Last week, Hoban Law Group announced a major international expansion, with new offices in Latin America and the European Union. The Denver-based law firm said they will have four new offices across the EU by late fall and two new offices in Latin America by spring of 2018.
Bob Hoban, managing partner and co-founder of Hoban Law Group, says they have already been working internationally for years. “HLG steps in to global markets quickly as our direct work with government officials on policy and regulation has kept us in this important global curve,” says Hoban. “We have accepted the challenge of being global cannabis industry leaders & experts and will work with strategic industry-leading partners, such as New Frontier Data, to move the industry forward across six countries.”
The press release says the law firm has been advising governments around the world on cannabis policy for several years, as well as working on a handful of international business transactions in the past. These new offices will work mainly with structured finance, mergers and acquisitions, worldwide trade, regulatory law and equity placement in the cannabis (including industrial hemp) industry. “Combining the firm’s corporate practice, with our intellectual property and tax practice groups will position our firm’s client’s to succeed at the highest levels in this international marketplace,” says Hoban.
The press release also announced they have added Andrew Telsey, an experienced securities attorney, to their firm. He has helped take more cannabis businesses public in the U.S. than any other attorney.
Hoban Law Group, founded in 2009, is the nation’s largest cannabis business law firm. They have attorneys in every state that has legalized cannabis in the United States.
To round out our federal reform review, we look at the bills introduced into the 115th Congress that attempt to resolve the banking and taxation problems faced by state-legal cannabis businesses. As this is perhaps the biggest thorn in the side of the cannabis industry, any movement by the feds on these issues will be welcomed. As it turns out, there are four proposals currently pending for fixing the broken cannabis financial services system, with each proposal comprising a pair of House-Senate companion bills. We look at each pair in turn.
S. 1156 – SAFE Act; or, Secure and Fair Enforcement Banking Act
Policy: These SAFE Acts would prohibit federal prosecutors and federal regulators from preventing or disciplining in any way a depository institution simply because that depository institution serviced a cannabis-related business.
Impact: The impact of these bills would be widespread for both the cannabis industry and for financial service institutions looking to capitalize on the cannabis industry. For banks, the bills would remove all of the barrier-risks that are now keeping them out of the cannabis business. Currently, the feds have handed down policy guidance to banks stating that as long as they submit what are called “Suspicious Activity Reports, or “SARs” for cannabis-related accounts, and conduct their due diligence to ensure such accounts are complying with state law, then those banks will not be pursued by federal law enforcement. The problem with this guidance is that it is only policy, it is not law, and so it can change on as little as an administrative whim. The protection from cannabis business risk, most banks have determined, is therefore temporary at best and illusory at worst. Passage of the SAFE Act would instantly change all of that and initiate a banking bonanza. Banks will be racing to profit off of what is amounting to a newly minted billion dollar industry. Cannabis businesses will benefit greatly from all of this. Not only will they be able to stop operating strictly in cash and have access to all the traditional financial services that other businesses heavily rely on, but they will also be the beneficiaries of a highly competitive, and therefore affordable and efficient, cannabis banking market.
Introduced: May 17, 2017 by Senator Jeff Merkley (D-OR)
Introduced: April 27, 2017 by Representative Ed Perlmutter (D-CO)
Cosponsors: 7 Republicans, 44 Democrats
Referred to House Committees on:
Subcommittee on Crime, Terrorism, Homeland Security, and Investigations
S777 – Small Business Tax Equity Act of 2017
HR 1810 – Small Business Tax Equity Act of 2017
Policy: These bills would carve out an exception to IRC 280E allowing cannabis businesses to deduct ordinary business expenses from their federally taxable revenues.
Impact: If enacted these bills will dramatically ease the tax burden for cannabis businesses. Currently, even when they are in perfect compliance with state law, cannabis businesses are not permitted to deduct ordinary business expenses. This means that net taxable revenues are, and are going to continue to be, substantially higher than net taxable revenues for businesses in any other industry. If enacted, profit margins—and therefore product quality, operational efficiency and innovation—are going to uptick across all states that have legalized.
