Part One of this series took a look at how the regulated cannabis market can only be understood in relation to the previous medical market as well as the ongoing “traditional” market. Part Two of the series describes how regulation defines vertical integration in California cannabis, and conversely, how vertical integration can address some of the problems that the regulations create. But first:
A Grain of Salt
Take the conventional wisdom about vertical integration with a grain of salt. Expected benefits may not materialize under the current circumstances:
Overall, the business environment is highly challenging due to extensive regulation, over taxation, insufficient retail capacity and competition from the “traditional” market. As a result, integrating businesses upstream or downstream may mean capturing losses, not profits.
The three major types of cannabis activity span three major industrial sectors: raw materials (i.e., cultivation), manufacturing and service (distribution, testing and retail). As a result, a vertically integrated company needs to carry out very different types of activity, which require very different types of core competencies, equipment and facilities.
Developing core competencies is especially challenging because each of the major cannabis sectors is still evolving.
Realizing the benefits of vertical integration requires an additional core competency in cross-sector operations.
Regulations Define the Supply Chain
California’s regulations define the cannabis supply chain by defining both the individual links (licensees) and the relationships between those links. Therefore, an understanding of vertical integration must be grounded in an understanding of the underlying regulatory definitions.
The regulatory definition of each link is extensive. For example, each licensee is tied to a specific facility, and must have its own procedures for production, inventory control, security, etc. When the links are strung together, this definition tends to preserve operational redundancies, and impede operational integration.
Overall, the relationships between the links are primarily defined in terms of preserving the chain of cannabis custody. On top of that, regulations define very specific (and very consequential) links between certain licenses, as discussed below.
A Taxonomy of Links
There are currently 26 types of cannabis license in California, 25 of which can be vertically integrated:
Cultivation – 14 licenses, including 4 sizes each for Indoor (up to 22,0000 sf), Mixed Light (up to 22,000 sf) and Outdoor (up to 1 acre), as well as Nursery and Processor (drying, trimming and packaging/labeling). Note that cultivation licenses are the only licenses that restrict the scale of activities.
Manufacturing – 5 licenses, including volatile extraction, non-volatile extraction, everything but extraction (i.e., infusion) and packaging/labeling.
Testing (Type 8), for testing cannabis according to state standards prior to sale. The owner of a testing license cannot own any other type of license.
Distribution (Type 11), acts as the gateway between cultivation and manufacturing on the one hand, and retail on the other. The distributor’s gateway status is entirely an artifact of regulation – cannabis must be officially tested before it is sold to a consumer, and only a distributor can order the official test. All products must stay in a “quarantine” area at the distributor until they pass testing. Products that fail testing must be destroyed if they cannot be remediated.
Transport (Type 13), which can move cannabis between licensees (with a narrow exception). This license does not allow for official testing.
Delivery Retail (Type 10), for delivery services that are subject to the vagaries of software platforms and the intransigence of local authorities.
Microbusiness (Type 12), which allows the licensee to carry out cultivation (up to 10,000 square feet), non-volatile manufacturing, distribution and retail.
Event Organizer
Self-Distribution – A Case of Useful Integration
You may gather from the previous section that shoving a gratuitous and mandatory distributor into the middle of the supply chain creates problems for cultivators and manufacturers. Savvy operators solve this problem by getting a distribution license. This allows the cultivator or manufacturer to:
Pick the time and place for the testing of its cannabis products.
Avoid paying someone else for the storage of cannabis products as they await test results or purchase.
Reduce transport costs (particularly if the distributor is near the other operations).
Sell directly to retailers.
The bottom line is that vertical integration in California cannabis is useful as a means to an end, as opposed to an end in itself. Therefore, cannabis operators should carefully consider how vertical integration will benefit their core business before incurring the risks and expenses associated with an additional license.
This article is an opinion only and is not intended to be legal advice.
It’s no secret that the rollout of cannabis legalization has underperformed in countries like Canada. Since legalization in October of 2018, industry experts have warned that the projections of the big cannabis firms and venture capitalists far exceeded the expected demand from the legal market.
Today, major production facilities are closing down, some before they even opened, dried flower inventory is sitting on shelves in shocking quantities (and degrading in quality), and an extremely robust illicit market accounts for an estimated 80% of the estimated $8 billion Canadian cannabis industry. None of those things sound like reasons for optimism, but while some models for cannabis business are withering away, others are beginning to put down stronger roots. Crucially, we are beginning to see new business models emerge that will be able to compete against the robust black market in Canada.
The Legal Cannabis Industry Can’t Compete
Legal rollout in Canada could easily be described as chaotic, privileging larger firms with access to capital who were able to fulfil the rigid – and expensive – regulatory requirements for operating legally. But bigger in this case certainly did not mean better. The product these larger firms offered immediately following legalization was of a lower qualityand higher price than consumers would tolerate. In Ontario, cannabis being shipped to legal distributors lacks expiration dates, leaving retailers with no indication of what to sell first, and consumers stuck with a dry, poor quality product.
The majority of existing cannabis consumers across the country prefer the fresher, higher quality and generally lower priced product they can easily find on the illicit market. That preference couldn’t be clearer when you look at the growth of inventory, which is far outpacing sales, in the graph below:
Which brings us to the crux of the matter: when it comes to building up the Canadian cannabis industry, what will succeed against the black market that has decades of expertise and inventiveness behind it?
Rising From the Ashes: Craft Growers and Other Small-Scale Producers
The massive facilities like Canopy’s may be shutting down, but our friends over at Althing Consulting tell us that those millions of square feet facilities are being replaced by smaller, more boutique-style cultivation facilities in the 20,000 ft tier, which are looking to be the future of the industry.
Consumers have consistently shown a strong preference for craft cultivators and other small-scale producers who produce higher quality, more varied products that are more responsive to consumer needs. It also hasn’t hurt that prices are also coming down: Pure Sun Farms in Delta, BC is consistently selling out of their $100/ounce special, which is highly competitive even with the illicit market.
This vision of the industry matches up better with the picture we’ve been getting from other legalization projects around the world. It also squares with other indicators of success. Despite the small market capture of the legal market, industry employment numbers are still relatively high, especially when compared with more established legal consumer products markets such as beer. In fact, craft cannabis growers now employ nearly as many people as the popular craft brewing sector here in British Columbia.
But in order to make the craft cannabis market actually competitive in both the regulated and unregulated spaces, the government will have to address four major challenges.
