The legalization of adult-use marijuana in California will have a ripple effect throughout the cannabis industry in ways that won’t be fully realized for years to come.
In a state where chasing gold rushes is a rite of passage, hundreds of thousands of modern prospectors will be impacted by business ventures, tax revenue and jobs created in the cannabis space. But the path to go from the well-known Wild West of Weed to a tightly regulated, highly taxed marketplace is fraught with regulatory hurdles.
“Anybody who has not started this a year ago is way behind the 8-ball,” Canna-Hub CEO Tim McGraw says. “California is a very, very arduous place to develop real estate, let alone on the scale that we’re doing it and in the industry we’re doing it in. There are a lot of eyeballs on you and there’s no cutting corners.”
Risk vs. Reward
The legalization of commercial marijuana in California represents a massive opportunity for thousands of entrepreneurs. But the undertaking also comes with a great deal of risk for operators, ranging from the enforcement of federal laws and potential criminal charges to business failures and bankruptcies.
Businesses and individuals that believe the green rush will be a clear path to success are unprepared for the challenges that lie ahead.
“I think there’s going to be a huge wake-up call for a lot of people in California,” says McGraw, who points to mandated third-party testing and seed-to-sale tracking as two of the biggest hurdles for operators. “There’s going to be a lot of growing pains, both for operators and state regulators, and I see a lot of consolidation happening.”
For legacy producers like Jon VanderClut of Frogville Farms in Nevada County, these are uneasy times. He’s been watching the wholesale price of marijuana fall steadily for years. Recently, he says he’s “barely getting $1,000 a pound” for his Clean Green Certified cannabis.
“It just gets to the point where it’s not economically feasible,” VanderClut says. “Prices are still the same at retail, but small farmers are getting pinched to death right now. It seems like every month, it’s another pinch.”
VanderClut will be applying for a license that would allow 10,000 square feet of mixed-light production. He sees the seed-to-sale tracking system as a way to stop prices from plummeting further, by keeping bad actors out of the market. But, as states like Washington and Colorado have shown, legalization tends to drive the wholesale prices downward, giving larger players a distinct advantage.
“With Prop 64, instead of having a couple hundred-thousand new millionaires in the state, we’re just going to end up with five richer billionaires,” VanderClut says. “I’m not very optimistic, but I’m hopeful.”
Business attorney Alexandra Stupple says entrepreneurs can prepare themselves for the ultra-competitive market by taking care of standard business functions, such as getting service and sales contracts ready.
“I have met a large amount of people who have been operating below the radar because of the legal limbo cannabis is in and have therefore not been following good business practices, such as entering into written contracts,” she says. “Continuing to operate loosely will be detrimental to those businesses as new players come into the industry. The industry’s conversion from an unregulated, quasi-legal one into a regulated one is going to cause heartache for less savvy industry participants because of the influx of more experienced, larger-scale businesses into the cannabis industry.”
Longtime operators and new entrants alike will be impacted by the statewide regulations, but legacy growers who have become accustomed to the minimalist Prop 215 rules may be hit the hardest.
The transition into 2018 is an unusual time for any industry. The state’s number one cash crop is going from relatively unregulated to highly regulated overnight, Stupple says.
“You would need a soothsayer to predict all the problems that will arise as the regulators and the regulated alike get their bearings in this new world,” she says.
The best advice she can give any prospective applicant is to obtain all local approvals and get security plans, floor plans and operating procedures ready for state application submission.
One of the biggest problems she sees in the state regulations is pesticide limits that are too low.
“The state included in the regulations more pesticides and lower allowable levels than did Oregon, and the levels in Oregon were so low that the levels had to be changed because there was not enough product passing laboratory testing and therefore not enough legal product available for sale,” Stupple says. “It forced, for a time at least, some businesses back into the unregulated market.”
She says the concept of regulating pesticides and other contaminants is a worthy cause, but the heavy-handed approach by the state could cause problems on the supply side.
While this issue is not as much of a concern for VanderClut at Frogville Farms — he uses pesticide-free organic cultivation practices — the greater subjects of regulations and government overreach are major issues as he looks toward the future.
