The Maryland Cannabis Administration has reported that dispensaries throughout the state have collected over $91.4 million in sales this past August. With officials predicting cannabis sales in Maryland could exceed $1 billion by 2025, many are looking to enter the cannabis space with the hope that they too can get a piece of the pie. However, the track record for cannabis entrepreneurs proves otherwise. Embarking in the cannabis industry is extremely risky due to a highly-regulated landscape that is often unclear, difficulty accessing capital and high upfront costs. Due to all this uncertainty, success in this industry is very unpredictable. With Maryland now the 22nd state to authorize adult-use sales, how can entrepreneurs blaze a trail through this emerging industry? Below are a few suggestions to prevent your hard work from going up in smoke.
Regulatory considerations
As in any highly-regulated industry, there are important measures that need to be accounted for to remain compliant. Therefore, those who want to get into the cannabis space must familiarize themselves with relevant state and federal regulations at play. Balancing the line between federal illegality with state legality is hard to keep track of, especially with the ever-changing regulations. This is especially important as laws vary from state to state, so if a green cannabis entrepreneur enters the space with the hopes of expanding their business beyond their state, knowledge of the varying laws can help an entrepreneur break into new markets as more and more states begin to legalize cannabis. Further, as states like Maryland have had to develop policies surrounding marijuana on their own, without federal guidance, it should come as no surprise that the Cannabis Reform Act that went into place in June of this year will be subject to change as lawmakers have already predicted that they will have to make further changes to current regulations. Below is a list highlighting a few key pieces of regulation.
The Controlled Substance Act
The Controlled Substance Act is a federal law that classifies cannabis as a Schedule I substance as it is considered a drug “with no currently accepted medical use and high potential for abuse.” Although cannabis is a Schedule I drug, many of its derivates (hemp, delta 8, CBD, epidiolex) have been labeled as exceptions from this schedule. Because of cannabis’ listing on Schedule I, cannabis entrepreneurs must be mindful of the fact that they are unable to move their products across state lines. Therefore, entrepreneurs need to be mindful that expansion in the cannabis industry is very limited unless one can obtain licenses to do so. However, a recent letter from the U.S. Department of Health and Human Services to the Drug Enforcement Agency claims otherwise and suggests the DEA reschedule cannabis to a Schedule III drug, which would create many positive effects on the industry as a whole.
The Marijuana Opportunity Reinvestment and Expungement Act (MORE)
The Marijuana Opportunity Reinvestment and Expungement Act (MORE) is a proposed regulation that would decriminalize cannabis by removing it from the controlled substance schedule, eliminate criminal penalties in connection with federal cannabis offenses, and expunge past federal cannabis convictions. Removal of criminal penalties would provide better opportunities as it would incentivize new money into the cannabis market. However, keeping in mind the latest Department of Health letter to the DEA, as referenced above, this stance on rescheduling could hinder the efforts of the MORE Act to deschedule cannabis altogether, if not further confuse our political leadership.
The Secure and Fair Enforcement Regulation (SAFER) Banking Act
The Secure and Fair Enforcement Regulation (SAFER) Banking Act would allow financial institutions to provide banking services to cannabis businesses. Passage of the SAFER Banking Act would be one of the most crucial elements to getting the cannabis industry off the ground as it would enable cannabis companies to obtain loans and other financial support from banks. Currently, most banks are skeptical of lending money to cannabis companies due to its federal illegality. SAFER would shield the cannabis industry from federal repercussions by providing legal protections when working with states in which cannabis has been legalized. With this protection, the cannabis industry would have increased financial access as they would be able to open bank accounts, deal with credit cards instead of cash and procure loans.
Each state has varying criteria as to how and what types of licenses are available (grower, cultivation, dispensary, testing, transportation, etc.), what products can be sold (tinctures, edibles, concentrates, etc.) along with specific dosage and potency criteria, testing and quality control, requirements on packaging, and a whole host of other considerations. Just a few weeks ago, the Senate committee on banking, housing and urban affairs moved forward with SAFER. The House of Representatives has already passed similar legislation (SAFE), so the Senate committee’s approval is a significantly positive sign.
Financial considerations
Businesses also need to be mindful of keeping costs low as it is essential for business sustainability, especially in competitive markets. Below are a few financial considerations to keep in mind.
Access to capital and planning. As previously alluded to, unlike other startups that can access capital from financial institutions via loans or even credit cards, cannabis startups have limited access to traditional banking and financing options. Therefore, unless an individual has capital on hand, they must reach out to investors, venture capitalists and friends or family to start up their business. Due to this lack of banking assistance, cannabis companies end up taking on loans from investors on very onerous terms. Additionally, the well-publicized downfall of many public cannabis companies has scared away many potential equity investors over the past few years.
Upfront costs. To be able to participate in any cannabis activity, one must procure a state cannabis license, which is very expensive. Depending on the type of license, a licensee could pay anywhere from $2,000 to $11,000 in application fees and then $40,000-$165,000 for annual licensing fees. Further, a license is limited not only to the type of activity, but also to that specific activity in the state. A cannabis company would have to procure various licenses to not only grow, cultivate and sell in Maryland, but to do those same activities in other states. Therefore, companies planning to enter the space with the hopes of expanding their operations across state borders need to account for costs to replicate grow facilities and dispensaries and costs of any associated licenses when developing any future growth plans.
280E tax implications. The effects of this rule of law have become the most crippling to the cannabis industry. 280E of the Internal Revenue Code limits businesses engaged in the “trafficking” of controlled substances from deducting ordinary business expenses (such as rent, utilities and marketing) when calculating their federal tax returns. So, until cannabis is removed from the Schedule mentioned above, cannabis entrepreneurs will need to consult with tax advisers to navigate through the complications from 280E.
Market supply and demand. In any consumable market, supply and demand will completely change your financial projections. Coupled with the 280E issues listed above, the cannabis entrepreneur must be forever cognizant with the adjustment to product pricing that supply and demand will naturally dictate. There are other variables within the supply-and-demand analysis that are important to recognize, such as quality of product, preferred products for a given market, number of licenses available, market competition, etc. But the most important takeaway regarding supply and demand is to be prepared at all times to edit your financial projections.
Starting a cannabis business can be a complex endeavor due to the regulatory limitations, but it can also be extremely rewarding. Therefore, it is essential to approach this industry with careful planning and compliance to navigate through the unique challenges of this industry successfully. Consulting with legal, financial and industry experts is highly recommended.
Interested in applying for a license or looking for legal expertise for your cannabis-related business? Our expert attorneys left the largest firms in the world to practice law differently, and are committed to driving legal and business value for clients. Contact Nemphos Braue to learn more.
George Nemphos and Tim Braue started Nemphos Braue LLC in 2016, combining big firm expertise with the flexibility and creativity of a boutique practice. From venture capital and private equity to intellectual property, mergers and acquisitions and general corporate counsel, Nemphos Braue is a different kind of law firm.
Nemphos Braue Of Counsel Bill Huber and Corporate Associate Michelle Varkey provide a combination of legal and operational expertise to address client needs across the full cannabis spectrum from seed to sale. Huber is also a cannabis dispensary owner and operator.
