One of the most common refrains I have heard when raising funds for marijuana businesses is “I hear marijuana is going to be big, but isn’t it risky?” The short answer: Yes. The longer answer: Yes, but…

Let me start out generally by saying that a marijuana business is most certainly riskier than your ordinary business, for a number of reasons, intense regulation and federal government policy being the most prominent, but the time to acquire a license is a major risk that seems to be often overlooked.

The Feds

In spite of the increasing pace of legalization of adult use marijuana across the United States, marijuana remains a Schedule I drug under the Federal Controlled Substances Act. Like other Schedule I substances, marijuana is regarded as:

  1. Having a high potential for abuse
  2. Having no currently accepted medical use
  3. Lacking accepted safety for use

Clearly individual states take a more pragmatic view, though there have been mixed messages from the federal government regarding enforcement over the past two administrations.

For a little background, up until January 4th, 2018, state legal marijuana businesses were generally protected from interference by the federal government under the Cole memo. This was a memo issued in August 2013 by then Deputy Attorney General James M. Cole which essentially stated that, given limited resources, the Justice Department wouldn’t enforce the federal prohibition on marijuana in states that “legalized marijuana in some form and … implemented strong and effective regulatory and enforcement systems to control the cultivation, distribution, sale, and possession of marijuana…”

Unfortunately, as mentioned above, former attorney general Jeff Sessions rescinded this memo in January 2018. This has left prosecutions up to the discretion of individual US Attorneys’ Offices, increasing the ambiguity around federal enforcement of marijuana prohibition, though there has yet to be a concerted effort by the Trump administration to pursue marijuana operations that are in compliance with state laws.

With the number of states that have legalized adult-use marijuana and the size of the businesses now successfully operating, it seems politically untenable for the federal government to actively pursue marijuana business operating within the bounds of state laws.

Banking

Limited access to the banking system has hampered marijuana businesses across the country, forcing many to deal in cash only. Theoretically, under the law, federal banking regulators could seize marijuana related accounts and take action against institutions providing banking services. Most banks do not want to run afoul of federal law or endanger their access to the FDIC Deposit Insurance Fund and so refuse to do business with marijuana companies. Thus most marijuana companies lack access to typical bank services like depository accounts or credit card processing.

According to data from the US Treasury’s Financial Crimes Enforcement Network, by March of 2019 there were 633 institutions banking marijuana businesses. The majority of those, 493, are banks, with an additional 140 credit unions. However, this data is based on Suspicious Activity Reports (SAR) filed by each institution for transactions deemed to be marijuana related, which likely overstates the number of account holders that have an active and transparent relationship with the filing institution.

Tyler Beuerlein, executive vice president for business development at Hypur, a banking technology and payment provider servicing high-risk markets, estimates that there fewer than 40 institutions that are actively serving marijuana businesses.

Most of the institutions banking the marijuana industry are state chartered banks and credit unions. In Massachusetts, only GFA Credit Union and BayCoast bank have committed to providing banking services to the adult-use marijuana industry. However, GFA will not provide services until a business has received its marijuana license, leaving startups back at square one to get off the ground. Century Bank, has been providing services to medical marijuana companies in Massachusetts for several years, but has no plans to provide similar services to the adult-use market.

It isn’t just companies that directly touch the marijuana plant that are hurt by federal banking policy but ancillary businesses as well. In April of 2018, the Small Business Administration (SBA) released guidance concerning SBA loans that “prevents the SBA from supporting loans to small businesses associated with the cannabis industry.” The policy change locked out SBA loans to direct marijuana businesses, indirect marijuana businesses and hemp businesses. This puts many small businesses relying on SBA loans at risk including architecture firms, accountants, grow light companies, testing services and accessory companies.

Any company or bank that handles the proceeds of a marijuana business is also at risk under federal money laundering laws, though how many links away from the original transaction the trail of money must be followed is an open question. I have had colleagues working in the industry who have had their personal accounts closed by their bank as soon as the bank discovers that their paycheck is coming from a marijuana related business. I have also seen accounts that take in investment monies closed as soon as the host bank looks into the history of the deposit. A friend of mine attempting to start an adult-use dispensary likened it to a game of whack-a-mole, constantly moving from bank to bank as each institution closed his accounts, both business and personal.