Introduced: March 30, 2017 by Senator Ron Wyden (D-OR)
Cosponsors: 1 Republican, 4 Democrats
Referred to Senate Committee on:
Introduced: March 30, 2017 by Representative Carlos Curbelo (R-FL)
Cosponsors: 10 Republicans, 24 Democrats
Referred to House Committee on:
Ways and Means
S. 780 – Responsibly Addressing the Marijuana Policy Gap Act of 2017
HR. 1824 – Responsibly Addressing the Marijuana Policy Gap Act of 2017
Policy: These bills combine to accomplish what each of the foregoing pairs accomplish separately. IRC 280E would no longer apply to state-legal cannabis businesses, and banking would become available for them as well. Additionally, advertising prohibitions in the CSA and the Communications act of 1934 would be removed, with the one exception that advertisements inducing travel from a state where cannabis is not legal to a legal cannabis state would be prohibited. Under Title II of the acts, barriers to federal bankruptcy proceedings would be removed. These bills would also reform the CSA as it relates to criminal liability for individuals, criminal record expungement and medical research for institutions, all of which are noteworthy but neither of which directly impact the legal cannabis industry.
Impact: For the impact of IRC reform, see “Impact” section under S.777/HR.180. For the impact of banking reform, see “Impact” section under S.1156/HR/2215.
By leaving advertising guidelines completely up to the states, we would probably witness the easing of advertising restrictions by the states. Currently, states have tight advertising rules because, after protecting consumers, they do not want their state’s legal cannabis industry to draw attention from the feds in any way. That concern would become moot and we could see more advertising in and across legalized states. This would drive competition across larger markets, in terms of both product and service quality and branding/marketing strategy.
Access to federal bankruptcy proceedings would clarify the landscape for all potential financial scenarios in the lifecycle of cannabis businesses, which in turn will ease uncertainty concerns of potential investors. The bankruptcy provision, combined with the banking provisions will undoubtedly open access to capital for cannabis businesses looking to grow operations and market presence.
Introduced: March 30, 2017 by Senator Ron Wyden (D-OR)
Referred to Senate Committee on:
Introduced: March 30, 2017 by Representative Earl Blumenaur (D-OR)
Cosponsors: 0 Republicans, 8 Democrats
Referred to House Committees on:
Crime, Terrorism, Homeland Security, and Investigations
Regulatory Reform, Commercial and Antitrust Law
Immigration and Border Security
Energy & Commerce
Ways and Means
Indian, Insular, and Alaskan Affairs
Education and the Workforce
Oversight and Government Reform
S. 776 – Marijuana Revenue and Regulation Act
HR. 1823 – Marijuana Revenue and Regulation Act
Policy: Subchapters A and B of these bills would impose two additional federal tax requirements on cannabis businesses. The first would be an excise tax on all producers, beginning at a rate of 10%, and growing each year that a producer is in business to a cap of 25% at five years. The second tax would be an occupational tax of $1,000 per year, to be paid by the principals of any cannabis producer or warehouse proprietor. Significantly, these bills would also authorize the federal government to regulate operations in the industry.
Impact: The tax impact of these bills would be a straightforward additional tax that cannabis businesses would have to pay, on top of state and local taxes. The burden of additional taxes will inevitably impact profit margins, initial decisions on whether or not to enter the market and strategies for expansion and innovation. The impacts of federal authorization and regulatory requirements was discussed in the second article of the series, specifically under the “Impact” section of HR1841
Introduced: March 30, 2017 by Senator Ron Wyden (D-OR)
Referred to Senate Committee on:
Introduced: March 30, 2017 by Representative Earl Blumenaur (D-OR)
On Election Day last year, voters in Massachusetts approved a measure to legalize recreational cannabis. With recreational sales beginning in July of 2018, lawmakers have tried to get a bill through the state legislature to settle on, among other things, a tax rate and regulatory framework.
On Wednesday, multiple news outlets reported that the legislature has reached a compromise on a bill that would change the measure that voters passed to allow for lawmakers to implement higher taxes, a strategy on local bans and a regulatory framework, reports The Boston Globe.