Challenge #1: License Distribution is Uneven and Chaotic
A December 2020 report by Ontario’s auditor general contains admissions by the Alcohol and Gaming Commission of Ontario (AGCO), Ontario’s cannabis industry regulator, that they lack the capacity and resources to manage the number of applications for private cannabis retailing. Problems relating to the issuing of licenses, including long delays and difficult requirements, are widespread across provinces. One way this becomes clear is by looking at the very uneven distribution of stores across the country in the graph below.
Challenge #2: Basic Regulatory Compliance is Complex and Time-Consuming
Smaller-scale micro cultivators, whose good quality craft product remains in high demand, still face prohibitive barriers to entry into the legal market. Licensing from Health Canada is one onerous challenge that everyone must tackle. Monthly reporting requirements have in excess of 477 compliance fields. Without additional support to navigate these requirements – including automation technology to ease the administrative burden – these smaller producers struggle to meet the minimum regulatory standards to compete in the legal market.
Challenge #3: A Long-Distance Road to Compliance and Safety Means Higher Costs
Even with all regulatory requirements satisfied, cannabis cultivators can’t sell their product from “farm to fork” (to borrow a phrase from the food industry). Many growers ship their product to be irradiated in order to ensure they are below the acceptable microbial threshold set by Health Canada. While irradiation positively impacts the safety of the product, new evidence shows that it may degrade quality by affecting the terpene profile of the plant. Furthermore, only a few facilities in Canada will irradiate cannabis products in the first place, meaning that companies have to ship the finished product sometimes thousands of kilometers to get their product to market.
Next year, Health Canada looks set to lower the limit on microbials, making it virtually impossible to avoid cannabis irradiation. If Health Canada follows through, the change will be a challenge for small-scale cultivators who strive to prioritize quality, cater to consumers who are increasingly becoming more educated about terpene profiles, and seek to minimize the environmental impact of production.
Challenge #4: It is Virtually Impossible to Market Improved Products
Finally, there is a marketing problem. Even though the regulated market has made dramatic improvements in terms of product quality from legalization two years ago, Health Canada’s stringent marketing restrictions means that cannabis producers are virtually unable to communicate these improvements to consumers. Cannabis producers have little to no opportunity to reach consumers directly, even at the point of sale – most legal sales are funneled through government-run physical and online stores.
What Can a Thriving, Legal Cannabis Market Look Like in Canada?
The good news is that change is being driven by cannabis growers. Groups like BC Craft Farmers Co-Op are pooling resources, helping each other navigate financial institutions still hostile to the cannabis trade, obtain licenses and organizing craft growers to advocate to the government for sensible regulatory changes. As a result of their advocacy, in October, the federal government initiated an accelerated review of the Cannabis Act’s restrictive regulations related to micro-class and nursery licenses.
Now, more co-op models are popping up. Businesses like BC Craft Supply are working to provide resources for licensing, quality assurance and distribution to craft growers as well. Indigenous growers are also showing us how cannabis regulation could work differently. Though Indigenous cultivators currently account for only 4% of Canadian federal cannabis licensees (19/459), that number looks to be growing, with 72 new site applications in process self-identified as Indigenous, including 27 micro cultivators. In September, Williams Lake First Nation entered into a government-to-government agreement with the province of British Columbia to grow and sell their own cannabis. The press release announcing the agreement includes the following statement:
“The agreement supports WLFN’s interests in operating retail cannabis stores that offer a diverse selection of cannabis products from licensed producers across Canada, as well as a cannabis production operation that offers farm-gate sales of its own craft cannabis products.”
More widespread adoption of the farm-gate model, which allows cultivators to sell their products at production sights like a winery or brewery, has a two-fold benefit: it better supports local, small-scale producers, and it offers opportunities in the canna-tourism sector. As the economy begins its recovery alongside vaccine rollouts and restrictions on travel ease, provincial governments will have the chance to leverage the reputation of unique regional cannabis offerings (i.e. BC bud) through these farm-gate operations.
While the cannabis legalization story in Canada has had its bumps, the clear path forward for greater legal market success lies in increased support for micro-cultivators. By increasing support for these small-scale producers to navigate regulatory requirements, more will be able to enter the legal market and actually compete against their illicit counterparts. The result will be higher quality and more diverse products for consumers across the country.
More and more we are seeing the development of proprietary hardware platforms in cannabis. With proprietary technology in hand, manufacturers often lean on MSOs, LPs and other brand partners to grow their business through existing sales channels.
We spoke with Mike McDonald, President and CEO at Ammonite, to learn more about the history of the Dablicator™ platform and Ammonite’s North American brand partner strategy. Mike formed Ammonite as a spin-off company from Jetty Extracts after getting to know the founders in a real estate transaction. Prior to Ammonite, Mike was an operator in the manufacturing and product development space, having helped to launch the Giant bicycle brand as well as growing and eventually selling the Atlas Snowshoe Company to K2 Sports.
Aaron: How did you get involved in cannabis?
Mike: Well, like a lot of folks in the industry, my background is pretty eclectic. I come primarily from an operator’s perspective – I’ve been in manufacturing, product development and company growth for my whole career. I lived in Taiwan for several years and helped to launch the Giant bicycle brand worldwide. I was also involved with a ski business that was started at Stanford as a thesis project called Atlas Snowshoe Company. Fast-forward, we built it into the largest snowshoe brand and activity in the US and later sold it to K2 Sports. So, I’ve always been involved in the growth of product-related businesses.
Mike McDonald, President and CEO at Ammonite
I’ve also done some real estate development as well; I actually sold our building to the Jetty guys, which is how we met. In that process, I got involved with their company, helped Jetty reorganize its business model, raise some money, and then just got addicted to the whole industry and really found it fascinating. I liked the team at Jetty and couldn’t resist jumping in, and now I’ve been full-time in the business for over three years.
Aaron: How did you get involved in Ammonite?
Mike: Ammonite is actually a spin out company from Jetty Extracts, which is one of the largest brands in California. Our main Ammonite product is called the Dablicator™ Oil Applicator, which was originally invented at Jetty as a medical device for cancer patients. We saw a big demand for it as a private label partnership product, so we decided to spin out a separate hardware company and really focus on developing unique IP and CBD and cannabis related hardware.
Aaron: What trends are you following in the industry?
Mike: Certainly the MSOs of the world are really expanding and the top three to five are making a mark with growth and more sophistication in the market. I think the social equity movement is really a big component that we’re all excited about in the industry. You’re seeing the larger players really put their money where their mouth is around that. We’ve always been a big part of that in California.
Specifically, regarding trends in the cannabis space, Colorado and California are probably the two most mature markets. We generally say what’s happening in California and Colorado eventually make their way out to the rest of the world. Vaping was invented in California and Colorado, and now it’s a huge part of the business where before, four or five years ago, the market was mostly flower-centric.