For operators and investors, the lack of banking access introduces risk for startup financing and ongoing operations. Where do you place investment dollars to launch your business? How do investors bank their dividends or other return? How do you pay your employees? Last week the average marijuana dispensary in Massachusetts pulled in $498,000 in revenue, owing $84,745 in state taxes and $14,955 in local taxes. Without access to banking how does this get paid? A paper bag of cash down to the Department of Revenue? Obviously this presents a not insubstantial public safety issue.

Even if a marijuana business is able to find a bank that will provide service, it typically comes with substantial monthly costs in the thousands to tens of thousands of dollars. This is a further startup and ongoing cost that every operator needs to be prepared for.

There could be some relief on the horizon from congress under the SAFE Banking Act of 2019. This bill, introduced to the House of Representatives in March 2019, would create protections for depository institutions providing financial services to state licensed cannabis related businesses. However, as of this post the bill has been reported by the House Committee on Financial Services, but no further progress has been made. At this point, passage of the bill by the full House seems unlikely, but it is promising that banking access is a problem that is gaining bipartisan recognition in the legislature.

State Licensing

State licensing is a common risk factor that I have heard, phrased as “What if you don’t get a license?” To date there has been only one company in Massachusetts that has been denied a license and this was at the provisional licensure stage.

At the Cannabis Control Commission hearing on this particular provisional license, the commissioners noted that it did not seem like the applicant had read the statute or the instructions for the application. With their rejection of this application the commissioners suggested that staff review of applications should catch most deficiencies which are then corrected by the applicant prior to being put before the full commission.

Within Massachusetts, I regard the risk of not obtaining a license as low. As long as an applicant follows the instructions and corrects any deficiencies in their application, they should obtain a license. Unlike some other states, there is no cap on the number of licenses of any category and the process to obtain a license is not competitively based. I reached out to the CCC to confirm this and received the following response:

On our initial review of an application, if there is information missing, we will contact the applicant to have them submit more information. Should all the necessary information be provided and the applicant is in compliance with our regulations, they should receive a license.

Like a drivers license, if an applicant fails, it is possible to reapply until obtaining a license.

That being said, the time it takes to move through the licensing process is extensive and an outright rejection would have a major impact on the timeline for any business trying to get started. For a summary of provisional vs final vs operational licenses in Massachusetts see this post.

Time

As Charles Finnie, Chief Strategy Officer for MariMed said in the July issue of Marijuana Business Magazine,

If you’re going to be a player and have staying power, just make sure you’re well capitalized.

Time, and by extension undercapitalization, is easily the biggest risk I have seen wreak havoc on plans to enter the adult-use marijuana industry. Looking at Massachusetts as an example, the queue for a license is extensive at this point, with 279 applications pending review to reach provisional status and 93 provisional applicants awaiting inspection to receive their final license. The Cannabis Control Commission (CCC) has been fairly consistent with their pace of awarding licenses. For example, at the next meeting on July 17th they will be considering

Provisional License

  • Cultivation - 1
  • Manufacturing - 2
  • Retail - 3

Final License

  • Cultivation - 2
  • Manufacturing - 1
  • Retail - 1

The length of this queue is further exacerbated by the start of license renewals this summer. It has been a year since the commission considered the first set of licenses and as such they are up for renewal, requiring staff and resources that will likely be diverted from addressing initial license applications. Given the pace of approvals and the length of the queue, applicants must be prepared with adequate capital to survive through the licensing process.

Rent or mortgage payments, staff salaries, high bank fees, insurance and professional services are just a few of the ongoing costs. Further, if using any debt instruments, be prepared to service that debt and be cognizant of how your repayment structure will be impacted by any delays. Startups should budget for all of the above with liberal wiggle room from day one and be prepared to return to investors to renegotiate or refinance. Managing investor expectations as far as the licensing process is concerned is imperative and should be a continuous and ongoing conversation for every marijuana entrepreneur.

It is unclear how many applications have been withdrawn due to a lack of capital, but anecdotally it is most certainly not zero.

But Wait, There’s More

This is by no means an exhaustive list of the risks that permeate adult-use marijuana, but these are some of the most common that I have discussed and addressed in my time in the industry. Leases, planning for taxes and the inevitable crash in wholesale marijuana prices, to name a few, also present challenges. I plan to further expand on the topic of risk in the future so stay tuned.