Protecting Consumer Health: The Need for More Stringent Lab Testing Rules
Milan Patel, CEO, PathogenDx
In this session, Milan Patel discusses:
The current problems with testing in the cannabis industry. (Loose regulation and enforcement, allowing operators without scruples to endanger consumers, E.G. increasing moisture to products to increase weight, while also increasing risk of mold.
Potential solutions to this problem. (Bring more attention to the problem, states need to follow CGMP for recreational markets, companies should test at every step of the supply chain)
Why this matters (beyond protecting consumers, this will help protect the reputation of the industry and individual companies within it.)
TechTalk: Millipore Sigma
Maria Nelson, Technical Consultant, AOAC International
Why Use an Accredited Laboratory to Test your Cannabis
Tracy Szerszen, President & Operations Manager, Perry Johnson Laboratory Accreditation (PJLA)
This presentation will educate listeners on the various aspects laboratories must meet in order to obtain ISO/IEC 17025 accreditation. This will include an overview of what the ISO/IEC 17025 standard mandates on laboratories, the accreditation process and timelines as well as best practices to become prepared for an assessment. Utilizing an accredited laboratory is critical to this market resulting in less retesting and reliable results to support safe products.
How Authenticity Testing Can Help Cannabis Businesses
Dr. Arun Krishnamurthy, NMR Spectroscopist, Purity-IQ
Metrc combines a software platform with radio frequency identification technology to track plants and cannabis products from seed to sale. The track-and-trace model quickly became adopted by dozens of states to regulate their cannabis markets over the years, becoming an important standard in the industry.
With government contracts in nineteen states and counting, Metrc has become an omnipresent fixture in the United States cannabis market. States work with Metrc to provide their market’s traceability software for the entire supply chain, which helps prevent diversion to the black market, offers security and safety, aids in recalls and regulatory compliance tools.
We sat down with Michael Johnson, CEO of Metrc, to discuss retail challenges, regulations, cybersecurity, compliance and more.
Aaron Green: What are the major compliance challenges retailers face?
Michael Johnson: Major compliance challenges that retailers face will vary from state to state, however, we do see common themes across state lines. Financial services, for instance, has been a historical industry hurdle, as most big banks and credit card companies deny access to their network, making it difficult for retailers across the board – from bank account setup to limited customer and patient payment options to security issues when managing a cash-only retail business. The tides are starting to change with more credit unions and state-chartered banks opening their doors to the industry, along with new payment technologies for consumers to use instead of cash.
Michael Johnson, CEO of Metrc
We also see common operational challenges, including inventory management issues due to human error, lack of consistent quality assurance, and product theft. Retailers regularly face strict packaging, labeling, and product safety laws along with requirements for public health, storage and sanitation procedures and additional layers of security and surveillance.
Finally, access to compliant and retail-friendly technology systems is important as it can have a major operational impact. If a retailer can choose, selecting the right platform will manage all their operational needs – from ID-scanning at check-in to inventory management to banking – while properly integrating with their state’s track-and-trace technology. That’s a major benefit and one that Flowhub brings to the industry, alongside Metrc.
Aaron: How does compliance for retailers differ from cultivators and manufacturers?
Michael: It is important to note that proactive compliance sits at the center of cannabis regulation. Not only does it ensure the maintenance of license(s) and overall businesses, it helps expand and enhance the industry as a whole. As a highly regulated sector, transparent and consistent compliance initiatives provide the necessary foundation for a safe and secure environment, strengthening all levels of the supply chain and the industry at large.
All industry players must adhere to specific licensing and documentation requirements – an expired or illegal license may lead to serious fines and carries the potential of losing the business. In a handful of states, employees may need a license as well. Real estate also comes into play for all license holders, with special cannabis zoning restrictions, such as requiring distance limits between select institutions.
Since retailers are customer- and/or patient-facing, they may experience unique operational requirements compared to cultivators and manufacturers, including ID-checking policies, customer or patient delivery laws, additional packaging and labeling rules, strict dispensation regulations, in-store and on-shelf product placement, retail signage, and product promotion rules, and more.
Just like retail, cultivation and manufacturing compliance will also vary across states, but with a host of additional compliance requirements to keep in mind – for example, biological, chemical, and physical hazards are something that play a larger role at facility operations, which are subject to Occupational Safety and Health Administration (OSHA) rules. Other compliance issues to highlight on the cultivation and manufacturing side include state requirements on inventory reporting, security patrols, waste removal, and meticulous logging.
Aaron: What is your process for evaluating vendor integrations?
Michael: At Metrc, we maintain an efficient and consistent process for evaluating vendor integrations – an example of our commitment to ensuring the safety and security of legal cannabis markets.
First, integrators petition access into specific instance(s) by filling out a form with their basic information (business name, software name, contact info, etc.), along with any state-required agreements that must be signed. The integrator is then given a set of steps to perform in each instance requested. The steps provided are then evaluated by our API Support team. When all steps are performed accurately, the integrator is added into production and an API key is generated for their use. Licensees must also issue the TPI a User API key to gain access to the API. Overall, the process is a combination of meeting state, Metrc, and licensee requirements.
Aaron: Can you address the cybersecurity landscape METRC faces? What is METRC’s process for dealing with cybersecurity threats?