There’s a trend away from inhalables, with more awareness around lung-related illnesses and of course COVID, so we’re seeing a big growth in edibles, drinks and so forth. Interestingly enough, although it’s an inhalable, infused pre-rolls are a big growth sector as well. Jetty is actually launching an infused pre-roll program in February.
Folks are looking for ways to get their medicine without smoking – and this has definitely led to a growth in the oil application business. Oil application has traditionally been delivered via a syringe. Dablicator™ oil applicator is essentially an improved, more convenient syringe. On the medical side, patients have been taking oil sublingually, putting it in food and drink and so forth for years because a lot of them can’t smoke. As that trend transfers over to the adult use market, oil application is becoming really big. You can take it sublingually; you can put it in your food or beverage. On the recreational side, you can add it to your loose flower or joints, or of course, dab it directly onto your rig via the heat resistant tip.
Further, you’re probably familiar with a lot of these portable dab rigs that are taking off, like the G Pen Roam and the Puffco Peak and a variety of others. So now you can dab on the go with your standard wax and shatter in a jar. It’s just not the most convenient way if you’re up on a hike or on a mountain bike ride. So now, with a portable dab rig and something like the Dablicator™ oil applicator, you can have a really convenient mess-free way to enjoy cannabis. The big growth in concentrates and areas that aren’t necessarily inhalables is where our product hardware really fits in.
Aaron: How did you come up with the idea for the Dablicator?
Mike: The Jetty team had a friend that had brain cancer. He was doing a lot of chemotherapy and was having trouble eating and keeping weight on and he couldn’t smoke. So, the guys at Jetty began to bring him cannabis oil, which he was able to use ingesting it from a spoon initially and it really helped him with his pain, his anxiety and his appetite. In that process, we realized that there wasn’t really a great way to deliver oil. Syringes were there, but they were kind of sketchy and they weren’t convenient.
So, the Jetty team developed a better mousetrap. Several iterations later, this Dablicator™ product was ready for patients. In fact, it became a big part of the Jetty Shelter Project, a non-profit where the team delivers cannabis to cancer patients, and it was a very much sought-after product delivery device in that world. So, it was developed inside of a need on the medical side and it’s really sort of grown inside the expansion on the adult-use side.
Aaron: Can you explain how the Dablicator™ oil applicator works from a perspective of form and function?
Mike: Pre-Dablicator™ you would use a syringe type product – for direct oil application, sublingual application, or as an add on to your flower. The difference between Dablicator™ oil applicator and a traditional syringe is that Dablicator™ is a twist and plunge product. Imagine a pen filled with oil, but instead of inhaling it, you’re able to dispense it through a tip that is heat resistant, which means you can apply directly to your dab rig nail. You’re able to put it in your pocket without fear of cannabis oil leakage. It’s discreet, precise, compact and portable.
Aaron: How does the user dose using Dablicator™ oil applicator?
Mike: Basically, there’s measurements on the plunger of 55 milligrams apiece – one click is 55 milligrams, and you can dispense as many clicks as you like. What’s cool about the product itself is if you’ve clicked too many times accidentally, you can back it off and the excess oil won’t dispense. You can go to dablicator.com and see demo videos as well.
Aaron: Dablicator™ oil applicator started as a Jetty Extracts spin-off. I see you are now white labeling for other oil brands. How do you go about selecting your partners?
Mike: We call it our brand partner program. It’s not too dissimilar to what other hardware manufacturers, like PAX and GPen, are doing. We’ve got a patented and innovative device where our brand partners, MSOs and leading brands throughout the US and Canada, can take their existing vape and tincture oils and offer them in Dablicator™ oil applicator hardware.
Our focus is signing up major, well respected brands and MSOs on to the “platform,” meaning they are able to immediately offer between six and ten new SKUs to their consumers. They take their existing oils, put them into a custom branded Dablicator™ hardware unit and add their custom branded packaging. It’s a full turnkey solution. For example, one of our partners, 710 Labs, is developing their RSO and were shopping for a delivery method specifically geared towards medical patients. Within eight weeks, we had a custom program for them and delivered hardware, and we assisted on the packaging front as well.
Our partners have to be reputable folks that are interested in developing or delivering oil in a unique and innovative way. Frankly, our early partners are those that see where the growth is. 710 Labs is on the platform, as well as Surterra in Florida, Ancient Roots in Ohio, and we’ve got multiple conversations going to some of the other MOSs and the LPs in Canada.
Aaron: Are the brand partners loading the oil applicator themselves?
Mike: We customize the product for them and then ship them unassembled and empty. In their lab, they use the same machinery and equipment they use to fill their vape cartridges. They then fill their Dablicator™, assemble it, package it and ship it out just like any other product that they’re processing and manufacturing.
Aaron: What kind of oils are suitable for Dablicator™?
Mike: Pretty much any oil that’s going into a vape cart is suitable and then some. Some of our customers, including Jetty, started out with a THC distillate. Live resin is becoming a big product category in California as well as solventless oils. Dablicator™ oil applicator can accommodate everything from distillate to live resin to solventless to RSO and even full spectrum CBD. If it can flow, if it doesn’t crystallize up like shatter and sugars and diamonds, you can put it into Dablicator™, even the thickest of oils. It’s designed to contain any kind of liquids that are flammable.
Aaron: What geographies are you currently in?
Mike: We’re in multiple states throughout the US and actually just signed up with an LP in Canada. We only launched the program in August of 2020, and today we’ve got partners California, Colorado, Ohio, Arizona, Missouri, Florida, soon to be Michigan, Illinois, and throughout Canada.
Aaron: Any plans for international expansion beyond North America?
Mike: We’re getting inquiries on a regular basis from all over the place, including internationally. We’re in conversations with some folks down in Brazil. Spain is actually a big cannabis market and we’re having some conversations with some folks there. The inquiries are coming in faster than we can process the relationships, but right now our major focus is on North America.
Aaron: What are your goals with Ammonite?
Mike: We are developing a category, right? So today, oil dispensing isn’t top of mind. Today, if you want oil, you go into a dispensary and say, “Hey, give me those syringes.” My goal is that a year from now, you can walk into Harborside in Oakland and you see a wall of different branded Dablicator™ oil applicators. The goal is to really turn the oil dispensing business into a category, and then position Dablicator™ oil applicator as the best and leading product in that category.
Aaron: What are you personally interested in learning more about?
Mike: Well, I’ve got two teenagers – two daughters, as a matter of fact, a freshman and a senior – and they’re being homeschooled right now. So that’s been quite an interesting development!