“I’m 52 and I’ve seen the story spun a million different ways and it always seems to turn out the same,” VanderClut says. “The Man’s got you under his thumb. If you want to navigate through this life and through this world of big government, then you’ve gotta jump through the hoops or just turn your back.”
Cannabis may eventually be ruled by large corporations and the biggest players in the industry, but for now, there’s still plenty of opportunity for independent, family businesses to be successful.
The opening of California’s adult-use market represents the culmination of three years’ worth of planning and preparation for Eli Melrod, who saw his own dream come to fruition in November.
Back in 2015, Melrod “could see the writing on the wall,” he says. He knew Governor Jerry Brown was going to pass overarching regulations on the existing cannabis industry, and based on polling data, it was only a matter of time before full legalization would come to California.
“It struck me as a huge opportunity,” he says.
He spent a year and a half educating himself. He visited farms and toured manufacturing facilities, but it was a job at a Northern California testing lab that proved to be his crash course on the industry’s complete supply chain. It also led him to realize how dire the issue of contamination was in California’s industry. He regularly saw marijuana going to market with high levels of residual solvents, heavy metals and now-banned pesticides.
From that experience, he came to believe there was a gap in the retail sector that could be served by a dispensary that was committed to safe and effective products.
“We feel like our model is really distinctive and we’ve been getting really positive feedback from the community,” says Melrod, the company’s CEO and co-founder. “It’s very natural, and it really celebrates cannabis as a botanical and as a plant-based medicine.”
Solful, which hosted its grand opening in November, was designed to fit well with Sonoma County, about an hour north of San Francisco, where people care about sustainability and are conscious about what they put into their bodies. Melrod compares it to a co-op grocery store, where shoppers can read about the origins of the products they’re looking at and speak with highly educated retail associates. The layout is upbeat, warm and natural, and the company has focused on curating a distinctive, high-quality selection of products with an emphasis on organic, biodynamic and regenerative cultivation techniques.
“We call it muddy-shoe sourcing,” Melrod says of the retail outlet’s process for selecting its vendors. “We try to get out and visit the farm, get to know the producer. We’re looking for love-worthy quality; everything in the shop, we would give to a loved one.”
Now, Solful is “fully prepared” for the transition to adult-use sales, Melrod says, but he is concerned about the supply chain. Growers are somewhat of a mixed bag, ranging from folks who already have permits to those who haven’t even started the process.
“We’ve done our best to pick suppliers who are either permitted already or are in the process, so there can be a smooth transition,” Melrod says.
But regardless of how smooth or bumpy the change happens, Melrod says the Sebastopol shop will stick to its broader mission.
“We don’t just see ourselves as a retail store,” he says. “We see it as a community space where folks can come in and get information and come together.”
Location, Location, Location.
People probably get tired of hearing it, but location has a monumental impact on the success of a business, even beyond the obvious concerns with zoning and land-use permits.
Location is generally thought to be more critical for retail businesses, but cannabis farms also have to take into account the climate, access to water and distance from retailers. For example, a farm in Arcata might have great water and a perfect climate, but it’s about a 10-hour drive from the major population center of Los Angeles.
Meanwhile, warehouse owners are able to capitalize on the competitive real estate market and the green rush mentality that has so far consumed every state to legalize recreational cannabis.
“I’m concerned about the commercial warehouse market,” says Alex Mountjoy, the CEO of Mountjoy Sparkling. “Right now, it’s very much at a peak in pricing and cannabis businesses are being forced to lock themselves into the most punishing lease terms that I’ve ever seen in my life. I know that’s not sustainable and a lot of people will go out of business or have to walk away from their leases.”
Providing business-friendly lease options and eliminating headaches like zoning were some of the reasons McGraw founded Canna-Hub, a series of cannabis business campuses with its first site in the Fresno area and another about 50 miles north of Sacramento. Canna-Hub is working out the logistics of a couple other potential locations and searching for a site in Southern California.
McGraw saw the synergy of grouping a variety of cannabis businesses together — from cultivation facilities to testing labs to banks to supply stores — as a way to capitalize on the economies of scale. This model could vastly reduce the time, resources and security concerns of transporting product and money across the state.
The goal is to establish the premier business parks in the cannabis industry, similar to a Google or Amazon campus in the tech industry.