Michael: Cybersecurity threats are shared across industries and although not unique to Metrc or the cannabis sector, cybersecurity threats and the value of data continues to change. Maintaining strict safeguards around data privacy and the security is a top priority at Metrc and we keep a constant pulse on changes in the cybersecurity landscape, to maintain this safeguard for our customers, industry users, and Metrc as a whole.
Aaron: What trends in cannabis regulation are you following?
Michael: Cannabis rules and regulations are ever evolving, which is why it is vitally important for anyone in the industry to stay up to date. Examples of some we are following closely at Metrc include the SAFE Banking Act, Marijuana Opportunity Reinvestment and Expungement (MORE) Act, and Cannabis Administration Opportunity Act (CAOA); and more generally federal legalization, public health protection, and environmental regulations.
Aaron: What’s next for METRC?
Michael: We continue to expand our customer and user feedback loop to ensure our roadmap meets the unique needs of markets and an overall evolving industry/regulatory landscape. Examples include continued performance improvements, more robust analytics capabilities, user-driven functionality updates, and exploring the design of a more sustainable RFID tag.
At its core, Flowhub is a point-of-sale and compliance software company, but they offer much more than that. After becoming the first company to integrate with Metrc in 2015, the platform quickly became a leading software company in the space.
The system helps dispensaries manage inventory, report sales data to regulators, manage payment processing, manage workflows and simplify compliance. Following a few stints at Dixie Elixirs, Weedmaps, and Neos Vape Pens where he saw the day-to-day inefficiencies of cannabis compliance, Kyle Sherman launched Flowhub about eight years ago.
As Founder & CEO, Sherman and his team have taken Flowhub to the next level, with over 1,000 dispensary partners processing $3 billion in annual sales. We caught up with Sherman to ask about compliance challenges facing the industry, 4/20 sales data, integration technology and more.
Aaron Green: What are the major inventory and point-of-sale challenges that retailers face?
Flowhub Founder & CEO Kyle Sherman
Kyle Sherman: Cannabis has yet to be federally legalized and the industry remains a highly regulated environment that’s subject to a patchwork of state and local regulations. Dispensaries face an influx of challenges compared to traditional retailers due to strict compliance requirements. Cannabis retailers are required to report all sales activities and inventory movements to their state regulators, sometimes in real time. If physical inventory does not match what has been reported to regulators, their license is at risk for suspension. Maintaining accurate inventory records across systems (including point of sale, Metrc, and ecommerce menus) is one of the biggest struggles we hear from retailers.
In addition to compliance, lack of financial services and support from large banks and credit card companies is a big challenge for the cannabis industry. This means most transactions in the industry are limited to cash. Managing such large quantities isn’t easy and it puts dispensaries at risk of theft, both internally and externally. While cash alternatives like ACH are becoming increasingly accessible, some retailers are choosing partners with predatory financial terms or those that don’t operate in compliance.
Flowhub’s point of sale software enables a dispensary to provide best-in-class customer experiences without worrying about compliance. The software is purposefully built for the cannabis industry, focused on making the jobs of dispensary owners and staff members as streamlined as possible. Flowhub also helps dispensaries hide the complexities of a cash-intensive industry by allowing customers to use alternative forms of payments at checkout, like ACH and Point of Banking. Cannabis businesses should be able to transact as easily as if they were selling coffee and doughnuts.
Aaron: We’re about a month past 4/20, how was 2022 different and how can retailers prepare for next year?
Kyle: 420 2022 was the highest cannabis sales day in history! Dispensaries brought in twice the revenue compared to an average Saturday which is typically the busiest day of the week.
While ecommerce has become a major trend for dispensaries since the pandemic, traditional retail shopping is still by far the preferred mode of purchasing for consumers. With loosening COVID restrictions, 420 2022 saw a return to in-store shopping and in-person events. We also saw that while flower still stands as the most popular product category, customer product preferences are beginning to shift toward alternative options like edibles, beverages, vapes and concentrates.
To prepare for next year, retailers should analyze their 420 data to understand customer preferences. Dig into customer demographics to find out who was shopping, at what times, and for which products. This information can be used to curate a strategic marketing and execution plan in 2023. With many dispensaries offering similar products, it’s more important than ever to have a distinct experience that differentiates from the competition. Consider forming unique partnerships, ways to give back to your local community and how you can facilitate a shopping experience others cannot replicate.
At Flowhub, you can track your dispensary analytics from your smartphone with our mobile View app. Retailers can see real time performance metrics including sales data (track your sales, before and after-tax, by product category, average basket size, and total number of transactions), employee data (see top selling budtenders for the most recent day, week, month or quarter), and inventory data (view total identified inventory discrepancies by room, or see your most popular vendor and products at a glance). With data at your fingertips, you can stay on the pulse of your business and more adequately prepare for key dates and specific times of year, like 420.
Aaron: Flowhub was the first to integrate Metrc. What synergies were unlocked with this integration?
Kyle: Flowhub has always been involved in federal legalization advocacy. In 2014, I lobbied the CO Department of Revenue to build an open API to Metrc. Integrating with Metrc opened the door for cannabis operators to accelerate workflows, increase accuracy and simplify compliance. Prior to the API, tracking and reporting cannabis sales was painful. We were all handcuffed to manual pen and paper processes. Flowhub paved the way for other software companies to integrate to the Metrc API which is now the standard for track and trace systems in most legal cannabis markets.
