What would a recreational marijuana market in California look like?

Nov. 10, 2016 3:50 PM PT

Cannabis will be taxed more than tobacco, marketed like wine, funded like the riskiest of start-ups and grown under bank-like security.

That’s the emerging vision of what California’s consumer market for marijuana, expected to be worth $6 billion by 2020, is going to look like after voters on Tuesday approved recreational use of cannabis.

Big money won’t be made overnight — it will take at least a year to roll out a state licensing system that will boost investor confidence in California cannabis.

Acreage limits, federal laws that bar banks from participating in the cannabis economy and block interstate movement of the product, and many local political issues are likely to cause big corporations to stand on the sidelines for a while, according to industry experts.

“I think those businesses that put their head in the sand and believe that they can still operate in the gray are in for a rude awakening.”

— Cannabis attorney Lance Rogers, Greenspoon Marder

That gives an advantage to the state’s home-grown medical cannabis industry, which has spent the last six years getting more and more local governments to grant cultivation and dispensary permits, a prerequisite to apply for state licenses.

“I think those entrepreneurs that have a [local] license are going to do well,” said Lance Rogers, a full-time cannabis attorney with Greenspoon Marder law firm. “I think those businesses that put their head in the sand and believe that they can still operate in the gray are in for a rude awakening.”

That gray area would include 130 or so dispensaries in Los Angeles, which currently operate under a laissez faire regime but don’t hold a physical permit — city voters will decide whether to convert that to explicit permission in a March ballot initiative.

Once licensing of every stage from cultivation to sale begins, so will steep taxation — $9.25 per ounce, a 15% excise tax and all local taxes. Many cities and counties that have permitted cultivation will charge upwards of $15 per square foot of plant canopy as well.

That cost, as well as the cost of security measures for the highly valuable crop, will create an additional constituency for tighter crackdowns on the “gray market” operators who can offer a cheaper product, analysts say.

“I do think that you could expect to see more enforcement directed toward people who are not operating in compliance with the state regulatory programs,” said Taylor West, deputy director of the National Cannabis Industry Assn.

Growing conditions are monitored in a commercial, legal marijuana greenhouse in Monterey County in October.

In the short term, the Adult Use of Marijuana Act will favor what many call the “craft beer” model — many small to medium-sized companies offering a broad array of products. Like the medical regulations passed last year, Proposition 64 caps cultivation at about half an acre indoors and an acre outdoors, but it lifts that limit by 2023, according to Calfornia NORML, a cannabis advocacy group.

In theory, this gives the industry time to mature before major corporations might show interest. But it slows plans to create vertically integrated, seedling-to-sale cannabis corporations that can reap economies of scale, said Steve DeAngelo, a pioneer of the state’s cannabis movement and chief executive of Harborside Health Center in Oakland.

“I’m not saying that’s the wrong thing to do; I have some sympathy for small growers and I do think there’s things we need to do to protect them,” DeAngelo said. “But the fact of the matter is to the degree that we are creating a protected niche for small growers who are less efficient, it will be the patients and consumers who will pay higher prices.”

DeAngelo also is executive chairman of FLRish Inc. a company formed last year that aims to be the first fully vertically integrated cannabis company in California. FLRish has created a host of separate limited-liability corporations for different licensing categories, according to public records.

One of those LLCs paid $3.4 million this year for a 47-acre property in the Salinas Valley that has multiple greenhouses — a move that DeAngelo believes will push cannabis in the same league as traditional horticulture.

”You could call it industrial agriculture, corporate agriculture, but you could also call it really efficient scaled-up agriculture,” he said.

DeAngelo said he envisions offering cultivation space to small-scale growers who need to scale up quickly if demand for their product increases.

“I would be a fool to say big tobacco isn’t going to be a big player in this space.”

— David Dinenberg, CEO of Hollywood software firm Kind Financial

By 2023, when acreage limits are lifted, companies such as FLRish could face competition from more mainstream corporate agriculture, including big tobacco or pharmaceuticals, that will cater to consumers looking only for the cheapest product.

“Big tobacco is used to growing plants — it’s a different type of crop, different type of process, but they have the infrastructure to mass produce the product,” said David Dinenberg, CEO of Kind Financial, a Hollywood firm that sells compliance and tracking software. “I would be a fool to say big tobacco isn’t going to be a big player in this space.”

West said cannabis is more likely to mimic the wine industry, with its large companies that control a lot of shelf space, and smaller labels appealing to a more discriminating buyer.

“Plenty of people are happy with a $7-$10 bottle of wine, when they know what they’re getting,” said West. “But I also think you’re going to have parts of the industry that develop to really cater to those with more sophisticated tastes … or who have demands that go beyond price and availability.”

The state’s plan to use bar coding in a “seed-to-sale” tracking system lends itself to offering consumers a reliable brand and a marketing narrative behind their purchase, such as organic, outdoor-grown, pesticide-free and other distinctions.

And just as you can buy wines produced by Francis Ford Coppola or Lorraine Bracco, cannabis users can buy Willie’s Reserve, Marley Natural and Leafs By Snoop.

New consumers bewildered by the vast array of weed varieties and products are likely to expect the sommelier or coffee barista model, in which highly knowledgeable retail staff can guide their choice, West said.

Formidable obstacles, however, will keep cannabis from being “just like” any other industry. Paramount among them is financing and interstate commerce. Both are fettered by the fact that marijuana remains a Schedule One controlled substance under federal law. No federally regulated bank can finance it or touch its proceeds.

At least a score of venture capital firms have sprung up to fill the void, though their funding is small compared with other sectors of the start-up economy.

“I see a lot of deals, but I can’t do most of the deals I want to do,” said Adam Bierman, CEO of MedMen, a cannabis-focused investment and management firm in Culver City. “If there isn’t certainty, I can’t place those dollars.”

Tuatara Capital, the largest private equity fund in cannabis, has said it won’t touch cultivation in California, largely because it has doubts about the certainties of its regulations.

Privateer Holdings, whose investments include the Marley Natural brand run by the children of the famed Reggae singer, leads the field in raising capital for cannabis. It reported raising $75 million last year, from a fund run by PayPal co-founder Peter Thiel.

CalCann Holdings, a Santa Ana consulting and real estate financing company, has raised $20 million in connection with projects in Santa Ana, Lynwood, Desert Hot Springs, La Mesa and other locations, said Aaron Herzberg, the firm’s partner and general counsel.

“Any reasonable project that has a good chance of success, we’ve been able to attract the capital,” Herzberg said. “We have multiple people vying on the same project.”

Investors are savvy and ask tough questions — the first of which is, “What’s your strategy for getting a license?” Rogers said.

“Are there real opportunities? Yes. Do people need to do their due diligence, just like any other investments? Absolutely,” Rogers said. “There are a lot of snake-oil salesmen out there.”

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Times staff writer James Rufus Koren contributed to this report.