In a statement to supporters, Matt Schweich, director of state campaigns at Marijuana Policy Project (MPP), the biggest changes are in local control and taxation. “After weeks of persistent advocacy from Massachusetts residents, the Senate and House have reached a compromise that largely respects the will of the people,” says Schweich. “The legislation adjusts the local control policy, allowing local government officials in towns that voted “no” on the 2016 ballot initiative to ban marijuana businesses until December 2019. For towns that voted “yes” in 2016, any bans must be placed on a local ballot for voters to approve.” Therefore if a town wants to ban cannabis sales, they need to bring it to a vote for the people to decide. 72% of the population voted in favor of the ballot initiative. “The maximum tax rate — which depends on whether towns adopt optional local taxes — will increase from 12% to 20%,” says Schweich. “Under the bill, the state tax will be 17%, and the local option will be 3%.” A major push behind increasing the tax rates concerned lawmakers’ worries that the original 12% tax rate would not cover regulatory costs and government expenditures on the industry.
The ballot initiative created the Cannabis Control Commission, the regulatory body overseeing the industry, with three board members. That agency will remain in the new bill, just with five board members that will write the rules on things like marketing, safety, fines and penalties and fair business practices.
Schweich says the MPP helped orchestrate over 1,000 calls to legislators, urging them to reject the House’s version of the bill, which some have called draconian. “The bill isn’t perfect, and we preferred the original language of the ballot initiative,” says Schweich. “However, given how problematic the House bill was, we are satisfied with the final compromise.”
The bill is expected to pass votes in both the House and Senate on Thursday and Governor Charlie Baker is expected to sign the bill that same day.
On July 1st, dispensaries in Nevada began recreational cannabis sales, where thousands flocked to retail shops on opening day throughout the state. In Las Vegas, 38 dispensaries were flooded with customers in long lines, with waits up to three hours, according to the Las Vegas Sun. Nevada joins four other states, Oregon, Colorado, Washington and Alaska, in legal recreational cannabis sales.
Another article on the Las Vegas Sun claims the state did a total of $3 million in total rec cannabis sales in the first four days of it being legal. Over the next six months, it is estimated the state will do $30 million in total cannabis sales. According to that article, that generated roughly $500,000 in tax revenue for the state in those first days.
An article in the Reno Gazette Journal quotes Nevada Dispensary Association Executive Director Riana Durrett as estimating roughly $1 million in tax revenue for the state in the first four days. The four dispensaries in Reno that are open for recreational cannabis sales reaped hundreds of thousands of dollars within a few days, according to Will Adler, executive director of the Sierra Cannabis Coalition.
Blum, a dispensary with locations in Las Vegas and Reno, owned by Terra Tech, did roughly $100,000 in revenue on the first day at their Reno location, according to the Reno Gazette Journal. On Friday, July 7th, after a week of record sales, the state acknowledged there might be a shortage of cannabis, with growers unable to meet market demands. In an email sent on Friday, the Nevada Department of Taxation announced Governor Brian Sandoval endorses a ‘statement of emergency’, giving officials the ability to consider more applicants for distribution licenses, according to the Reno Gazette Journal. “Based on reports of adult-use marijuana sales already far exceeding the industry’s expectations at the state’s 47 licensed retail marijuana stores, and the reality that many stores are running out of inventory, the Department must address the lack of distributors immediately,” says Department spokeswoman Stephanie Klapstein. “Some establishments report the need for delivery within the next several days,” says Klapstein. Nevada legalized recreational cannabis on Election Day in 2016, when voters approved Ballot Question 2.
Election Day last year also yielded legal recreational cannabis in Maine, Massachusetts and California, all of which are expected to roll out regulations and implement recreational sales in 2018. Given Nevada’s massive numbers in sales and tax revenue in the first week, many anticipate high opening day sales revenue numbers in Maine, Massachusetts and California.