Aaron: What’s next for Flowhub?
Kyle: Flowhub is strategically growing alongside the cannabis industry. We’re looking forward to supporting newly legal markets like New Jersey, where AU is now legal. We also recently integrated with Aeropay to offer dispensaries compliant ACH payments. Later this year we’ll have some major product developments coming out that I can’t disclose just yet but they’re very exciting! Stay tuned.
By Abraham Finberg, Simon Menkes, Rachel Wright No Comments
Some states, like California, Colorado and Washington, have welcomed cannabis with open arms while others have taken a while to come to the party (or haven’t gotten there yet). Missouri, whose licensed sales only began in October 2020, is one of the late arrivals.
Perhaps it’s in the nature of the people of the Show Me State to wait for proof that something is a good thing rather than being early adopters. Even Missouri’s nickname came into being as a statement of skepticism when Missouri Congressman Willard Duncan Vandiver, in an 1899 speech in Philadelphia, said, “Your frothy eloquence neither convinces nor satisfies me. I am from Missouri. You have got to show me.” (Not surprisingly, perhaps, Missouri’s state animal is the Missouri Mule).
Missouri legalized the use of medical cannabis on December 6, 2018. Compared to many other states, Missouri’s definition of what constitutes medicinal use is more tightly defined. For example, most medical cannabis states allow “anxiety” as an acceptable condition for a prescription; Missouri does not.1
Current Status of Adult Use Cannabis
St. Louis, Missouri
Missouri is now locked in a battle to legalize adult use cannabis, with the group Legal Missouri 2022, among others, working hard to put the measure on the ballot this year. At the same time, Representative Ron Hicks (R) is pushing to legalize recreational purchases with his Cannabis Freedom Act. “I want the legislature to be able to handle it so that when there are problems and things need to be changed, it can be changed,” Hicks said.2 Missouri Governor Mike Parson (R), who has been against recreational usage, has stated he would “much rather have the legislators have that discussion out here and see if there is a solution other than doing the ballot initiative.” Parson added, “If it got on the ballot, it’s probably going to pass.”3
Cannabis Business in Missouri: Only Cost of Goods Sold Deduction
Missouri has maintained its state tax code to be in conformity with Section 280E of the Internal Revenue Code, which disallows deductions and credits for expenditures connected with the illegal sale of drugs, stating:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business … consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law.4
This is true for both corporation5 and individuals6 in Missouri.
Governor Mike Parson recently vetoed a bill to eliminate conformity with I.R.C. Section 280E. Eliminating conformity would have lowered the tax burden on medical cannabis businesses, and increased Missouri’s competitiveness.7
State Sales and Cannabis Taxes
Missouri taxes retail sales at 4% of the purchase price.8 In addition, Missouri taxes retail sales of medical cannabis another 4% of the retail price.9,10 The medical cannabis tax is collected by dispensary facilities who then remit it to the Department of Revenue using Form 5808.11
Tax compliance is burdensome in Missouri, with dispensaries having to file returns monthly, even when they have no tax to report.12 Missouri also doesn’t allow cannabis businesses to pay their taxes in cash.13
No Tax on Tax
It’s important to note that Missouri doesn’t charges sales tax on cannabis tax nor cannabis tax on cannabis tax (unlike high-tax states like California). Under Missouri’s law, the tax is “separate from, and in addition to, any general state and local sales and use taxes that apply to retail sales.”14 Under Missouri’s sales tax law, “ Tax collected as a part of a sale should not be included in gross receipts.”15 Missouri has not specified whether the medical tax constitutes tax collected as a part of a sale; however, its regulations state that gross receipts from the sale of cigarettes do not include the amount of the sale price that represents the state cigarette tax.16 If the medical tax is analogous to the cigarette tax, gross receipts from the sale of medical cannabis likely excludes the amount paid as medical cannabis tax.
If the Legislature-Sponsored Cannabis Freedom Act Passes
If the Cannabis Freedom Act passes, Missouri will have a number of additional interesting changes. The bill would only allow for double the number of current medical cannabis licensees to serve the adult use market. It would also allow for people with non-violent convictions to petition the courts to have their record expunged (cleared).
