Top 6 growing pains in California’s cannabis marketplace

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Every state that’s legalized cannabis for adults 21-and-up has faced that moment or even series of moments that threatened to really derail or seriously stymie market development. California is at that crossroads and has been almost from the outset of the first issuances of cannabis licenses back in January 2018. California will, of course, eventually and sufficiently deal with its myriad of cannabis issues, but right now there are a select few that are really affecting licensed businesses and the success of this important democratic experiment. In no particular order, my top six (current) threats/growing pains to the development and success of California’s cannabis marketplace are:

  1. State licensing woes and low licensing numbers.  Every state at some point experiences what seems to be either too much licensing (see Oregon) or just too little to satisfy demand. Right now, California is probably in the latter category. And with too few licenses comes lack of access for consumers and the growth and continued operation of illegal operators. The state has done its best to mitigate the licensing log jam (see, for example, the new and improved provisional license concept), but even that hasn’t done much to spur huge licensing numbers. Right now, according to the AP, “California has 7,392 licensed cannabis businesses. The [Bureau of Cannabis Control] oversees 2,630 companies with either provisional or annual licenses, while the state Department of Public Health oversees an additional 932 manufacturers. The state Department of Food and Agriculture oversees 3,830 farmers.” Whether it’s based on local control issues (see below) or the fact that licensing, itself, is just too onerous for stakeholders, California just doesn’t have a swell of legal operators with licenses at this point. In fact, just last week, the state suspended 394 licensee applications, representing 5% of the licensed market, because those applicants weren’t progressing with the mandatory track and trace training requirements, which is a cornerstone of legalization (being able to monitor the inventory at all times).
  2. Local control. Most people don’t realize that the majority of California cities and counties still completely ban commercial cannabis activity. And the majority of cities and counties that do allow for it only limit that activity to medical cannabis production and sales. Of course, the local control pitch was a big part of getting Prop. 64 and the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MACURSA”) through into actual law, and cities and counties have inherent police powers anyway to ensure the protection of the health and well-being of their citizens. Still, in California, to secure a state license of any kind, you must have local approval to operate from your city or your county. And in local jurisdictions that have bans, this means that licensing is impossible; it also means that these communities are hotbeds for unaccountable illegal cannabis activity, which of course undermines legal operators at every turn.
  3. Illegal market actors. Every state continues to deal with the illegal cannabis market, and it will always exist in some capacity regardless. At the same time, when barriers to entry are too high or intense or taxes are way too high and/or there’s too much red tape, regulators may be helping to spur the illegal market they seek to eliminate. In California, the illegal market is alive and well in certain communities for a number of reasons. The usual culprits are municipal bans, lack of enforcement by the state or locals, the fly-by-night nature of these operators, egregious taxation that makes legal operation too expensive, and constant changes to or inconsistent regulator interpretations of state and local rules that can bankrupt operators. Moreover, the brazen attitudes and recklessness of illegal actors (especially in California) know no bounds–a perfect example is the vaping crisis, which is almost entirely attributable to illegal cannabis vapes and cartridges, for which the legal cannabis industry has suffered from reactionary state and local bans and new restrictions on lucrative vapor products at the state and local levels.
  4. Lack of transparency and consistency from regulators. Being a cannabis regulator is no easy task. To wrangle and control a new industry unlike any other is incredibly difficult and many challenging policy and legal decisions have to be made by these regulatory bodies without any assistance (or budget) from other branches of state and federal governments. At the same time though, and in my experience, the best cannabis regulators are those that are consistent, transparent, and responsive to stakeholders, and especially those that do not engage in “business as usual” politics, only dealing directly with paid lobbyists and trade groups. In California, my personal experience with the three governing bodies at the state level has been mixed. At the outset of licensing, it seemed it was easier to secure more comprehensive, direct responses to questions or concerns about various regulations (and there are A LOT of regulations). Now though, depending on the agency and depending on the analyst with whom you may be dealing, you would be lucky to even get a substantive response to important regulatory questions within a couple weeks of submission, if at all. Some of that delay or lack of response is understandable as regulators wear many hats and are on the constant go relative to enforcement and maintaining the regulatory structures surrounding licensing. And maybe some of the delay or non-responsiveness is due to the size of California and the massive undertaking that is licensing, but I can say that in almost a decade of practice in this area it is not yet simple or easy for stakeholders to consistently communicate with state regulators, which puts at risk business practices and a solid understanding of regulatory compliance in order to avoid regulatory violations.
  5.  Taxes. In my opinion, no state has figured out the gold standard for cannabis taxation that isn’t so high as to hinder business but isn’t so low as to incentivize extreme consumer cannabis use. In California, there are multiple levels of cannabis taxation–a 15% excise tax on retail sales (on top of state and local sales tax), a varying cultivation tax depending on the type of product that enters the commercial market, and then applicable local cannabis-specific taxes and fees. In July, the SF Chronicle estimated that “Californians are paying up to 45% tax rates on cannabis purchases — nearly 40% higher than the standard 6% state sales tax.” When taxes are unflinchingly high like this, the illegal market is energized and consumers tend to turn that way to avoid paying too much for their cannabis even if that cannabis isn’t tested or quality assured. Since MAUCRSA’s inception there’s been little to no tax reform to provide any kind of relief to cannabis businesses, including on the local level (with very few exceptions from cities that want the tax revenue to justify the social cost).
  6. Lack of access to banking. If you’re motivated and capitalized enough to secure local approval and a state license, and you can bear the significant tax burdens, you still likely will have difficulty securing a bank account in California. Because California’s regulations aren’t the tightest in the cannabis union, on the whole (and especially regarding the vetting of owners and financial interest holders), financial institutions have not openly banked the industry pursuant to the 2014 FinCEN guidelines (which are still alive despite the rescinding of the 2013 Cole Memo). The lack of access to banking forces the classic public safety threat of all-cash, which is also a logistical nightmare for cannabis businesses that must taxes and run payroll. While other states with stricter regulatory regimes, like Washington State and Colorado, have options for cannabis banking, California still lags in this area, but I’m hoping that will change as cannabis regulations progress.

None of the foregoing are new or novel cannabis industry issues on a state-by-state basis. However, since California has had cannabis legal reform since 1996, you wouldn’t be out of bounds to think that such a state could quickly and effectively deal with these issues, but that’s not been the case (despite the fact that they are now several state legalization blueprints from which to borrow). Nonetheless, I remain confident that California will eventually come out on the other side with successful and long-lasting licensees in tow after it makes through these growing pains.

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