CannaLaw: The Changing Landscape of the California Cannabis Industry

Story by Dale Schafer

     In the last month I have been witness to a county board of supervisors opting to spend about a million dollars of general fund money to monitor a 50-square-foot personal medical garden and forego multiple millions in taxes and fees by refusing to permit commercial cannabis activity. I also witnessed a small, broke farming community sell a closed prison to a cannabis manufacturing corporation and authorize indoor cultivation, along with manufacturing, on a large scale. While one county collected $5,000 each from over 700 applicants for commercial cultivation permits, another refuses to consider any permits for commercial cannabis activities.
     California is made up of many regions within a very large geographic area. While it is considered a “blue” state politically, many regions, and communities, are “red.” There are 58 counties and hundreds of cities, each vested with the constitutional authority to control the land within their respective boundaries through land use ordinances. The new medical cannabis law, the Medical Marijuana Regulation and Safety Act (MMRSA), requires a local regulatory permit for commercial cannabis activity before applying for one of the state licenses. When MMRSA was initially signed by the Governor, it contained a provision imposing a 100 square foot personal medical garden restriction, with a limit of 500 square feet for a caregiver, as the default state limit on personal grows, unless a local city or county enacted a different limit by March 1, 2016. Almost half the cities and counties opted for bans that could be modified later. Although the legislature has since lifted the deadline, the bans remain.
     Political battles are being fought all over the state to gain the anticipated permits from cities and counties that are believed to be so lucrative.
     Many local jurisdictions are opting to send the questions of permits and taxes to the voters in November. The initiative to legalize recreational cannabis use, Prop 64, is on the ballot and, should it pass, it will subsume MMRSA, while following most its local control for commercial cannabis activities. As a further confounding factor, the Legislature is hard at work with clean-up legislation directed at MMRSA. Trying to anticipate the political and regulatory landscape is rather like trying to read tea leaves in mud.
     If anyone wants to invest in the California cannabis industry a word of caution is necessary. There is a popular belief that cultivating is the fastest way to a reasonable ROI. Indoor cultivation easily comes to mind because it is possible anywhere, especially close to major population and consumption areas.
     However, at least 20% of the cost of production is in electricity and certain pests defy eradication. The plant evolved outdoors and sunlight is free, but the traditional outdoor cultivation areas are either controlled by local growers or are in ban locations. MMRSA requires yearly renewal so planning a budget can get dicey when the whole operation can end after a year. That dynamic only increases when you consider more capital-intensive activities.
     A distribution center—a necessity for much of MMRSA—is modeled after our alcohol regulation. It will require a large structure, vehicles for transport, a separate but necessary affiliated license, and deep pockets while operations take shape, all while operating under a yearly license. A manufacturer will require not only a physical plant but sophisticated and expensive equipment.
     Dispensing is another activity that is believed to be lucrative and have a reasonable ROI. As certified and vetted employees are added into the equation, costs grow exponentially and, oh, that pesky yearly license. Prop 64 allows for larger cultivation activities and more vertical integration (MMRSA allows only two types of licenses), but brings substantial taxes on production and a 15% excise tax.
     How much can it cost to operate in California? The closed prison sold for $4.1 million. A distribution center located in a local area contains 17,000 square feet with no realistic hope for revenue until the state begins to issue licenses after January 1, 2018. The regulations have not even taken effect yet, but they will be strict and costly. Each city and county will be allowed to regulate more strictly than the state, if they choose. Testing labs will be tightly regulated for uniformity—something lacking today—and they are another capital intensive startup. If you’re a number cruncher, this is a nightmare.
     If you’re thinking about investing, good luck. Each day the landscape changes. I spend countless hours trying to understand the local politics and trying to anticipate the variables that can be seen from this vantage point, as the train rolls along the tracks. I try to stay involved in local politics where there is any hope of persuasion and try to organize local stakeholders who are afraid and not used to working together, or even getting into the sunlight.
     My advice to those who ask is to make plans that are malleable. Get involved in local politics wherever you want to consider your investment. Try to find people who can assist, without being sold snake oil or a bill of goods. If you’re going to invest, do it for the long term. Expect three to five years of volatility, so capitalize for at least that timeframe. Get trustworthy advice from business, accounting, land use, regulatory, insurance and financial people. If you believe you can make the kind of ROI currently being made by those operating outside the system, forget it. The costs will be higher and the price for cannabis will drop, perhaps precipitously. Be prepared to put on your big boy, or girl, pants, put your seatbelt on and look down the road for years of hard work.