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Michelle Mabugat and Alexa Steinberg Discuss the Business of Cannabis in L.A. Times B2B Publishing

Cannabis attorneys Michelle Mabugat and Alexa Steinberg share insights regarding the latest developments within the business of cannabis.

Q: Are cannabis sales still climbing?

Michelle Mabugat, Counsel, Greenberg Glusker LLP: No. Legal sales in California are on a declining trend, hitting their lowest quarterly point since the start of the COVID-19 pandemic. The state is currently on track to hit $5 billion in sales this year, which would be a 7% drop from 2022. If projections hold true, it would be the second consecutive annual decline since recreational use was legalized in 2016, a first for this market. This decline coincides with a surge in illicit market sales and is attributed to high taxes, a lack of retail access across the state, and a years-long credit crisis with the industry. But even with this downturn, California’s cannabis sales numbers still comprise nearly 20% of the country’s $26 billion industry and even exceed the entire GDP of some small countries.

Q: How can a consumer determine which businesses are licensed?

Alexa Steinberg, Counsel, Greenberg Glusker LLP: Both the state and local jurisdictions have safeguards in place to ensure consumers are aware of which businesses are licensed and which are not. At the simplest of levels, licensees are required to display their state and local licenses. Los Angeles, for example, has taken this one step further with the implementation of their new emblem program aimed at discouraging the operation of unregulated cannabis retailers. Just as food operators are required to display a health rating, the program requires licensed cannabis retailers to display a unique emblem so that it is highly visible to the public from the exterior of the store.

Q: How does the cannabis business in California differ from other states where it is also legal?

Mabugat: First, California’s market size and consumer base are unrivaled due to the state’s large population and robust tourism industry. Second, its regulatory framework is more sophisticated and mature than most as it was one of the first states to legalize recreational use in 2016. Third, California has a unique challenge with its extensive illicit market – a result of high tax rates and regulatory costs – which many other states do not face to the same extent. Furthermore, local control in California allows municipalities to either implement their own local regulations or opt out entirely from allowing cannabis businesses, which creates a patchwork of varying laws and accessibility. As a result of these operational hurdles, many large, public companies have chosen to avoid the California market, preferring instead to invest in states with more streamlined regulations, lower taxes and lesser competition from illicit markets.

Q: Can a business owner open a business now and get a license later?

Steinberg: The simplest answer is no. Cannabis is arguably one of the most regulated industries in California. With a two-tiered licensing system, operators are required to have a license from both the state and their local jurisdiction before opening their doors for business. This goes for any type of cannabis operation – whether cultivation, testing, retail or anything in between. For most applicants, the road to obtaining a license, however, is fraught with challenges. For example, in most jurisdictions, Los Angeles included, applicants are often required to secure a location for their cannabis business as the first step in the application process. The issue with that? It puts the cart before the horse. The application process is not necessarily known for its smooth or expeditious nature, in fact, it’s the exact opposite. This leaves applicants in limbo for prolonged periods, enduring months, and, at times, over a year of rent payments for a dormant space until both their state and local license applications are approved.

Q: How would you rate the status of raising capital for cannabis businesses today?

Mabugat: It’s slim pickings out there. Money is too expensive and capital raises continue to decline this year. This follows last year’s significant decline in capital raises across all cannabis sectors, a reversal from 2021’s boom driven by sales growth, lower interest rates and hopes for federal reform. Although capital markets may have dried up, the flip side is that strategic buyers can acquire distressed, undervalued assets at rock-bottom pricing to pick up market share. This presents growth opportunities for companies that can weather this year’s tough economic conditions for the cannabis industry.

Q: Can individuals legally grow cannabis in their homes in California?

Steinberg: State law allows for an individual, 21 years of age or older, to grow up to six cannabis plants at home. A license is not required for this type of cultivation. However, the cannabis must be purposed for individual use only and not for commercial use or sale. Commercial cannabis purposed for sale can only be grown after acquiring the appropriate state and local licensing, and only at a commercial location. Each city governs where cannabis can be grown. For example, in Los Angeles, cannabis can only be grown indoors, in buildings that are zoned for manufacturing, only so long as the building is 600 feet from a defined sensitive use, like a school.

Q: What tax considerations should a new cannabis business consider?

Mabugat: The tax regime for cannabis is not business-friendly. Section 280E of the Internal Revenue Code prevents cannabis businesses from deducting normal business expenses from their income, which results in higher effective tax rates. State and local tax rates are also significant. Failure to timely pay taxes can lead to hefty penalties (up to 50%), license revocation, raids by taxing authorities and even personal liability for business owners. Cannabis companies may want to explore Qualified Small Business Stock (QSBS) treatment – a unique, but often overlooked, tax savings opportunity which certain cannabis businesses may qualify for. If eligible for QSBS treatment, investors could save millions in capital gains upon an exit. But QSBS is complex and requires proper structuring and careful planning from the onset to ensure eligibility.

Q: What advice would you offer California-based cannabis companies that want to expand to other states in 2023?

Steinberg: Expanding across state lines is not so simple for a cannabis company. Selling or transporting cannabis across state lines (even when going from one state where cannabis is legal to another i.e. from California to Nevada) implicates interstate commerce, which is regulated by the federal government, where cannabis remains illegal. With that in mind, cannabis companies need an entirely independent supply chain (local cultivators, manufacturers and distributors) in each state in which it plans to operate. The best piece of advice for an MSO (multi-state operator) is to get local counsel in each state and jurisdiction in which your business operates. Each state and city/county regulates its cannabis industry under different policies. Retaining counsel familiar with the unique regulations governing your business in each state and city/county makes a world of difference.

The “Conversations with the Experts” feature was originally produced and published by the L.A. Times B2B Publishing Team. The full feature can be accessed here.