“These are going to be best-in-class facilities,” McGraw says. “Over time, I expect our real estate portfolio to be one of the most valuable in California.”
Because Canna-Hub is a real estate holding company, not a cannabis company, it does not compete with its own tenants. Instead, the company acquires land and handles zoning, entitlement, design and construction.
“This is not for the faint of heart,” McGraw says. “This is not something you can pick up and put together on a weekend. This has taken me and my team 12- to 14-hour days every day for a year. We cut through a lot of red tape for operators.”
Tenants can be as involved in the design as they want to be.
“They have the ability to take a vanilla box and do their tenant improvements themselves,” McGraw says, or they can have Canna-Hub handle that aspect.
The facilities are zoned and permitted for any type of cannabis business except outdoor cultivation and marijuana retail. Currently, the two sites are projected to have about 1.5 million square feet of operational space. The massive campuses are also highly efficient from an environmental impact angle, McGraw says. The campuses are designed to recapture 70% to 90% of their water, while producing about 90% of their own power through bio-generation and cogeneration.
“What we’re doing, we consider to be the most cost-effective opportunity in the state,” McGraw says.
Larger indoor or hybrid greenhouse (mixed light) cultivators could be looking at 50,000 square feet or more, depending on the needs of the operation. The minimum size lease is 5,000 square feet, although McGraw says exceptions could be made for something particularly important to the industry, such as a tissue culture lab.
“Tissue culture, I believe, is the future of genetics,” McGraw says. “I’ve had the luxury of visiting some of the largest tissue culture labs in the world, and I know some tissue culture operators very well. I believe in 10 years from now, we’ll look back and think it’s silly we ever used seeds or even clones. … With tissue culture, not only can you get an exact copy of the plant, but you can also genetically clean up the plant. … It’s already used almost exclusively in high-end horticulture.”
An Explosion of New Products
Due to its long-standing medical market, California’s cannabis retailers already carry a wide selection of products beyond the traditional flower and pre-rolls, including more extracts and edibles than some shops that have been operating in other recreational markets for years.
But infused cooking oils and custom-blended tinctures are really just the beginning. Now, as North America’s most populous state braces itself for adult-use cannabis sales, we’re going to see an explosion of new products hitting the market, allowing some shops to become veritable marijuana supermarkets. These new products — some of which we cannot even fathom yet — have the potential to become the biggest brands in the industry.
But they could also be some of the industry’s biggest busts as California consumers still spend the majority of their money on flower, accounting for 55% of sales compared to just 12% of the market for edibles, according to data provided by BDS Analytics. However, simple statistics aside, it’s clear the edibles category has the most room for growth as cannabis continues its evolution toward a mainstream product, more closely resembling beer and wine than a Schedule I substance.
One interesting contender for the hearts and minds of consumers is Mountjoy Sparkling, a THC-infused fizzy water that could capitalize on the immense popularity of LaCroix and other bubbly beverages.
Alex Mountjoy, who has been manufacturing consumer products for about 20 years, wanted to create a high-end, high-quality brand that people could easily connect to.
The zero-calorie beverages fit much better with an active lifestyle than the sugary and chocolatey edibles that make up the largest share of the edibles market. It also has the look of a product that wouldn’t be out of place in a Whole Foods grocery store, with bright colors and a clean, crisp, professional design.
“We wanted a product that was ‘photogenic.’ We come from a design and marketing background, so we’re treating this like a mainstream brand with national awareness,” Mountjoy says. “That means being elegant, being accessible. When we build things that we can be proud of and want to use ourselves, then they end up being products that other people enjoy as well.”
Mountjoy Sparkling started its proof-of-concept phase in the spring of 2016; as of November, the product was distributed through about a dozen dispensaries and Mountjoy hopes his business background will help catapult the brand’s acceptance across the state.
“I’ve been rich; I’ve been broke. I’ve been hiring; I’ve been laying off. I’ve been opening factories; I’ve been closing factories,” Mountjoy says. “I certainly haven’t seen it all, but I have a lot of in-the-trenches sales experience and manufacturing experience. I think being successful in business is often about avoiding mistakes. And I hope the mistakes I’ve made in the past will allow me to not make the same ones moving forward.”