I think on the cannabis side, it’s just fascinating what it is as a business model. It’s the most recent multi-billion-dollar opportunity in consumer products. You only get a chance to participate in something like that maybe once in a lifetime. I’m really looking forward to seeing it become more adopted into the mainstream and it’s already becoming that way from a consumer perspective. I am watching the cannabis market become legal from a federal perspective, hoping that the social equity component of the industry really stays with it.
I’ve been in a lot of businesses over the years; I feel like one of the gray hairs in this business that is actually an operator versus someone who came over from the financial side. I am continuing to learn, grow and work with great people and this has been a really amazing experience for me.
Aaron: Okay, great. Mike, that’s the end of the interview. Thank you for your time today!
According to a press release sent out last week, Complex Biotech Discovery Ventures (CBDV) has expanded their testing capabilities considerably with the new addition of a vapor/smoke analyzer. CBDV is a licensed cannabis and psilocybin research laboratory embedded in the University of British Columbia, led by CEO Dr. Markus Roggen.
Dr. Markus Roggen, Founder of Complex Biotech Discovery Ventures (CBDV)
The ability to analyze vapor and smoke is a relatively novel concept for the cannabis space, but has been utilized by the tobacco industry for years now. In the early days of adult-use cannabis legalization in the United States, stringent testing regulations for contaminants like pesticides were adopted out of a fear for what would happen when consumers ingest toxic levels of contaminants.
One of the common refrains iterated throughout the industry over the past ten years was that there just wasn’t enough research on how different contaminants affect patients and consumers when burned and inhaled. We still don’t know too much about what happens when someone smokes a dangerous pesticide, such as myclobutanil. Beyond just contaminants, the new technology allows for companies to measure precise levels of cannabinoids in vapor and smoke, getting a more accurate reading on what cannabinoids are actually making it to the end user.
The smoke analyzer at CBDV
This new development coming from our neighbor to the north could lead to a breakthrough in the cannabis lab testing and research space. CBDV claims they can now analyze cannabis material with a much more in-depth analysis than basic compliance testing labs. The new technology for analysis of smoke, vapor, plant material and formulations allows companies to thoroughly understand their materials in each stage of the product formulation process, all the way to product consumption.
Beyond just smoke and vapor analysis CBDV also offers NMR spectroscopy, metabolomics, nanoparticle characterization, computational modeling and other testing services that go far beyond the traditional compliance testing gamut.
“Our new services offer comprehensive insights into plant material, extracts, end-products and even the smoke/vapor by using state-of-the-art analytical instruments,” says Dr. Roggen. “By understanding the chemical fingerprint of the material, cannabis producers can eliminate impurities, adjust potencies, and optimize extraction processes before wasting money and resources on producing inconsistent end products. As a chemist I am really excited about adding NMR and high-res mass spectroscopy to the cannabis testing offerings.”
As a cannabis lawyer, I spend a lot of time thinking about the ways that regulations affect a cannabis company’s bottom line. Since I’m in California, the ways are many.
In late 2017 I became the chief compliance officer for an Oakland startup that carried out delivery, distribution, cultivation and six manufacturing operations. A big part of my job was preparing my company, along with several equity cannabis companies, for California’s First Wave of cannabis licenses.
For the most part, First Wave licensees came from California’s essentially unregulated medical cannabis market, and/or from California’s by-definition unregulated “traditional” market. When California began issuing licenses in January 2018, many First Wavers were unprepared because their businesses practices had evolved in an unregulated market. A big part of my job was to help them adapt to the new requirements. As a result, I saw the regulations, and the effects of regulations, in sharp relief.
Regulation touches virtually every aspect of the legal cannabis industry in California. So anyone who wants to understand the industry should have at least a basic understanding of how the regs work. I’m writing this series to lay that out, in broad strokes.
Some key points:
The regulated market must be understood in relation to the previous unregulated (medical) market as well as the ongoing traditional market.
Regs define the supply chain.
Regs are designed to ensure product safety and maximize tax revenue.
Many regulations mandate good business practices.
Local enforcement of building, health and safety codes tends to be zealous and costly.
A Tale of Three Markets
California’s regulated cannabis market can only be understood in relation to the medical market that preceded it, and in relation to the traditional market (illegal market) that continues to compete with it.
The Before Times
California’s legal medical cannabis market goes back to 1996, when the Compassionate Use Act passed by ballot measure. One fact that shaped the medical market was that it was never just medical – while it served bona fide patients, it also served as a Trojan horse for adult-use (recreational) purchasers.
Another fact that shaped the medical market was a near complete lack of regulation. On the seller’s side, you had to be organized as a collective. On the buyer’s side, you had to have a medical card. That was it.
Meanwhile, the cannabis supply chain was entirely unregulated. This tended to minimize production costs. It also meant that a patient visiting a dispensary had no way of verifying where the products had been made, or how.
The Regulated Times
Licensing under the Medical and Adult-Use Cannabis Regulation and Safety Act (the “Act”) began on January 1, 2018. It was the beginning of legal adult-use cannabis in California. It was also the beginning of the Regulated Times, as the Act and accompanying 300-plus pages of regulations transformed the legal cannabis market.
Across the supply chain, the internal procedures of cannabis companies are subject to review by state agencies;
Cultivators and manufacturers cannot sell directly to a dispensary – they must go through a distributor;
All cannabis must be tested for potency and a long list of contaminants by a licensed testing laboratory before it may be sold to consumers;
And beginning in 2019, all licensees were required to participate in the California Cannabis Track and Trace (CCTT) program, which is designed to track all cannabis from seed to sale.
Just as importantly, the Act establishes a dual licensing system – that is to say, in order to operate, a cannabis company needs a local permit (or other authorization) as well as a state license. In fact, local authorization is a prerequisite for a state license. And your local jurisdiction will have its own rules for cannabis that apply in addition to the state rules, up to and including a ban on cannabis activities.
Needless to say, operating in the Regulated Times is a lot more complicated and expensive than it was during the Before Times.
Especially when you consider the taxes. For example, in the City of Los Angeles, sale of adult-use cannabis is taxed at 10%, which means that any adult-use purchase in L.A. gets a 34.5% markup:
15% state cannabis excise tax, plus
10% Los Angeles Adult Use Cannabis Sales tax, plus
Note that the distributors must collect the excise tax from the retailer, so the 15% markup is not necessarily visible to the consumer. Similarly, consumers are generally unaware that there is a cultivation tax of $9.65 per ounce (or about $1.21 per eighth) of dried flower that the distributor has to collect from the cultivator.
Theoretically, all of this might be unproblematic if licensed retailers were only competing with each other. Which brings us to:
The Traditional Market
The traditional market is the illegal market, which is to say, the untaxed and unregulated market.
