November 2016

Twenty years ago, California voters were the first to decriminalize the use of medical marijuana. Tuesday, those voters approved Proposition 64, making California the largest single market for “legal” recreational marijuana use in the United States. With certification of that vote by the Secretary of State, the Adult Use of Marijuana Act will become law in California. Nationwide, the passage of Prop 64 and ballot initiatives in other states means that marijuana is now decriminalized at the state level, for either medical or recreational use, for more than one in five Americans. Federal law remains unchanged, however. Marijuana remains a Schedule I controlled substance and possession is punishable as a felony. While the Obama administration opposes legalization, it had been working to ease the tensions between state and federal law. It is unclear at this time, however, whether the incoming Trump administration will take a similar approach.

In addition to allowing California residents over the age of 21 to grow and consume marijuana on a personal basis, Prop 64 appears poised to usher in an era of rapid growth in cannabis-related commerce by creating a state-level regulatory scheme for cultivation, processing, quality assurance, distribution, and retail sales to recreational consumers. For this regulatory framework the initiative piggy-backs, and expands on, medical marijuana legislation passed in late 2015, as well as the framework California uses to regulate the alcoholic beverage market. Small, independent growers would be able to create something similar to the microbrewery and small winery business models, with one business growing, processing, and selling product directly to the consumer. As with alcoholic beverages, however, “tied-house” laws will preclude large-scale vertical integration within the industry. Larger-scale business will be limited in the types of licenses (growing, distributing, retailing) they can hold. The newly-created Bureau of Medical Cannabis Regulation of the California Department of Consumer Affairs will become the Bureau of Cannabis Control. Lori Ajax, a veteran of the California Department of Alcoholic Beverage Control, is Chief of the new Bureau and will head up the state’s efforts to develop the regulatory licensing scheme specified by the initiative.

This is no small market. Perhaps unsurprisingly, there are now market research companies focused on the cannabis industry. They project growth from the current $7 billion industry to a $22 billion industry by 2020. For point of reference, that is about the same size as the “craft” beer market.

At the same time, the regulatory challenges are obviously significant. The state won’t be ready to issue licenses until 2018, although some Legislators are discussing an interim scheme to permit medical marijuana dispensaries to make recreational sales in order to fend off growth of the black market, prompting some for-profit investors to try to gain entry to the medical dispensary businesses. Prop 64 also permits “dual” regulation by local authorities. While voters in the City of Santa Barbara approved a 20% gross-receipts tax in anticipation of recreational marijuana sales, the City, County, and most other local jurisdictions have implemented local licensing and permitting moratoriums on the cultivation and retailing of cannabis. For public safety reasons there are enclosure requirements written into the cultivation provisions of Prop 64, and ag parcels with existing greenhouses are experiencing increased market demand in anticipation that the moratorium will eventually be replaced with appropriate zoning regulations.

Foremost among the regulatory challenges to the cannabis industry is the severely limited access to credit markets and even basic merchant-banking services. Because possession of marijuana remains criminalized under federal law, most banks have elected not to do business with the industry. Banks are of course heavily regulated, and required to monitor and report on transactions stemming from potentially illegal activities. The Obama Administration’s Departments of Justice and Treasury have issued “safe harbor” guidelines but, most financial institutions seem to have concluded that the risks outweigh the rewards. Until there are significant regulatory changes at the federal level, it seems likely that marijuana will remain primarily a cash business.

The dilemma, then, for entrepreneurs and investors considering entering the cannabis market is how to build a business or investment portfolio in the current regulatory environment and prepare for the coming regulatory changes at state and local level while not being so early to market that federal government takes an unhealthy and unprofitable interest. Truly, a goldilocks dilemma.

If you have any questions about the Adult Use of Marijuana Act, structuring cannabis businesses, local land use regulations pertaining to marijuana, or any other element of this month’s advisor, please feel free to contact me or the BFAS attorney with whom you regularly work.


                              Marcus J. Kocmur



            (Direct) 805.966.7715



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