Adult Use Taxes
The Act would allow the Department of Revenue to set an adult-use tax of up to 12%. There would be no such tax on medical cannabis sales.17
Normal Tax Deductions Allowed for Businesses
Licensed businesses would also be able to make tax deductions with the state up to the amount that they’d otherwise be eligible for under federal law if they were operating in a federally legal industry.18
Amendment Added to Act
In a move seen by many as a bid to derail the Cannabis Freedom Act, Representative Nick Schroer (R) amended the Act to bar transgender women from accessing no-interest loans for women- and minority-owned cannabis businesses, adding that only women who are “biologically” female would be eligible for the benefit. In the end, this addition may have the effect of scuttling the bill.19
Multiple Efforts to Place Cannabis on the Ballot
Even if the Act doesn’t pass, there are multiple efforts to place cannabis before the voters, including one by Representative Shamed Dogan (R), the group Legal Missouri 2022, which got medical cannabis passed by voters in 2018, and Fair Access Missouri.20
Comparison to Neighboring Oklahoma
Oklahoma, like Missouri, has not legalized the use of recreational cannabis, only medical cannabis. Also, Oklahoma taxes sales of tangible personal property (except newspapers and periodicals) at 4.5%, which is close to Missouri’s 4%.21 Tax is imposed on gross receipts or gross proceeds.22 Gross receipts (or gross proceeds) = Total amount of consideration, whether received in cash or otherwise. Credit is allowed for returns of merchandise.23
Oklahoma taxes retail medical cannabis sales at 7% of the gross amount received by the seller.24 Like Missouri, it has not specified any exemptions from the medical cannabis tax. Oklahoma’s medical cannabis tax base is the same as Missouri’s. Oklahoma’s medical tax rate is higher than Missouri’s. Therefore, Missouri’s tax treatment of medical cannabis is even better than Oklahoma’s.
Note, however, that Oklahoma has made it explicit that there is no tax-on-tax. “The 7% gross receipts tax is not part of the gross receipts for purposes of calculating the sales tax due, if the tax is shown separately from the price of the medical marijuana.”25
Oklahomans appear to be far more favorably disposed towards cannabis than Missouri, however. 2021 cannabis sales per person in Missouri was approximately $34, while Oklahoma boasted an impressive $210 per person, besting even California, which had $111/per person in cannabis sales.26
The Hidden Opportunity
Although Missouri only began licensed sales in October 2020, the state’s monthly sales has shown a strong upward curve. By the end of June 2021, monthly sales were just above $16 million. That number had shot up to $29 million per month for December 2021, and almost $37 million for April 2022.27 Patient enrollment is also increasing significantly.28
The best move, many experts believe, is to get into the medical market now, before the inevitable happens and adult use is approved. Competition is low at the moment, due to the lack of medical licensed dispensaries in the state. Although obtaining a license can be difficult, the current lack of competition, as well as the opportunity to gain a foothold in the cannabis industry before recreational purchases are approved, could provide a 10 times revenue increase from current medicinal sales levels.
Tyler Williams, founder of St. Louis-based Cannabis Safety and Quality and one of the St. Louis Business Journal’s 2021 40 Under 40, is optimistic about the future of Missouri cannabis. The state, he says, has been left “with only a few cannabis growers and manufacturers with a head start over the impending recreational market that is likely to come within the next couple of years.”29
The Bottom Line
The State of Missouri’s treatment of legal cannabis has been mixed, but the demand for the product by many residents of the state is unquestioned. If an entrepreneur has the foresight to get involved before all the wrinkles of legalization have been resolved, there is a possibility for very strong return on investment.
Infused flower and infused pre-rolls are two segments of the cannabis flower market sought after by consumers for their high THC content. Moon rocks are a type of infused flower product made by infusing flower with sticky concentrate and then rolling the sticky flower in kief. THC content of moon rocks often exceeds 50%.
Presidential is one of the largest infused flower cannabis companies and the third largest pre-roll brand in California, with products available in over 400+ retail stores such as MedMen, Gorilla RX, Sherbinskis, La Brea Collective and Royal Greens. Presidential’s success and growth has primarily been organic through word of mouth. Presidential recently launched the Presidential Suite in WeHo, a speakeasy-style lounge with entrance through a subway car inside a NY-style pizzeria, Esco’s. The suite offers events including exclusive cannabis industry nights as well as “pizza parties” held jointly with Esco’s.
We interviewed Everett Smith, co-founder and CEO of Presidential. Everett co-founded Presidential in 2012 following a professional basketball career in Europe. He has a background in marketing and brand development.
Aaron Green: Everett, how did you get involved in the cannabis industry?
Everett Smith: It was really just by chance. I was in Vegas after I was done playing ball overseas. I was working 9 to 5 at the convention center for a company called Freeman. I was out waiting for some clients and I met this guy who started talking to me about cannabis, about this company he was starting and how his friend was manufacturing the product for him. I didn’t love my job. I was looking for something exciting to do. So, I got their information, and I took him up on it and I called them every day for almost three months. Then it finally got together and long story short, we started.
Everett Smith, co-founder and CEO of Presidential
Green: What year was that?
Smith: That was in 2012.
Green: So, you met this person in 2012 and then three months later had it up and going?
Smith: Long story short, yes. After three months, we finally got together and got all the parameters figured out and then we started to create the brand, get the packaging, get the product, and put it out to the street. That all probably took six to eight months.
Green: Presidential is known for moon rocks and infused pre-rolls. How did you hit upon the concept of infused flower? Why did you make that your focus?
Smith: The gentleman I was talking about before – he’s no longer our partner – was manufacturing for his friend and that’s what he did, so that’s what we got introduced to and then as soon as we started selling it, I just found ways that it could be improved. I listened to the customers we were selling to. My old partner wasn’t willing to do that due to the manufacturing time, so we took it into our own hands and got an investor, my partner now, John Zapp, and we figured out how to manufacture it ourselves. We had zero idea what we were doing and we figured it out. I have to give credit to John, he is the one who figured out the formula we are using right now. There was a lot of bumping our heads, a lot of trial and error, a lot of figuring it out. And luckily, we did.