Legalization of adult-use cannabis was supposed to destroy the traditional market, but it hasn’t. As of early 2020, the traditional market was estimated to be 80% of the total cannabis market in California. This is not surprising, since the traditional market has the advantages of being untaxed and unregulated.
The traditional market has a pervasive negative effect on the legal market. For example, the traditional market tends to depress prices in the legal market and tends to attract talent away from the legal market. Some of these effects will be discussed in the following articles.
This article is an opinion only and is not intended to be legal advice.
The culture of the cannabis industry is filled with passion that many envy, and for valid reasons. The roots of the cannabis plant go back thousands of years. As of this writing, there are no documented human deaths that were caused by a phytocannabinoid overdose. However, it is not all rainbows and unicorns.
Before breaking ground, fundraising, proper facility design, competitive application and permitting requirements are just the start. Once operating, businesses struggle to stay current with regulations that continue to evolve. Cannabis cultivators struggle to scale while mitigating pest infestations, which is a part of life in the conventional agricultural industry. A lack of consistent products frustrates consumers, while regulators and policy makers continue to struggle on the best way to regulate a commodity that has seemingly endless demand. The reality is dizzying!
However, amidst all of the challenges and opportunities, a continually overlooked tool stands out: a Quality Management System (QMS). Merriam-Webster defines a system as “an organized set of doctrines, ideas, or principles usually intended to explain the arrangement or working of a systematic whole.”
A QMS documents processes, procedures and responsibilities that ultimately direct an organization’s activities to meet customer and regulatory requirements as well as continually improve its effectiveness and efficiency. In other words – it steers innovation through the collection of data while ensuring products are safe for the consumer. For further reading, the American Society for Quality (ASQ), now over 70 years old, is an excellent resource and provider of resources and formal training programs that are recognized and revered around the world.
Step 1: Define your stakeholder requirements
This all starts with knowing your stakeholder (e.g., customer, regulatory body) requirements. For simplicity’s sake, let’s start with your customer; at a fundamental level, they expect safe, consistent and reliable products that impart a certain experience.
How does that translate into specifications? Let’s look at them one at a time.
What does “safe” mean? For an edible, safe means the product is free of physical, chemical and microbial hazards. Knowing what potential impurities could be in your product requires understanding your raw materials (inputs) and the manufacturing process. To take a deeper dive, some of the aspects of safety and quality, product specifications and testing considerations are discussed in this recent Cannabis Industry Journal article by Dr. Roggen and Mr. Skrinskas here.
An example of a compliant label in Oregon
What does “consistent” mean? This builds off and complements the safety profile. It could mean a consistent fill level, an acceptable range of cannabinoid concentration, and so on. For example, in the US Pharmacopeia’s peer-reviewed article about quality attributes of cannabis inflorescence (commonly known as flower or bud), they recommend 20% as the acceptable variance in cannabinoid content. For a product labeled as having 25% THC, the product will actually test to between 20% and 30%. This may be surprising, and discomforting for some, but the reality is that products on the market consistently fail to meet label claims.
What does “reliable” mean? That could mean that you always have inventory of certain products on the shelves at your dispensary. Defining “always” as a SMART goal – perhaps it means that you will have your top 3 products in stock at least 90% of the time. Customers need to feel like they can rely on your business to provide them with the products they want. Take the time to capture the data on what your customers want and work to satisfy their needs and you’ll watch your business really accelerate.
Step 2: Build your processes to meet these expectations
This is where your written standard operating procedures (SOPs), forms and records come into play. Your SOPs serve to memorialize your operations for consistency. Most SOPs in the cannabis industry are not written by the actual operators of a process. Rather, they are written by the legal and compliance team without review by the operators to confirm that what they are stating reflects operational reality. The audience needs to be the operators. Without effective SOPs that are utilized by your employees, your business will struggle to meet the established specifications. Cannabis businesses in Colorado, the oldest regulated adult-use cannabis market in the United States, continue to see 1 in 8 of their products fail final product testing! Cannabis businesses that understand their processes, document them in SOPs and have records to prove they follow their SOPs (see Step 3) are able to reduce errors that ultimately lead to costly rework and product failures.
Consistency in quality standards requires meticulous SOPs
Step 3: Monitor and improve
You have your requirements, you have your process, but how do you know that they are being adhered to? By the time you have results from a third-party lab, it’s too late. Look internally. Records and logs that show preventive maintenance was performed, room and canopy temperature and humidity checks, inventory reports, production records, extraction equipment report and employee training records shouldn’t be filled out only to be filed away. These records are data, which is your most valuable tool. Unfortunately, records are one of the most overlooked assets in today’s cannabis business. A team independent from operations (typically a Quality Unit) should be regularly reviewing these for inconsistencies and trends that can alert you to catastrophic failures before they occur.
Initially, the additional expenditure and learning curve may make this seem like an added burden, but keep in mind that succeeding in today’s cannabis industry requires long-term customer retention. By biting off one piece at a time, you can slowly implement a QMS that will improve your business, increase customer satisfaction, and ensure your brand is a staple for years to come. Remember, quality and compliance is a journey, not a “set it and forget it” situation.
The definition of a Quality Management System includes ‘continuous improvement’. Look forward to a future article which will discuss the importance of tools like a CAPA Program – Corrective Action Preventive Action (which all cannabis license holders in Colorado are required to have in place as of January 1, 2021) and how they complete your QMS, keeping you compliant and mitigating your business risks!
Between the patchwork quilt of rules and regulations that is the modern cannabis industry, products pass through many hands before being sold to a customer. From sourcing, cultivating, manufacturing, distributing and vending, the relationships between a licensee and their vendors/partners up and down the supply chain is complex and touches many stakeholders along the way.
While the focus on quality packaging, dope labeling, delicious ingredients and consistently potent cannabis is a priority for most companies, what often isn’t thought about is the liability in bringing these components together in terms of compliance.
Compliance responsibility falls on licensees as a direct term and condition of licensure within their state. To operate, licensees must maintain and be able to demonstrate compliance with a plethora of rules and regulations. Compliance is the name of the game in cannabis.
While most operators understand this, what most do not think about is how the compliance or noncompliance of their vendors affects their own liability.
Sharing Noncompliance & Liability
Supply chain partners are automatically segregated by whether or not they are plant touching licensees or not.
Licensees are the only entities in the supply chain that can be fined, administratively held, suspended, revoked or even arrested due to noncompliance. This fundamental nature means that supply chain partners are automatically segregated by whether or not they are plant touching licensees or not.