According to the Marijuana Policy Group, the U.S. cannabis industry is expected to reach more than $13 billion in sales by 2020 and create more jobs than the U.S. manufacturing industry. According to Viridian Capital’s Cannabis Deal Tracker, there were close to 100 M&A transactions in the U.S. cannabis industry in 2016 and approximately $1.2 billion was raised in equity and debt. As the cannabis industry has grown more mature and businesses begin to have more capital available, the M&A activity within the industry is poised to grow significantly over the next years to assist businesses gain necessary scale and take advantage of synergies and diversification.
The Obvious Wrinkle
U.S federal law has prohibited the manufacture and distribution of cannabis since 1935. The U.S. regulates drugs through the Controlled Substances Act, which classifies cannabis as a Schedule I drug (i.e., drugs determined to have a high potential for abuse with no currently accepted medical use and a lack of accepted safety regarding their use). Yet, more than 25 states have by now legalized cannabis for medical and/or recreational purposes and, as a result, there is a clear conflict between such state laws and existing federal law. To possibly help bridge that conflict, the U.S. Attorney General’s office in 2013 issued guidance directing the federal government not to intervene with state cannabis laws except in specific, limited circumstances, but, contrarily, the DEA has shown no desire to re-classify cannabis. To add to the confusion, President Trump and the new U.S. Attorney General have provided mixed statements and signals about their positions.
All of this means that it continues to be risky to acquire cannabis businesses. The requirements to legally grow, distribute, prescribe, and use cannabis for either medical or recreational purposes vary widely by country, state, and local jurisdiction, making it tricky to determine whether such businesses can be legally combined, in particular, across state lines.
Pick the Right Team of Advisors
When preparing to sell or buy a cannabis business, it is important to pick the right team of advisors. Your regular legal counsel, accounting firm or CPA may not be the right advisors for a cannabis M&A transaction. Choose a legal counsel that not only has experience with cannabis laws and regulations, but also has cannabis M&A experience and can offer expert advice on areas like IP, employment, tax matters, etc. Similarly, verify that your accounting firm or CPA has real experience with financial and quality of earnings analysis and due diligence.
Conduct Gating Due Diligence Up Front
In any contemplated M&A transaction, it is wise to prioritize your due diligence investigations. There will always be some more prominent risks and business objectives in a particular industry or with respect to a specific target business. It will be more cost and time effective if those specific risks and business objectives are prioritized early in the due diligence process. These can dictate whether you even want to pursue the target further before you dig into a deeper and broader due diligence investigation. Conducting gating due diligence up front is even more important in an industry like cannabis that contain complex and thorny regulatory hurdles.
So, before you spend money and time on a broader legal, business and financial due diligence investigation, have your legal counsel analyze and confirm that the potential transaction is feasible from a regulatory perspective. This will include whether it is possible to obtain or transfer necessary local and/or state licenses and whether a combination or sale can occur across state lines if necessary. Early on in the process, It is also advisable to request that the target business complete a legal compliance questionnaire or discuss with the target its regulatory compliance program, policies and training. Such up front due diligence will either clear a path to negotiations and broader confirmatory due diligence or flush out “red flags” that may kill a possible deal or require the buyer to investigate further before proceeding.
Important Terms and Pitfalls in the M&A Agreement
Generally, a sale or purchase agreement for a cannabis business does not appear to vary much from a similar agreement in any other industry. However, the complex environment and the premature nature of the industry impacts certain deal terms and processes in different ways from most other developed industries.
Here are few examples to keep in mind when preparing and negotiating a sale or purchase agreement:
Third Party and Governmental Consents: Buyer’s legal due diligence must focus on the consents that may be required from seller’s suppliers, customers, landlords, licensors or other third parties under relevant contracts. Additionally, the due diligence should focus on consents and approvals required by local and state regulators as a result of the sale. The M&A agreement should contain solid seller representations and warranties about all such consents and approvals and any such material consents and approvals should, from a buyer’s perspective, be a condition precedent to closing of the transaction.
Legal Compliance: A buyer should not agree to a boilerplate seller representation about the target’s compliance with laws. Be specific and tailor seller’s legal compliance representation to relevant state and local cannabis laws, regulations and ordinances. From a seller perspective, be careful and thoughtful about any appropriate exceptions (including the federal prohibition) to be disclosed to buyer in the disclosure schedules underlying the sale or purchase agreement.