Green: You mentioned you felt like other companies weren’t doing it right. What was the difference that Presidential brought to the table?
Smith: Quality. These other companies were focused on profit margin. They weren’t using quality products. They were using the same product twice in different things, which is the ultimate no-no. I just found that if you started with high-quality raw goods, and put them together, you are going to have an even better product.
Growing up my mom was kind of a hippy. We just like stuff from the earth. Good organic stuff. So, we were taking flower that I knew was being grown organically at the time and then infusing it and it created a better product. We packaged it better than anybody else’s packaging at the time. I have a background in marketing so at that time, I was just trying to create a product and a brand that my friends and I would like. I thought we were our target user at the time. I was working in my late 20s.
Green: Where were you located at the time?
Smith: We were in Los Angeles.
Green: What were some of the challenges of launching a brand in Los Angeles back in 2012?
Smith: Some of the challenges included: education of the consumer; getting clients in the door and making them feel safe to come into a dispensary and purchase medicine at the time; and the legalities – maneuvering all the different propositions that were coming down and being able to do it legally and safely. The legal issues were probably our biggest hurdle. Then there was the challenge of introducing people to Moon Rocks. Infused flower was a brand-new concept, so we had to find as many people as we could to introduce the product to.
Green: I’m just imagining back to 2012, I think Moon Rocks would have been completely new to me. How did you get customers over the hump of trying something new?
Smith: I would get big jars of Moon Rocks. They look crazy. We saw people walk by and just watched the reactions. It was like, “Whoa, what’s that? What in the world is that?” Then we use the tagline: “World’s Strongest”. We’re starting with nice, tasty flower. We’re putting 90% THC distillate on it and then when we’re taking kief in the mid 40s 50s (% THC), and we’re covering it. So we’re putting THC on top of THC of on top of THC.
Putting “The World’s Strongest” on there and just putting big jars out in front of as many people, at as many conventions, and at as many dispensaries that would let us set up a patient appreciation day. That’s how we did it.
Green: You are in retailers across California. What were the keys to your success in building out your distribution network?
Smith: Sales. Knocking on doors. My partner comes from the car business. He was a fixer-upper helping dealerships all over the country become more profitable. So, just having that mentality of going out every day and knocking on doors trying to get every single possible client. I want to say it was like being a car salesman and Hollywood, or something similar. At first it was me and John every day knocking on doors. Then the business built on itself.
We have the same process now. Knock on the doors and send our brand ambassadors in there to do customer appreciation. They get our product in front of people and it’s worked for us. The marketing money we do spend we spend in the stores, because we see a direct correlation there. At the end, it really goes back to the knocking on doors.
Green: Do you notice anything different between 2012 sales and prospecting versus today now that your brand awareness has changed?
Smith: Absolutely. Everything is very corporate now. Before 2014, you could knock on the door and the person that you needed to see was sitting right there. The owner was the buyer. Now, you have to get through layers of people to get to the actual decision-maker because they’ve become so corporate. So that’s the biggest difference I see, but I wouldn’t say it’s a negative. I would say that our industry has become more positive. We can guarantee regular pay. We can guarantee that the products are going to be on the shelves and we can cut or markup the pricing. Those are the changes I see and they’re not always easy, but I think they’re for the better.
Green: What does the future look like for Presidential? More broadly, what does the future look like for the industry in terms of infused flower and pre-rolls?
Smith: Right now, the infused flower market is one of the fastest-growing markets. I see that becoming the norm, and the same for pre-rolls. We’re looking at expansion and trying to become one of the national players in this game. We’re swinging for the fences.
Green: What geographies are you looking at?
Smith: Right now we’re in California. We are in negotiations to launch in Nevada in July. We were getting ready to launch in Oklahoma, but had a deal fall through so now we are kind of switching gears. I would say by end of year we’ll be in Oklahoma, and my partner John is trying to close a deal for Michigan. So, those are the markets we have on the table right now. We’re looking to close those all before the end of the year.
Green: What trends are you following in the industry?
Smith: We have the number one selling blunt in California, but in terms of pre-rolls we are number four in terms of sales. The three companies ahead of us all sell minis and packs of minis, whereas we sell single 1 gram and 1.5 gram pre-rolls. So, in July, we’re launching three-packs of minis, so three 0.7 gram blunts and three 0.5 gram pre-rolls.
You can infuse the flower with pretty much any kind of concentrate the way that we do it. I’d like to come out with some diamond products, that’s hot right now. We’re following the wave and trends of the concentrates.
Green: What in your personal life or in cannabis are you most interested in learning about?
Smith: In my personal life, I’m interested in financial craftiness. You know, make your money and make your money work for you. I personally, in the business, would like to learn more about the smokeless form factors of cannabis. Things like beverages and capsules. I think that’s where the industry will end up going. So, I’m interested in learning more about the manufacturing of beverages and capsules and what it entails.
Green: Thanks Everett, that concludes the interview.
Just over a month ago, a handful of dispensaries in New Jersey began selling cannabis to adults over the age of 21. The state issued licenses for adult use sales to seven alternative treatment centers (ATCs), otherwise known as medical cannabis businesses already established in the state. In total, thirteen dispensaries in the state started selling cannabis to adults over 21.