In the case of mutual licensees such as a manufacturer and dispensary, the liability for compliance falls on both entities. A single manufacturer that makes an error on labeling language or a cultivator using the incorrect containers both pass on their liability to any downstream partners.
iComply has seen regulators quarantine hundreds of products among multiple dispensaries who never checked the compliance of the supplying manufacturer. Surprisingly, most dispensaries don’t think of the liability passed to them amid hundreds of SKUs and multiple manufacturers and cultivators. Confounding the issue further is that everyone in the industry can interpret the same rules in completely different ways.
Assuming your supply chain partners are 100% compliant is a dangerous pitfall.
By not checking noncompliance from supply chain partners, operators accumulate evidence dating back years. Like METRC being off, these issues tend to snowball until they seem overwhelmingly difficult to handle. And it doesn’t just stop at labeling issues. Noncompliance can fall on all supply chain partners and be left in the hands of a licensee in a variety of ways.
Business partners like security contractors can often run afoul of regulations and put their licensed partners at risk.
Even worse, are supply chain partners who don’t have a motive to be compliant as they do not own licenses and often have a poor understanding of cannabis compliance. A packaging provider, marketing company, CBD provider, security company, vending machine providers, waste disposal companies and other commonplace suppliers and partners can often run afoul of regulations and put their licensed partners at risk.
Since regulators can only enforce the licensed entity, many states have made it clear that licensees are ultimately and fully responsible for any actions of noncompliance taken by third parties contracted by the company – regardless if they touch cannabis or not.
Areas of Common Noncompliance in Cannabis
Like a game of “Hot Potato” (worth millions of dollars), we’ve seen common noncompliance liability get passed down the supply chain in the following areas of cannabis operations:
Product liability
Packaging and labeling
Test result manipulation
Expired licenses
Input or ingredient defects
Inventory tracking errors
Recordkeeping and manifest errors
Some of these areas of noncompliance rely with non-licensed supply chain partners such as packaging, ingredients or third party printed labels. Often, these folks simply don’t know what they don’t know and make mistakes – not knowing the thousands of dollars they could be costing their licensed partner down the line.
Other areas in which compliance should be expected from licensed partners lies in product liability, test result issues, inventory tracking, manifests and recordkeeping. No one usually wants to be out of compliance and usually these issues arise from licensed partners who are simply confused, mistaken or ignorant to the requirements of ongoing and changing rules.
It’s hard to keep all of one’s suppliers and supply chain partners on the same page over the long run and amid a multitude of changing rules. But what you resist, persists…
Managing Compliance in the Cannabis Supply Chain
Nothing worth it is ever easy; but it is possible to identify common areas of noncompliance in one’s cannabis operation and supply chain partners and to do something about.
To identify problem areas, iComply recommends conducting regular auditing at a macro level; but to also dive deeper into micro level audits of all of one’s books and records (covering vendor files) and packaging and labeling for at least 12 months.
You don’t know what you don’t know, so one must begin by investigating and understanding where liabilities are occurring between themselves and their supply chain partners. Once valid feedback and noncompliance is discovered, it can be remediated.
Like triage, you have to stop the bleeding before you can prevent further injury.
Consistency in quality standards requires meticulous SOPs
It is always more expensive and time consuming to continue reacting to noncompliance and trying to fix issues after the fact. This is how snowball effects happen until the problems seem so overwhelming, operators tend to simply ignore the liability. While it is human nature, it is also extremely dangerous and detrimental when multimillion dollar licenses are on the line.
An ounce of prevention is worth a pound of cure –Benjamin Franklin
By implementing proactive compliance measures, cannabis businesses can avoid costly noncompliance consequences and position themselves as proactive checkpoints of supply chain compliance. We recommend integrating the following procedures, documents, training and tools into one’s operational compliance infrastructure:
New vendor checklist
Packaging and labeling checklists by product type
Virtual review of labels/non-cannabis packaging
Calendar expiration dates for licenses and products
Compliance auditing of key vendors and strong contracts regarding liability
Input product checklists and tracking as per GMP compliance
This snapshot is just the tip of the iceberg when it comes to the depths of liability a cannabis business is exposed to by its supply chain partners. To truly manage compliance, one must be aware of shared risk and implement proactive measures to prevent suppliers and supply chain partners from inadvertently affecting the operational compliance of your cannabis business.
Selecting Supply Chain Partners
There are plenty of fish in the sea and plenty of suppliers vying to do business with you. iComply has seen the good, the bad and the ugly. We’ve been on the front lines of developing markets like California where we warned our clients to steer clear of companies like Kushy Punch long before they finally lost their license for noncompliance.
Preventing contamination can save a business from extremely costly recalls.
We advise our clients on the importance of being selective and conducting due diligence in vetting supply chain partners and vendors. Most fundamentally, how aligned are the values of potential partners? Are they in the business for the same reasons you are? What brought them to the cannabis space? How do they value relationships and what do they know about compliance?
Too often when focused on price or speed, people miss the more important fundamentals of relationships. We serve as vetters for our clients whether they are shopping for a POS provider, a bank or a waste disposal company. Beyond the cultural alignment, the more objective questions begin to take shape in vetting a potential partner. This can differentiate between license holding and non-holding supply chain partners.
For plant-touching licensed partners, we recommend answering the following before entering into business partnerships that affect your supply chain:
Copies of licenses, contracts, and a catalogue of products
For products being selected, prior to ordering a sample, obtain a copy of the label by email first. Or an EMPTY sample of product packaging and labeling to vet against a packaging and labeling checklist.
Search news articles on the company and ask if they have had compliance issues before. Obtain documentation if there have been compliance issues previously.
Ask how they manage their compliance and prevent noncompliance down their supply chain. Do they train their staff? Do they conduct regular audits internally? How often do they update SOPs and reconcile inventory?
For non-plant touching partners, we recommend answering the following:
Obtain any certifications for quality assurance or in credentials for services.
Ask for references from other customers who have cannabis licenses.
Discover how familiar they are with the cannabis industry AND the rules and regulations in your market.
Ensure they have an understanding of how they impact your compliance. Discover how they plan on preventing areas of concern together.
Make sure they know you are ultimately responsible for noncompliance and understand what they are willing to do to protect you.
Ensuring accountability across the supply chain means selectively choosing partners who share the same values of integrity and professionalism. On more complicated deals, such as licensing IP or your brand to operators in new states or markets, we recommend that you mandate a compliance program that offers third-party validation to ensure the internal integrity of your partners. Too often, brand risk isn’t considered in the fast-paced expansion of the industry and operators must not only be vetted, but held accountable, when representing one’s brand and products.
For all intents and purposes, the wild web of the supply chain in cannabis is the industry. We are a collective of collaborators who all serve the goal of delivering high quality and safe products to cannabis consumers globally. For those committed to minimizing their risk to protect their profits, cannabis compliance is the key to success.