Financial statements: The cannabis industry is very fragmented and consists of many small businesses. Many of these small businesses do not have financial statements prepared in accordance with GAAP and may consist of only management prepared financials. In that scenario, a buyer should have its financial advisor do an analysis of the financials available and ask seller to provide a representation and warranty about the accuracy and good faith preparation of the provided financials.
Escrow: Typically, a buyer will request some part of the purchase price be placed with an independent financial institution for a period of time post-closing as a source of recovery for losses as a result of breaches by seller of any of the representations and warranties in the definitive sale or purchase agreement. Due to the federal cannabis and banking regulations, many of the larger commercial banks will not provide financial services to cannabis businesses, in particular if the business touches the plant. The parties must therefore consider alternatives, including local financial institutions with more relaxed compliance requirements or perhaps place the escrow in a trust account of a law firm or other independent party.
Working Capital Dispute Procedures: Similar to the escrow, larger accounting firms generally do not provide services to cannabis businesses. Due to the rapid evolution of cannabis related regulations, if the terms of the transaction include provisions for a post-closing working capital/purchase price adjustment and related dispute procedures, it is advisable to not name an arbiter in the agreement. Instead, parties should agree to mutually select the arbiter if and when a dispute should arise.
Indemnification: Because of the tricky legal environment of the cannabis industry, it may be prudent for a buyer to request, at the very least, that certain parts of seller’s legal compliance representation and warranty not be subject to the “regular” caps, deductibles and other indemnification limitations. Also, if a buyer has unearthed a significant issue in its due diligence investigation, it should consider asking seller for a special indemnity for such issue that would be indemnifiable regardless of buyer’s knowledge of the issue and not be subject to the general indemnification limitations.
R&W Insurance: If there’s a lot of competition for the purchase of a target, particularly in a bidding process, it is now common for buyer to offer to purchase a representation and warranty insurance policy (“R&W Insurance”) to possibly gain an advantage by limiting the seller’s post-closing indemnification exposure. The good news is that many of the R&W Insurance carriers do offer such insurance in connection with the sale and purchase of cannabis businesses. However, typically, R&W Insurance cannot be obtained for insured amounts of less than $5 million. Experienced M&A counsel can advise of the advantages and disadvantages of R&W Insurance and assist in the negotiation of the related terms.
The above are just some examples of what to expect in a cannabis M&A transaction. Every M&A transaction will have its unique issues that will need to be appropriately reflected in the sale or purchase agreements and good M&A practices will continue to evolve with the industry. If you are an owner of a successful cannabis business, buckle your seat belt and be prepared for an exciting ride as the industry gets closer to significant consolidation.
According to National Cannabis Industry Association (NCIA) executive director Aaron Smith, seven measures were introduced today at the Capitol, covering a variety of issues that, if signed into law, would ease many of the legal implications on the federal level affecting cannabis businesses in legal states currently.
In a very important development, Rep. Carlos Curbelo (R-FL), a member of the House Ways and Means Committee, joined Rep. Earl Blumenauer as a lead sponsor of the 280E tax reform bill. According to an NCIA press release, that bill is The Small Business Tax Equity Act of 2017 and was introduced in the Senate by Sen. Ron Wyden (D-OR), Sen. Rand Paul (R-KY) and Sen. Michael Bennet (D-CO).
That bill gives cannabis businesses in legal states the opportunity to take business deductions like any other legal business. Right now cannabis businesses cannot deduct any expenses related to sales, given its Schedule I status. “Cannabis businesses aren’t asking for tax breaks or special treatment,” says Smith. “They are just asking to be taxed like any other legitimate business.”
Rep. Jared Polis (D-CO) introduced the Regulate Marijuana Like Alcohol Act in the House, which would put cannabis in the section of code that regulates intoxicating liquors, essentially giving the ATF oversight authority. “The flurry of bills on the Hill today are a reflection of the growing support for cannabis policy reform nationally,” says Smith. “State-legal cannabis businesses have added tens of thousands of jobs, supplanted criminal markets, and generated tens of millions in new tax revenue. States are clearly realizing the benefits of regulating marijuana and we are glad to see a growing number of federal policy makers are taking notice.”