The seven companies awarded adult use licenses were Ascend, Curaleaf, GTI, Acreage, Verano, Columbia Care and TerrAscend. The state’s roll out created a lot of controversy over allowing already established, larger medical cannabis businesses and multi state operators to begin adult use sales before smaller businesses and social equity applicants get licensed.
Sales totals in the first month of New Jersey’s adult use market
Earlier this week, the New Jersey Cannabis Regulatory Commission (CRC) held a public meeting where regulators discussed progress, sales totals so far, conditional license applications and more. According to the meeting notes, between April 21 and May 21, retailers in New Jersey did $24,201,875 in cannabis sales with 212,433 transactions. During the meeting, regulators considered 46 conditional license applications and four testing lab license applications.
According to NJ.com, six new dispensaries were awarded licenses to begin adult use sales. Of the six new retail locations, Curaleaf opened their Edgewater location to adult use customers and Ayr Wellness received approval to begin adult use sales at all three of their medical locations in Eatontown, Union and Woodbridge. Ascend and TerrAscend also received approval to begin adult use sales act their locations in Montclair and Lodi, respectively.
About two weeks ago, the CRC testified before the state’s Senate Judiciary Meeting to share progress on the legal cannabis market, just over a year after the CRC was established. Jeff Brown, executive director of the CRC, discussed the agency’s goals and some challenges ahead of them. Brown says the CRC will be focusing on additional rules for adult use, modernizing the medical rules, enforcing regulatory compliance and information sharing in the near future. He also mentioned a couple challenges the industry is currently facing that they wish to address, including: expanding access to capital for entrepreneurs , removing impediments to finding real estate, educating municipalities to open up opportunities for applicants and ensuring medicinal cannabis access is unimpeded by recreational sales.
“We have made great strides in all of these efforts, and when we look at how New Jersey compares against other states, we fair pretty well,” Brown told lawmakers. “Beginning recreational sales on 4/21/22 was an important milestone. But it doesn’t mark the end of the process, it marks an important step in a multi-year effort to establish New Jersey as the premier cannabis market on the East Coast.”
Update: Governor McKee has signed the Rhode Island Cannabis Act into law, making it the 19th state to legalize adult use cannabis.
In Rhode Island this week, lawmakers voted to approve a bill that would legalize and regulate adult use cannabis. The state’s legislature passed the bill with overwhelming majorities in both the House of Representatives and the Senate.
The House voted 55-16 and the Senate voted 32-6 to approve the Rhode Island Cannabis Act, a bill that allows adults over 21 to possess, purchase and grow cannabis. The legislation contains a provision for automatic review and expungement of past cannabis convictions. Similar to other neighboring states, the bill also allows for allocating tax revenue from cannabis sales to communities most harmed by cannabis prohibition, such as low income neighborhoods.
Rhode Island Gov. McKee
Governor Daniel McKee has expressed support for the bill previously and is expected to sign it into law. According to Jared Moffat, state campaigns manager for the Marijuana Policy Project, Rep. Scott Slater, Sen. Josh Miller and Rep. Leonela Felix are to thank for their leadership in bringing the bill to a vote. “We are grateful to Rep. Scott Slater and Sen.Josh Miller for their years of leadership on this issue. Rhode Islanders should be proud of their lawmakers for passing a legalization bill that features strong provisions to promote equity and social justice,” says Moffat. “We’re also thankful to Rep. Leonela Felix who advocated tirelessly for the inclusion of an automatic expungement provision that will clear tens of thousands of past cannabis possession convictions.”
Among other provisions, the bill establishes a 10% sales tax in addition to the state’s normal 7% sales tax and 3% local sales tax. A quarter of all retail licenses will go to social equity applicants and another quarter of all licenses will be reserved for worker-owned cooperatives. The legislation also includes a “social equity assistance fund” that will offer grant money, job training and social services to communities most impacted by cannabis prohibition.
As the regulated cannabis industry matures, M&A activity is expected to continue accelerating. Whether they are existing licensed businesses looking for acquisition opportunities or new investor groups seeking to enter or expand their positions in the industry, investors should recognize the special due diligence challenges associated with cannabis industry transactions.
Above all, investors should avoid the temptation to omit or short-circuit long-established due diligence practices, mistakenly believing that some of these steps might not be relevant to cannabis and hemp operations. Despite the unique nature of the industry, thorough and professional financial, tax and legal due diligence are essential to a successful acquisition.
Surging M&A activity
Over the past few years, as the cannabis industry matured and the regulatory environment evolved, M&A activity involving cannabis and hemp companies has undergone several cycles of expansion and contraction. Today, the expansion trend clearly has resumed. Although the exact numbers vary from one source to another, virtually all industry observers agree that 2021 saw a strong resurgence in cannabis-related M&A activity, with total transactions numbering in the hundreds and total deal values reaching into billions of dollars. Moreover, most analysts seem to agree that so far, the pace for 2022 is accelerating even more.
Today, many existing cannabis and hemp multistate operating companies are in an acquisitive mood as they look for opportunities to scale up their operations, enter new markets, and vertically integrate. At the same time, the projections for continued industry growth over the next decade have attracted a number of investment funds and private equity groups, which were formed specifically for the purpose of investing in cannabis and hemp businesses.