Ensuring accountability across the supply chain means selectively choosing partners who share the same values of integrity and professionalism. In doing so, the industry elevates its legitimacy and more effectively expands in a sustainable manner that protects all stakeholders involved.
Noncompliance affects licensees the most and they must be the most vigilant, but it takes a village to raise an industry. Compliance affects most everyone in the supply chain and the loss of any operator hurts the entire industry.
According to a press release published this week, Quicksilver Scientific, a nanoemulsion delivery technology company, announced a partnership with Truss CBD USA, which is the joint venture between Molson Coors and HEXO Cannabis.
Quicksilver is a manufacturer of nutritional supplements that uses a patent-pending nanoemulsion delivery technology. Their technology is what enables companies to produce cannabinoid-infused beverages.
Because cannabinoids like CBD are hydrophobic, meaning they are not water-soluble, companies have to use nanoemulsion technology to infuse beverages. Without this technology, beverages with cannabinoids would have inconsistent levels of compounds and they wouldn’t work well to actually deliver the cannabinoids to the body. Nanoemulsion essentially cannabinoids water soluble, thus allowing the delivery of cannabinoids to the bloodstream, increasing bioavailability.
Dr. Christopher Shade, Ph.D., founder & CEO of Quicksilver Scientific says they have perfected their nanoemulsion technology over the past decade. “CBD is not water-soluble, which creates challenges for manufacturers when attempting to mix it into beverages,” says Dr. Shade. “Our innovative nanoemulsion technology overcomes these challenges by encapsulating nano-sized CBD particles in water-soluble spheres that can be directly added to beverages. The result is a clear, great-tasting product with greater bioavailability, a measure of a compound’s concentration that is absorbed into the body’s bloodstream.”
The Veryvell beverage product line
Quicksilver is providing their technology to be used with Veryvell, the joint venture’s new line of non-alcoholic, hemp-derived CBD beverages. The beverage line is already available in the Colorado market. According to the press release, the three product offerings include: “Focus” (grapefruit and tarragon with ginseng and guarana), “Mind & Body” (strawberry and hibiscus with ashwagandha and elderberry) and “Unwind” (blueberry and lavender flavors with ashwagandha and L-Theanine).
Any brewmaster from the more than 7,000 U.S. craft breweries will tell you one of two things: That their art is a science, or that their science is an art. The answer might depend upon the brewer’s individual approach, but a combination of experience, process, precise measurement and intuition is exactly what’s required to create great beer. In a very similar way, the cannabis industry has its own version of the brewmaster: Extraction technicians.
A cannabis extraction technician deploys knowledge from multiple science disciplines to apply industrial solvents, heat and pressure to plant matter through a variety of methods with the aim to chemically extract pure compounds. Extraction techs use their passion for the cannabis and hemp plants, combined with chemistry, physics, phytobiology and chemical engineering to help create a result that’s not quite art, but not quite completely science. By manipulating plant materials, pressure, heat and other variables, the extraction technician crafts the building block for what will become an edible, tincture or extract.
Similarly, brewmasters use their knowledge of multiple science disciplines like chemistry and microbiology, as well as different brewing processes and a variety of ingredients to develop creative recipes that result in consistent, interesting beers. The brewmaster’s work is both science and art, as well. And they also manipulate plant materials, pressure, heat and other variables to achieve their desired results.
Author Jeremy Diehl collects cannabis extract from equipment for testing
“I would certainly consider brewing to be an art and a science, but it takes a very disciplined approach to create consistent, yet ever evolving beers for today’s craft market,” says Marshall Ligare, PhD. Research Scientist at John I. Haas, a leading supplier of hops, hop products and brewing innovations. “We work to ensure brewers can create something different with every new beer, as well as something that helps create an experience as well as a feeling.”
In both brewing and extraction, the art comes in the subjective experience of the craftsman and his or her ability to curate the infinite possibilities inherent in each process. However, both are a science in their requirement of establishing production methodologies that guarantee a consistent, reliable product experience every time to win customer loyalty (and regulatory compliance). In the same way hops determine recipes for beer flavors, the cannabis plant determines extraction recipes, especially considering the role that terpenoids play in the quality, flavor and effects of the end product.
The development of new and appealing cannabis products is beginning to mimic the vast variety of craft beers now found all over the world. In the same way beer connoisseurs seek out the perfect stout, lager or IPA, discriminating cannabis consumers now search for that gem of a single-origin, specialty-strain vaporizer oil or irresistible dab extract.
“I see an exciting new day for quality-focused, craft extraction that tells a story, not only of where the cannabis plant might have been grown and how, but also the care that was taken in the processing of that strain into smokable or edible oil,” says John Lynch, Founder of TradeCraft. “Imagine the impact in the marketplace when product-makers figure out how to do seasonal one-offs where engaged connoisseurs are willing to pay a premium for the art behind limited releases.”
In the same way hops determine recipes for beer flavors, the cannabis plant determines extraction recipes
In either process, you’re essentially creating art with science. Each process works with different strains. Each is concerned with chemical and flavor profiles. Each has its own challenges. In both worlds, quality depends upon consistency. You’re creating art, but you need to replicate that art over and over – which can only occur with strict control of the process. Brewmasters seek control of things like yeast quantity and health, oxygen input, wort nutritional status and temperature, among other things. In their pursuit, extraction technicians seek to control temperature, pressure and flow rate–as well as all the ways these variables interact with each other. What enables this control in both efforts is the equipment used to achieve results.
“A modern brewhouse is very much like a scientific laboratory,” Ligare says. “Brewers treat their setup with the same care and attention a scientist gives to their lab equipment, and are equally concerned with precision, cleanliness and the purity of the result. With each new beer, they want to develop a process that can be controlled and replicated.”
The key to creating a precise process is to use instrument-grade extraction machinery that performs to specifications – and allows you to repeat the process again and again. The value of using high-quality instrumentation to manage and monitor either the brewing or extraction process cannot be overstated. Although it seems counterintuitive, this is where the “craft” comes into play for both brewing and cannabis extraction. Precise instrumentation is what allows the brewer or extraction “artist” to manipulate and monitor the conditions required to meet recipe standards. Along with the quality of the ingredients (hops, cannabis, hemp, etc.), the quality of the equipment utilized to create the product is one critical element impacting the end result. “Imagine the impact in the marketplace when product-makers figure out how to do seasonal one-offs where engaged connoisseurs are willing to pay a premium for the art behind limited releases.”
