provisional licences — which are offered as a stopgap measure while businesses wait for their full annual business permits — can help legacy operators struggling to keep up.
Regulated industry ‘unwelcoming at best’ to old-school operators
Additionally, Proposition 64 relies heavily on legal jargon and the help of law enforcement, which can be another deterrent for legacy businesses built on hustle, and often some degree of secrecy, rather than formalized education. And with the high costs, many legacy operators partner with white-collar investors and attorneys to start or keep their businesses afloat. But monied interests often take advantage of a lack of business knowledge.
“I’ve had to educate myself tremendously just to make sure I can speak the language that these people are speaking,” Montmarquet explains. “So, if I’m in a meeting and they’re talking about 1031 Real Estate transfers, I know what 1031 Real Estate transfers are.”
Nevedal, however, says the bill wasn’t written to be confusing.
“Prop. 64 looked at the Medical Marijuana Regulation and Safety Act passed by legislators in 2015 and just put the vast majority of that framework into this bill,” she says.
Nonetheless, legislative jargon combined with regular contact with state and local governments makes the regulated industry is unwelcoming at best to old-school operators — many of whom, like DeAngelo, have been impacted by the war on drugs. For doing business with a now-legal substance, people faced jail time, raids and other harassment from law enforcement.
“In San Jose, you have to go to the police station for crying out loud — I get PTSD when I go to San Jose and get my little badge for Harborside,” he says with a dark sense of humour. The San Jose Police Department, who is in charge of the city’s cannabis regulations and enforcement, did not respond to requests for comment about how to improve the system.
The Bureau of Cannabis Control, the agency tasked with regulating California’s industry at the state level, has declined to comment.
California’s overcapitalized weed market due for further reckoning
When governments don’t account for legacy operators, they lose out on some of the best cannabis talent around, Montmarquet says. She compares legacy operators to computer hackers hired for their invaluable underground knowledge.
“These hackers are extremely knowledgeable and valuable to the white market,” she says. “What legacy operators have is extremely undervalued knowledge right now.”
Ron Gershoni, CEO and co-founder of Oakland-based Jetty Extracts, agrees.
“All of the innovation that I see is coming from legacy operators, and it’s precisely because there’s that really deep understanding of the product and the consumer,” he says. “Our focus used to be only those two things because that was the only way you were getting products into the market and sold.”
To bring these people into the legal fold, state regulators will have to shape future legislation with them in mind. Bureaucratic hurdles could be lowered and simplified to increase accessibility, and state-funded financial assistance is needed to help legacy operators meet the cost of compliance.
Gershoni suggests giving the black market businesses local government turn a blind eye to, like the many unlicensed dispensaries in Los Angeles, a fast track to licensing.
Montmarquet — who reviews equity contracts at the Success Centers for entrepreneurs impacted by the war on drugs — says 2020 has given her some hope.
Three years after the start of California’s green rush, many corporate companies found their business models upended by a pandemic that increased demand on delivery, generated staffing conundrums and imposed unpredicted costs for things like PPE. Many of them were already failing at the start of the year, due to public relations problems and inflated IPOs.
These market shifts have only re-solidified why legacy operators are so vital, Montmarquet says.
“Now that so many overcapitalized, corporatized companies have failed, a new tone is set for respecting legacy operators, and respecting those of us who have been here doing this. We told you so.”
Mugglehead Link: https://mugglehead.com/neglecting-legacy-cannabis-operators-is-costing-california-billions-a-year/