Sen. Wyden and Rep. Blumenauer introduced The Responsibly Addressing the Marijuana Policy Gap (RAMP) Act, which addresses banking and tax fairness for businesses, civil forfeiture, and drug testing for federal employees. Both Blumenauer and Wyden represent Oregonians, who could benefit tremendously if it becomes legislation. Rep. Blumenauer also introduced The Marijuana Tax Revenue Act, which would put a federal excise tax of initially 10% on cannabis sales, then rising to 25% after five years, according to the NCIA press release.
Members of Congress last week announced the formation of a ‘Congressional Cannabis Caucus’ in order to organize and affect cannabis policy at the federal level. Representatives Earl Blumenauer (D-OR), Dana Rohrabacher (R-CA), Jared Polis (D-CO) and Don Young (R-AK) announced the creation of the caucus on February 16th. Cannabis advocacy and drug policy groups were quick to commend the formation of the organization.
In a joint statement issued on Friday, the National Cannabis Industry Association, the Marijuana Policy Project, the Drug Policy Alliance, NORML, Americans for Safe Access, Students for Sensible Drug Policy, Law Enforcement Action Partnership, Doctors for Cannabis Regulation, and Clergy for a New Drug Policy expressed commendation and excitement for the new group. “We commend Representatives Blumenauer, Rohrabacher, Polis, and Young for their leadership on the issue of cannabis policy,” reads the statement. “The establishment of a Cannabis Caucus will allow members from both parties, who represent diverse constituencies from around the country, to join together for the purpose of advancing sensible cannabis policy reform. It will also facilitate efforts to ease the tension between federal prohibition laws and state laws that regulate cannabis for medical and adult use.”
The members of Congress that formed the caucus all represent constituents in states where cannabis is legal for medical and adult use. “The formation of this caucus is a testament to how far our country has come on the issue of cannabis policy,” says the joint statement by the drug policy reform groups. “We look forward to working with caucus members to translate this growing public sentiment into sound public policy.” According to their statement, 44 states so far have adopted laws effecting cannabis prohibition on the state level, representing 95% of the U.S. House of Representatives and 88% of the Senate.
Representatives Blumenauer and Rohrabacher have been prominent cannabis policy reform advocates in the past. Blumenauer supported the bill to legalize adult use cannabis in Oregon back in 2014 and Rohrabacher introduced the Rohrabacher–Farr amendment to Congress, which prohibits the Justice Department from spending money on interfering with state medical cannabis laws.
According to an article on Roll Call, Blumenauer says the caucus will focus on more medical research and the tax and banking regulations hurting cannabis businesses.
On Election Day in November, two major states in the Northeast legalized recreational cannabis: Maine and Massachusetts. It seems that a handful of other states in the region are looking to legalize recreational cannabis now that their neighbors have done so.
In New Hampshire, a bipartisan bill was introduced on January 4th to establish “a commission to study the legalization, regulation, and taxation of marijuana.” The commission formed by House Bill 215 aims to “study the experiences of states that have or are in the process of legalizing and regulating the recreational use of marijuana by adults, with particular attention to be given to the ways the changes in marijuana laws in Maine and Massachusetts, as well as Canada, impact our state,” the bill states. Notably, the bill provides for a representative from the Marijuana Policy Project to be a member of the committee.
New Hampshire Senate Minority Leader Jeff Woodburn (D) says he plans to sponsor a recreational legalization bill separate from House Bill 215. According to the New Hampshire Union Leader, Woodburn would work with lawmakers and stakeholders to set a timeline and regulatory framework.
In Connecticut, a number of lawmakers have sponsored bills this session that would legalize recreational cannabis. Senate President Martin Looney (D) filed a bill that would legalize, regulate and tax cannabis, with the tax revenue going to the state’s general fund, according to the New Haven Register. State Rep. Melissa Ziobron (R) introduced a piece of legislation that would legalize adult use over the age of 21. Lawmakers are optimistic that with Massachusetts legalizing it, perhaps the outcome will be different than previous failed attempts to push cannabis legalization.