In cannabis extraction, a second crucial decision is determining which solvent is the best solution for the recipe you’re using and the end result you’re hoping to achieve. This decision is a part of the “craft” of extraction, and determined according to a combination of criteria. There’s no question that each solvent has a business case it serves best, and there is ongoingdebate about which approach is best. But overwhelmingly, the solvent that best serves the most business needs is CO2 due to its inherent versatility and ability to have its density tuned to target specific compounds.
“Control is what makes or breaks any craft product,” says Karen Devereux, Vice President of Northeast Kingdom Hemp. “We’re based in Vermont and love how Vermont is known for its quality craft beer, cheese and maple syrup. We wanted to bring that craft approach to hemp extraction, and everyone knows that any craft endeavor is focused on the details and getting them right again and again. You can’t do that without controlling every aspect of the process.”
Greater control of the process can also open up worlds of discovery. The inherent “tunability” of CO₂ enables the extraction technician to target specific compounds, enhancing the potential for experimentation and even whimsy. This can lead to entirely new products much in the way a brewer can control his process to create new, interesting beers.
American portrait photographer Richard Avedon famously declared that art is “about control,” describing the artistic process as “the encounter between control and the uncontrollable.” The same can be said for beer making and cannabis extraction. The more precisely you can control variables, the more options you’ll have for yourself and your customers. The more choices you’ll have with regard to different recipes and products. And the more loyalty you’ll ultimately generate among fans of your products.
After a slow start following a disappointing 2019, M&A in the cannabis space closed 2020 with a bang, with more than $600 million in deals announced immediately following the November elections. Prospects for the New Year are expected to continue the explosive year-end trend with a backlog of nearly $2 billion in deals heading into 2021. The COVID-19 pandemic boosted sales of cannabis products, and election results opening up five new states to legal cannabis use and possible federal regulatory reform are further boosting prospects. Analysts now predict the U.S. cannabis market is poised to double by 2025.
Growth is expected to be led by multi-state operators who have achieved scale, cleaned up their balance sheets and stockpiled dry powder for roll-up acquisitions. Cannabis companies raised nearly $134 million in the two weeks before Election Day, a 185% increase over the same period last year. Most of the money flowed to multistate operators. In addition, the biggest stocks by market capitalization saw a roughly 20% bump ahead of the election and now are trading at record volumes, providing plenty of stock currency for further acquisitions.
Among the headline acquisitions last year:
Curaleaf continued its multi-state expansion with two of its largest acquisitions – the all-stock purchases of its affiliated cannabis oil company Select and of Grassroot, another MSO player. Curaleaf is now the largest cannabis company in the world based on annualized revenues, with annualized sales of $1 billion and operations in 23 states and 96 open dispensaries. Curaleaf also raised $215 million privately last year end for further expansion.
Close behind, Aphria and Tilray announced in December that they will merge, creating what they say will be the largest cannabis company in the world with an equity value of roughly $3.8 billion. The combined entity will have facilities and offices in the U.S., Canada, Portugal and Germany. The deal is expected to close during the second quarter of this year.
Also in December, Illinois-based Verano Holdings LLC unveiled plans to go public at a $2.8 billion valuation through a reverse takeover of a Canadian shell company. That deal followed the announcement that Verano will merge with Florida-based AltMed.
In addition, publicly traded New York cannabis firm Columbia Care signed a definitive agreement last month to acquire Green Leaf Medical, a privately held Maryland-based cannabis manufacturer and retailer, for $45 million in cash and $195 million in stock. The acquisition is expected to close this summer. Including Green Leaf’s inventory, the Columbia Care will operate 107 facilities, including 80 dispensaries and 27 cultivation and manufacturing facilities. Columbia Care also took advantage of cannabis fever last year by raising $100 million privately.
Also in December, Ayr Strategies announced it would acquire Liberty Health Sciences, one of the largest cannabis companies in Florida, for $290 million in stock, as well Garden State Dispensary, a New Jersey marijuana company for $41 million in cash, $30 million in stock and $30 million in the form of a note. This follows Ayr’s $81 million acquisition of an Arizona medical marijuana operator in November. Voters approved marijuana use in Arizona and New Jersey in November. Ayr has completed a string of acquisitions in Nevada, Massachusetts, Pennsylvania, Arizona, Ohio and, upon the closing of December’s deals, New Jersey and Florida.
Not all cannabis companies will rely on acquisitions, however. Trulieve, as an example, has focused its efforts on Florida and organic growth. It remains to be seen whether a multi-state approach fueled by acquisitions or a single-state organic growth model will prove the more lasting. Growth and profitability in the short term likely will continue to be hampered by limits on economies of scale due to federal restrictions and differing state laws.
In light of the maturing industry and the 2019 bust, the valuation model for acquisitions in the cannabis space is evolving from one based on sales, typically associated with emerging growth industries, to a more mature industry model based on profits or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). Most cannabis MSOs have stabilized and generate positive EBITDA, which justifies the evolution away from a sales-driven model.
From a legal standpoint, the same limitations that have vexed the cannabis industry for years will continue to challenge deal makers until there is greater clarity on the federal front. Institutional investor reluctance, financial industry constraints, haphazard state regulation and the unavailability of federal forums such as national copyright and trademark registration will continue to be issues for acquirers and their lawyers in the space.
Acquisition agreements will continue to have to address the federal Damocles’ sword should expected relaxation of federal enforcement under the Biden administration and further legislative relief does not materialize as expected. Although the U.S. House in December passed the “Marijuana Opportunity Reinvestment and Expungement Act” (MORE) to remove cannabis from the Controlled Substances Act, the Senate did not take up the bill in 2020 and it will have to be re-introduced in 2021. Notably, the MORE Act does not affect existing federal regulation of cannabis, such as the Food, Drug and Cosmetics Act, under which the FDA has limited the use of CBD in certain products despite hemp being removed from the Controlled Substances Act in 2018.
The cannabis M&A market is moving into a more mature phase, as MSOs will be choosier in their approach rather than continuing the land-grab mentality of years past. Due to improved financial strength, 2021 should see these MSOs continuing to expand their footprints either within existing states or new ones. Although uncertainties abound, further consolidation and expansion through add-on acquisitions is likely to continue apace in 2021, providing plenty of opportunities for deal makers and their lawyers.
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The three major types of cannabis activity span three major industrial sectors: raw materials (i.e., cultivation), manufacturing and service (distribution, testing and retail). As a result, a vertically integrated company needs to carry out very different types of activity, which require very different types of core competencies, equipment and facilities.
The regulatory definition of each link is extensive. For example, each licensee is tied to a specific facility, and must have its own procedures for production, inventory control, security, etc. When the links are strung together, this definition tends to preserve operational redundancies, and impede operational integration.
