The No. 1 Hurdle Facing California Cannabis Entrepreneurs
And why it's forcing some to go to the black market.
California’s newly regulated marijuana market is the biggest in the world, but not everyone seeking to do business there can acquire the tools to even break in, let alone succeed.
Many cannabis business owners are encountering a lack of funding opportunities, curbing their ability to thrive and forcing some to operate in the illicit market, according to several industry sources.
After California became the first state to legalize medical marijuana in 1996, the industry developed with homegrown businesses – meaning the vast majority of companies were startups with little seed money or overhead.
But that changed in January with the rollout of a new regulatory system that is actively squeezing out thousands of long-standing legacy MMJ businesses.
The rules are making it harder for new companies to find their financial footing, because entrepreneurs must often pay hundreds of thousands of dollars to secure licenses and comply with regulations covering everything from product potency and packaging to zoning.
“Since all of the regulations went into place, now it takes a few hundred thousand to a few million to start,” said Kimberly Cargile, CEO of Sacramento retailer A Therapeutic Alternative.
Related: California's 'Pot Desert' Problem
Get out or break the law?
The problem is perhaps most acute for legacy companies that would like – but are unable – to take part in the fully legal market.
Many are either already located in cities or counties that have banned cannabis commerce or have just a limited number of business licenses.
The choice is either to quit the industry altogether, pivot to the illegal market and risk possible criminal penalties, or relocate to a jurisdiction that’s granting permits.
How many legacy operators are facing such a decision?
“Sadly, it’s probably in the thousands,” said Morgan Paxhia, co-founder of Poseidon Asset Management in San Francisco.
“What we hear about all the time – which is the opposite of what was intended with legalization – is a mass defection to the black market,” Paxhia added.
“You have a ton of operators that are like, ‘Screw this, I can’t get a permit. … Am I either going to be broke or am I going to a well-established black-market system?’”
One grower in Calaveras County, northeast of San Francisco, said his family sunk more than $200,000 into getting local and state licenses before the county decided in early 2018 to ban all cannabis cultivation.
And now, because he can’t afford to pick up and move his operation to a county that will give him a permit, he’s almost certainly going to start selling illegally.
“This is how I make a living, and I don’t really have another option to go anywhere else or do anything else,” said the grower, who asked not to be identified. “We have made a decision to just go black market with our stuff.”
The grower said he’s inquired about financing and found that his small-scale operation doesn’t produce enough volume to get the attention of anyone who can offer the several hundred thousand dollars he needs to build out a new farm.
“They want you to be holding several half-acre or 1-acre permits and licenses to even think about investing,” he said. “Most of the bigger guys, a half-acre grow isn’t going to make them the kind of money they want to make.
“They want something extremely large, and that’s not what we’re about. We’re about higher quality on a lower production scale. So for us, that doesn’t work.”
Another entrepreneur in the San Francisco Bay Area has been trying for months to get her 5-year-old MMJ delivery business licensed, to no avail.
She’s also investigated moving, but that appears cost-prohibitive.
“It would definitely be a problem for us. We figure easily $500,000,” said the businesswoman, who also asked for anonymity.
Part of the problem, she added, is most local jurisdictions want business license applicants to already have physical locations lined up before even applying – meaning she’d have to shell out for a location before even knowing if she’d be granted a business permit.
When asked about taking on an investor, she said many small businesses don’t want to give up ownership unless it’s absolutely necessary:
“Why in the world do you want to now give away a chunk (of equity) if you don’t have to? It’s not like we’re going to Shark Tank and saying, ‘This business would be successful if you would invest this money in it.’ It is successful. It’s just that we’re being shut out of the marketplace because we don’t have these licenses.”
Licensees don’t have it easy either
Unlicensed businesses aren’t the only ones struggling to find cash to help stay afloat.
“We put a lot of money in on our own, and we started crowdsourcing … but up until now, it has been really hard to find an investor for one lump sum, or even a portion of it,” said Ella Alpina, co-founder of Thrive Society, a distribution company in Nevada City.
Although her company has already landed a distribution license from the state, her company’s problem is that it’s a startup, and therefore has no track record to attract investment.
“It’s hard to get large funding if you haven’t proven that you can execute,” she acknowledged. “We’ve been told that by investors, that we have to be up and running and have something to show before an investor is going to take a chance on you.”
Even if startups can attract investors, the deals put on the table can often be heavily weighted in the investor’s favor, said Ariana Tibbets, co-founder of Gold Mountain, a distributor based in West Sacramento.
“We’re already being hit up by venture capital firms that want to get into the cannabis space, but they want to take advantage by taking 30%, 40%, 80% of business equity,” Tibbets said. “We are looking, but we’re being very careful about who we want to get into bed with.”
The end result
A lack of local licensing across the state for legacy companies, combined with the high cost of complying with regulations and lack of access to financing, is leading to one thing: Major market consolidation.
That’s Paxhia’s prediction.
“The general trend is, taxes are too high, regulations are too onerous, and as a result, you’re seeing mass consolidation. I wouldn’t be surprised if this massive market is controlled by about 20 groups that will have significant market share in the next two years,” he said.
Those market leaders will likely corner 80% of the California cannabis market, leaving the other 20% for small operators to fight over, he predicted.
“It’s the old 80/20 rule, and it’s happening very fast.”