Weighing investments in an exploding industry

Massive expansion requires careful planning and research

Photo by Inae Bloom.

Early in 2016, industry leaders worried that too many marijuana ballot initiatives could spread resources too thin, leading to losses at the polls. November’s election, though, saw recreational or medicinal measures pass in eight of nine states.

With multiple other states authorizing medical marijuana or new regulatory structures earlier in 2016, nearly 60% of the U.S. population now lives in a state where marijuana is legal for either recreational or medical purposes.

As new cannabis states open for business, investors have many choices. Treatable medical conditions, population and other factors relative to market size are critical, but so too are regulatory issues. State frameworks are all different, and 10 key considerations can help investors evaluate which best fit their profile and objectives.

– Federal Compliance: The elephant in the room is the elephant in the White House. President Donald Trump has spoken favorably of state’s rights and medical marijuana, but future federal policy is unclear and will be implemented by a Department of Justice helmed by an anti-cannabis attorney general — with anti-cannabis Mike Pence a heartbeat away from the presidency.

The Rohrabacher-Farr Amendment, which offers some protection against the Department of Justice in medical states, expires in April. Even if it is renewed, investors should anticipate possible refinement of federal enforcement criteria embodied in the Cole Memorandum, and perhaps differential treatment of medical marijuana versus recreational.

Less risk-tolerant investors may wish to opt for states with stricter regulation, where the risk of federal intervention should be lower. Medical states may fare better than recreational.  Businesses that touch the plant will remain at higher risk.

– Rulemaking and Stability: Rules and implementing legislation are under development in many states. Investors should consider how much latitude administrators and legislators have to craft new standards and limitations that are not present in measures passed by voters. They should ascertain how industry participants can influence the rulemaking process. When will rules be done and licenses issued? How much stability and predictability is likely — for example, are there impediments to state legislatures changing initiated laws?

– Ability to Move Funds: What is the atmosphere for banking in the state? Has the state sought to ensure the free flow of money through non-bank mechanisms, such as closed-loop payment systems? How will investors receive funds and ensure proper accounting?

– Residency: Residency limitations for industry participants vary widely, with some states prohibiting out-of-state licensees or investors, or providing licensing advantages to in-state residents. Others have no limitations. Residency requirements may also be keyed to the level of control out-of-state participants exercise, or the type of business entity being licensed. These requirements affect how (and whether) investors can participate in a given state.

– Licensing: Licensure requirements and standards vary. Investors need to know who must be licensed, the criteria and the degree of flexibility provided to regulators. Is local government approval required? Can local governments impose different standards?

Investors and businesses applying for licensure and operating in multiple jurisdictions should have someone in charge of regulatory affairs across all jurisdictions. State regulators in every industry communicate with their counterparts, and inconsistent representations to different states have a way of coming to light. Adverse license decisions in one state can — and most likely will — affect licensing in all others.

– Vertical Integration: Can one business own licenses for growing, processing and selling, which provides for better control over product quality and costs? Or are licensees limited to one type of business?

– Caps on Licenses: Does the state cap the number of licenses for different types of businesses? If so, is there a competitive process for selecting licensees? Do criteria effectively limit opportunities to certain groups?

– Transitioning to Adult Use: Some legislators voted for medical marijuana licensing regimes specifically to prepare for voter-initiated adult use legalization. In medical states, what is the likelihood of adult use being enacted and can the state’s system easily adapt to such a change?  Will there likely be built-in advantages to medical participants, or is there a chance they’ll be left behind, as occurred in Washington’s transition?

– Regulatory Barriers: Does the regulatory structure allow the industry to flourish without choke points in the supply chain? Oregon’s rules for testing labs led to significant disruption. Three-tier wholesale/distribution requirements have been a flashpoint in other states. Inadequate plant counts or grower licenses can crimp supply and drive up costs.

– State and Local Taxes: How are transactions taxed and at what rate? Is the level of taxation easily susceptible to change? Will de facto taxes be established through regulatory fees?

Conclusion

With the number of new markets, investors should engage in a systematic state-by-state evaluation, weighing the relative economic and regulatory aspects of each market to create a framework for identifying, evaluating and pursuing specific opportunities. Understanding the wide range of regulatory systems and rules is daunting, but necessary to smartly determine where to engage in the industry’s continued growth.

 

Michigan attorney Lance Boldrey is co-chair of the Cannabis Law Practice at Dykema, an AmLaw 200 firm and member of the National Cannabis Industry Association. Dykema represents advocacy organizations, businesses and investors in the cannabis industry. He can be reached at lboldrey@dykema.com.

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