Lawmakers in Rhode Island told reporters they want to be the first state to legalize recreational cannabis via the state legislature, rather than a ballot initiative, the most common path to legalization for other states. Sen. Joshua Miller and Rep. Scott Slater of Rhode Island, both Democrats, plan to introduce a legalization bill, the seventh year in a row that such a bill has been introduced in the state. They are also hopeful that after Massachusetts’ legalized it in November, they will have more success this time around. “Our constituents think it is time for lawmakers to pass this legislation, and we should listen to them,” says Miller. “If we fail to pass the bill this year, we will lose significant ground to Massachusetts.” Their bill would tack on a 23% tax on cannabis sales.
In each state’s case, lawmakers are keeping a close eye on Massachusetts and Maine’s regulations and tracking their progress. While the bills in the state legislatures are nascent in their journey to becoming law, the important takeaway is that geographic proximity to states with legalized cannabis is a catalyst for reform in New England.
California’s tradition of social and political experimentation has made it the national leader in areas ranging from environmentalism and social justice to technology. Now it is poised to make the same far-reaching transformations in the cannabis industry.
As one of the world’s top ten economies and the nation’s most populated state (having a population of 38 million), California could propel the decriminalized recreational cannabis industry to $6.5 billion in 2020, according to a report by ArcView Group and New Frontier.
At the same time, California is in the process of moving from state to local zoning control, as far as issuing the OK to become licensed, effective Jan. 18, 2018. This means collectives and dispensaries have to obtain local approval before they receive a state license. It also puts greater pressure on gray market operations to become licensed.
On the regulatory front, the state is also heading toward a historic vote in November 2016 in the form of Proposition 64. This will open up the customer base to all Californians. It has a similar licensing path as the medical regulations the Governor signed last year, except it allows vertical integration between growers and dispensaries, which is not allowed under the medical regulations, except in very limited circumstances.
“My bet is the demand will outweigh the supply for a while and the legal cannabis businesses that are licensed by the locals and have their supply chain in place will end up profiting,” says Andrew Hay of Frontera Accounting, a cannabis-focused CPA firm based in California under the umbrella of the Frontera business group.
A Huge Market Awaits
If the Adult Use of Marijuana Act passes and is enacted by 2018, the state’s legal cannabis sales are projected to hit $1.6 billion in their first year, the ArcView and New Frontier market report said. Even without the new expanded legislation and working amid a fractured medical cannabis regulatory environment, California now accounts for about half of all the legal cannabis sales nationwide, according to the report.
At the same time, the state is well positioned to capitalize on new technology and financing from Silicon Valley in terms of human talent, money and the applications of new technology in both the medical and recreational sectors. One driving force will come from the Adult Use of Marijuana Act, which mandates that 10 percent of sales tax collected on cannabis sales be re-directed towards medical research and drug abuse programs.
In addition, according to Marijuana Politics, the expected tax windfall is slated to be divided up among a variety of programs: $10 million to public universities, $10 million to business and economic development, $3 million to California Highway Patrol and $2 million for medical cannabis research at UC San Diego. The remainder will be divided between youth drug education and prevention (60%), environmental protection (20%) and law enforcement (20%).
This flow of new funds is expected to propel research into biomedical and applied research, as well as nutraceuticals, or products derived from food sources with extra health benefits in addition to the basic nutritional value found in foods. The driving new ingredients in these products will be derived from cannabis.
Consolidating the Recreational and Medical Markets
Californians will vote in November 2016 to legalize the sale of recreational cannabis. This vote will have serious repercussions since it could mean that the delineation between medical and recreational markets will disappear.
“Should California vote to legalize recreational use this November, we expect implementation of a combined regulated market as soon as 2018,” says Matt Karnes, founder of GreenWave Advisors. Karnes says a merged California market is significant, not only because of its sheer size (it represents about 55% of the U.S. market), but also because it “would mark the first state to implement regulations for a fully legal market without initial oversight of medical use purchases. This could serve as a catalyst for similar action in Nevada, Arizona, Massachusetts and Maine which will also vote to fully legalize cannabis this November.”