These two classes of investors often pursue distinctly different approaches to their transactions. Unlike the largely entrepreneurial cannabis industry pioneers now looking to expand, the more institutional investors are accustomed to working with professional advisers to perform financial, tax and legal due diligence as they would for a transaction in any other industry.
Among both groups, however, there is sometimes a tendency to misunderstand some of the transactional risk elements associated with cannabis M&A deals. In many instances, buyers who are generally sensitive to potential legal and regulatory risks will underestimate or overlook other risks they also should examine as part of a more conventional financial and tax due diligence effort.
For example, since much of the value of a licensed cannabis operation is the license itself, investors often rely largely on their own industry understanding and expertise to assess the merits of a proposed acquisition, based primarily on their estimation of the license’s value. This practice provides acquirers with a narrow and incomplete view of the deal’s overall value. More importantly, it also overlooks significant areas of risk.
Because cannabis acquisition targets typically are still quite new and have no consistent earning records, acquirers also sometimes eschew quality of earnings studies and other elements of conventional due diligence that are designed to assess the accuracy of historical earnings and the feasibility of future projections.
Such assumptions and oversights often can derail an otherwise promising transaction prior to closing, causing both the target and the acquirer to incur unnecessary costs and lost opportunities. What’s more, even if the deal is eventually consummated, short-circuiting the normal due diligence processes can expose buyers to significant unanticipated risk down the road.
Recurring issues in cannabis acquisitions
The most widely recognized risks in the industry stem from the conflict between federal law and the laws of various states that have legalized cannabis for medical or adult recreational use. The most prominent of these concerns relates to Section 280E of the Internal Revenue Code (IRC 280E).
Although its use is now legal in many states, cannabis is still classified as a Schedule I substance under the federal Controlled Substances Act. IRC 280E states that any trade or business trafficking in a controlled substance must pay income tax based on its gross income, rather than net income after deductions. As a result, cannabis businesses are not entitled to any of the common expense deductions or tax credits other businesses can claim.
The practical effect of this situation is that cannabis-related businesses – including growers, processors, shippers and retailers – often owe significant federal income tax even if they are not yet profitable. Everyone active in the industry is aware of the issue, of course, and any existing operating company or investment group will undoubtedly factor this risk into its assessment of a proposed acquisition target.
The challenge can be exacerbated, however, by other, less widely discussed factors that also affect many cannabis businesses. These issues further cloud the financial, tax and regulatory risk picture, making thorough and professional due diligence even more critical to a successful acquisition.
Several of these issues merit special attention:
Nonstandard accounting and financial reporting practices. As is often the case in relatively young, still-maturing businesses, acquisition targets in the cannabis industry might not have yet developed highly sophisticated accounting operations. It is not uncommon to encounter inadequate accounting department staffing along with financial reporting procedures that do not align with either generally accepted accounting principles or other standard practices. In many instances, company management is still preparing its own financial statements with minimal outside guidance or involvement by objective, third-party professionals. Significant turnover in the management team – and particularly in the chief financial officer position –is also common, as is a general view that accounting is a cost center rather than a value-enhancing part of the management structure.
Such conditions are not unusual in young businesses that are still largely entrepreneurial in spirit and practice. In the cannabis industry, however, this situation is also a reflection of many professional and business services firms’ longstanding reluctance to engage with cannabis operators – a hesitancy that still affects some organizations.
When customary business practices are not applied or are applied inconsistently, acquiring companies or investors should be prepared to devote more time and attention – not less – to conventional financial due diligence. The expertise of professional advisers with direct experience in the industry can be of immense benefit to all parties in this effort.
Restructuring events or nonrecurring items in financial statements. Restructuring events and nonrecurring items are relatively common in many new or fast-growing businesses, and they are especially prevalent among cannabis operations. In many instances, such companies have engaged in multiple restructuring events over a short period of time, often consolidating operations, taking on new debt, and incurring various one-time costs that are not directly related to the ongoing operations of the business.
The inclusion of various nonrecurring items within the historical financial statements can make it much more difficult for a buyer or investor to accurately identify and assess proforma operating results, especially in businesses that have not yet generated consistent profits. Here again, applying previous experience in clearing up the noise in the financial statements can help improve both the accuracy and timeliness of the due diligence effort.
Run-rate results inconsistent with historical earnings or losses. A company’s run rate – an extraction of current financial information as a predictor of future performance – is a widely used tool for creating performance estimates for companies that have been operating for short periods of time or that have only recently become profitable. In cannabis businesses, however, run-rate estimates sometimes can be unreliable or misleading.
Because it is based only on the most current data, the run rate often does not reflect significant past events that could skew projections or recent changes in the company’s fundamental business operations. Because such occurrences are relatively common in the industry, the results of run-rate calculations can be inconsistent with the target company’s historical record of earnings or losses.
Historical tax and structuring risks new owners must assume. Like many other new businesses, cannabis operations often face cash flow and financing challenges, which owners can address through alternative strategies such as debt financing, stock warrants, or preferred equity conversions. Such approaches can give rise to complex tax and financial reporting issues as tax authorities exercise their judgment in interpreting whether these items should be reported as liabilities or equity derivatives. The situation is often complicated further by various nonstandard business practices and the absence of sophisticated accounting capabilities, as noted earlier.