In the report, “Mid Year Update: The Metamorphosis of the U.S. Marijuana Market Begins,” the firm said it projects cannabis sales in the U.S. to hit $6.5 billion for 2016. The firm forecasts that by 2021, revenues should reach about $30 billion. This assumes that marijuana will be legal in all 50 states to various degrees. The firm also notes that this year’s election choices can potentially generate $4.2 billion in incremental retail revenues by 2018 and $5.8 billion by 2021.
The Impact on Branding, Music and Culture
As the nation’s culture manufacturing center for films, TV and music, the cannabis business is also expected to shape artistic direction for years to come. Jeff Welsh is a partner at Frontera, a business group that holds a suite of services including the Frontera Law Group, Frontera Advisors, Frontera Accounting and Frontera Entertainment, which is headquartered in Sherman Oaks with a specific focus on the cannabis industry. Welsh says he sees more partnerships between the cannabis industry and mainstream entertainment outlets. Welsh recently signed Chris Sayegh, the herbal chef who uses liquid THC to create elegant restaurant-quality food, in a deal with the United Talent Agency. This marks a cultural breakthrough that links the cannabis and culinary industries.
Because Los Angeles is the largest market, this cultural nexus is expected to contribute more new alliances between celebrity branding and cannabis products.
Luke Stanton, founder and managing partner of Frontera, also said less stringent regulations in the cannabis legal environment could find their way into the regulations and laws of other states that often adopt California laws as templates for their own state. “We have seen this happen in other areas, such as environmental and criminal justice, so it would not be surprising to see our state regulations and policies being enacted in states nationwide, and even in some countries outside of the U.S.,” Stanton says.
California has also been the site of innovative marketing efforts between cannabis patients and growers. The Emerald Exchange held in Malibu, was the first event in cannabis that allowed a direct conversation between Northern California cultivators and the Southern California patient community. According to Michael Katz of Evoxe Laboratories, a California cannabis product manufacturer, “Often the farmers don’t have a chance to really engage with patients, and we wanted everyone to be able to come together, discuss practices, provide information and ultimately support the entire ecosystem of the cannabis community.”
Caveats for Investors
While the California market looks very attractive, it may be the siren’s call for investors until issues related to finding solid companies and taxation are settled.
Since more operations will have to become fully compliant with state regulations, these businesses will face more significant expenses to meet security, taxes, licensing fees, accounting and reporting operations requirements. This could drive smaller operations out of business or force them to become more efficient.
In addition, California’s huge potential and changing regulatory environment is attracting large growers into the state that will compete with smaller, established operations. According to Jonathan Rubin, chief executive officer of Cannabis Benchmarks, these regulations affecting commercial growing vary greatly by municipality. For instance, Mendocino and Humboldt counties have enacted measures to protect local growers, while other counties have not, Rubin says.
In addition, cannabis wholesale prices have been falling due to changes in cultivation methods and variations in supply.
Andrew Hay, a CPA at Frontera Accounting, believes investors should make sure there is a solid plan behind any cannabis company investment. “I’ve seen significant money thrown behind ‘cannabis brands’ with no substance,” Hay says.
“In these cases, the winners are the growers, manufacturers, distributors and dispensaries that are licensed (or are in the process of getting licensed), who pay their taxes and have a successful track record. I wouldn’t invest until you see the underlying operational structure, their tax/regulatory compliance and financials that prove there have been sales,” he says.
Another major problem for investors lies in the IRS accounting regulations. “The biggest hurdle I see facing the California cannabis business is the IRS / IRC 280E, which only allows cost of goods sold deductions. Every cannabis business should be planning their operations around IRC 280E, as there is no way to legitimately survive in the cannabis industry without doing so,” according to Hay.
“IRC 280E is here to stay regardless of California legalization. It is up to the Federal government to fix this issue, which I don’t see happening any time soon. Every cannabis business should hire a CPA and business attorney that work well together to devise a cost accounting strategy to minimize IRC 280E and its impact. Without this, an investor’s profits can go up in smoke to the IRS,” Hay says.