As a consequence, financial statements for many cannabis companies – including a number of publicly listed companies – often contain complex capital structures with numerous types of debt warrants, conversion factors and share ownership options. Although an acquisition would, in theory, clean up these complications, buyers nevertheless must factor in the risk of previous noncompliance that might still be hidden within the organization – a risk that can be identified and quantified only through competent and thorough due diligence.
Not as simple as it seems
On the surface, the fundamentals of the cannabis industry are relatively straightforward, which is one reason it appeals to both operators and investors. For example, participants at every stage of the cannabis business cycle – growing and harvesting, processing and packaging, shipping and distribution, and ultimately marketing and retailing – can readily apply well-established practices from their counterparts in more conventional product lines.
The major exception to this rule, of course, is the area of regulatory compliance, which is still shifting and likely will continue to do so for the foreseeable future. Outside of this obvious and significant exception, however, most other aspects of the industry are relatively predictable and manageable.
When viewed in this light and in light of the continued growth of the industry, it is easy to see why cannabis-related acquisitions are so appealing to existing business operators and outside investors alike. It is also easy to understand why buyers might feel pressure to move quickly to take advantage of promising opportunities in a fast-changing industry.
As attractive as such opportunities might be, however, buyers should take care to avoid shortcuts and resist the urge to sidestep established due diligence procedures that can reveal potential accounting and financial statement complications and the related compliance risks they create. The unique nature of the cannabis industry does not make these practices irrelevant or unnecessary. If anything, it makes professional financial, tax, and legal due diligence more important than ever.
Crowe Disclaimer: Qualified organizations only. Independence and regulatory restrictions may apply. Some firm services may not be available to all clients. Given the continued evolution and inconsistency of various state and federal cannabis-related laws, any company should seek competent legal advice relating to its involvement in the cannabis industry, including when considering a potential public offering as a cannabis-related company.
Regulators in New York are continuing their push forward in launching the adult use cannabis market. They have approved 58 conditional licenses for hemp growers to begin cultivating cannabis for the adult use market. In just the past few months, the state has already awarded 146 conditional licenses for cultivation.
The Office of Cannabis Management (OCM) in New York also announced their “Get Ready, Get Set” virtual workshop series, designed to help social equity applicants prepare for license applications and better understand the conditional licensing program.
Earlier this year, following an amendment to state law, the OCM launched the conditional licensing program to ensure that hemp farmers in the state with a desire to grow adult use cannabis could get started in the 2022 season.
Applications can be filed with the OCM for conditional licenses through June 30, 2022, with a $2,000 non-refundable application and licensing fee. The licenses are only for farms that have already grown hemp in New York State.
“New York is building the most inclusive cannabis industry in the country and including small farmers with an expertise is an essential component in accomplishing that goal,” says Chris Alexander, executive director at the OCM. “The growing season isn’t waiting for anyone and I’m grateful for the hard work of the CCB and my colleagues at OCM to ensure these licenses are being reviewed as quickly as possible so New York’s farmers can take full advantage of the growing season and cultivate the products that our equity entrepreneurs will be the first to sell when they open their dispensaries this year.”
The Boston Beer Company, Inc., known for brands like Sam Adams, Truly, Twisted Tea and Dogfish Head, has announced their entry into the cannabis market. According to the press release, the craft beer company is launching TeaPot, a new brand of cannabis infused-iced teas. Your cousin from Boston is getting into the cannabis game.
The line of canned, THC-infused beverages will hit stores in Canada this July. The cannabis beverages will be produced at Peak Processing Solutions in Windsor, Ontario and distributed by Entourage Health based in Toronto, Ontario.
The Good Day Iced Tea beverage
The first product of the brand is called Good Day Iced Tea and is strain-specific. It will be formulated with lemon black tea and infused with “Pedro’s Sweet Sativa,” a strain grown by Entourage Health in Ontario. More products will be announced in the next few months, the company says.
The press release emphasizes the size and growth of the cannabis beverage market, citing Headset retail data showing the Canadian beverage market is about double the size of its American counterpart and growing at an astounding 850% in the past two years. It’s no secret that the cannabis beverage sector is a rapidly growing market for cannabis brands. Canopy Growth has been targeting this portion of the market for years and Molson Coors launched a joint venture last year. A lot of other companies have been slowly getting more and more involved as of late.
The U.S. cannabis beverage market is certainly lagging behind our neighbors to the North, mostly stymied by slow state-by-state legalization, patchwork regulations and restrictive federal policies. Of the beverage giants and companies that have entered the space, most are doing so cautiously.
Dave Burwick, CEO of the Boston Beer Company, hinted at their desire to enter the U.S. market, but says they’ll focus on Canada in the meantime. “As we await further progress on U.S. regulations, we’ll continue to develop an exciting product pipeline in the federally regulated market of Canada,” says Burwick. “While beer is our middle name, we’ve also introduced successful hard teas, hard ciders, hard seltzers, and canned cocktails. We’re encouraged by the continued growth of the cannabis beverage category and we believe it’s one of the next innovation frontiers.”
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