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How to Successfully Launch a Legal Cannabis Business

By
Adam C. Uzialko
, Last Modified
May 31, 2019
Home
> Business Basics

The cannabis industry is newly legal, and as the industry shifts from the black market into the mainstream, it has experienced unprecedented growth.

Building an industry from the ground up takes a lot of hands; the cannabis industry has attracted entrepreneurs of all stripes, from cultivators to distributors to tech experts, all of whom want a piece of the multibillion-dollar pie. While the industry has already experienced rapid growth, projections suggest it is still in its early stages. With seemingly nowhere to go but up, you might be considering launching a marijuana business of your own.

The cannabis industry is a complicated space, due to both its youth and the legal circumstances surrounding it. This cannabis industry startup guide will provide a bird's-eye view of some things you should know about the marijuana business before launching a company of your own. Whether you're planning on opening a dispensary, obtaining a cultivation license or running an ancillary business, knowing the basics of the industry is essential to building a successful legal marijuana business. 

The birth of an industry

Medical marijuana is legal in 33 states plus Washington, D.C., while adult-use cannabis (sometimes called "recreational marijuana") is legal in 10 states plus D.C. An additional 15 states have decriminalized cannabis, reducing possession under certain amounts to a civil charge rather than a criminal one. The rash of legalizations began with California's passage of medicinal cannabis measure Proposition 215 in 1996 and culminated in Colorado and Washington's legalization of recreational cannabis in 2012. Since then, more states have followed suit. In just 20 years, what was previously a black-market product has become the cash crop of a new industry.

However, as the cannabis industry rises to prominence – multiple estimates place anticipated growth eclipsing the $20 billion mark by the early 2020s – the federal government maintains cannabis as a Schedule 1 controlled substance. That means cannabis is considered an illegal substance with no accepted medical use and a high potential for abuse.

Despite the federal prohibition, the cannabis industry grew and thrived largely on the back of the Department of Justice's 2013 missive known as the Cole Memorandum, which stated the feds would not interfere with cannabis operations that abide by their state's legal framework. The Cole Memorandum was rescinded by former U.S. Attorney General Jeff Sessions in 2018, but the industry remains protected by a hands-off culture among prosecutors, as well as a congressional measure known as the Rohrabacher-Blumenauer amendment that protects the medical cannabis industry. Rohrabacher-Blumenauer essentially states that no federal dollars will be appropriated for enforcement actions against state-compliant medical cannabis businesses. Unfortunately, even with these protections, the federal prohibition continues to create obstacles for legal cannabis businesses in other ways.  

Even with this albatross around its neck, the legal cannabis industry is a burgeoning one. According to industry analysts New Frontier Data, the U.S. cannabis industry was worth $10.4 billion in 2018. That value is projected to grow rapidly through 2025 to $26.3 billion. Already, the cannabis industry has directly created nearly 300,000 jobs, not counting those indirectly created by support businesses like marketing companies or professional advisors.

A variety of business

With big numbers like $10.4 billion in value, you might be thinking the window of opportunity has mostly closed, but industry insiders told business.com that it's still early in the game. Stuart Titus, Ph.D., president and CEO of industrial hemp company Medical Marijuana Inc., said startups of all stripes still have ample opportunity to launch, grow and succeed in the cannabis space.

"The whole industry itself is at the very ground-floor level," Titus said in an interview at the Cannabis World Congress & Business Exposition. "We're certainly nowhere near maximizing what we could do. Look at alcohol prohibition. Suddenly, legalization spurred industries and businesses … We think the same is true for this industry."

Cannabis businesses come in all shapes and sizes. Most people think of massive cultivation operations or dispensaries with jars full of shimmering emerald buds. Those are certainly key elements of the industry; however, many cannabis entrepreneurs never even touch the plant itself. These include logistical support businesses, like distribution and transportation companies, or technology companies, such as dispensary software development or high-tech infrastructure for grow houses.

Science is also a huge driver of the cannabis industry, as it is in other agricultural endeavors. Labs are needed for testing the potency and genetics of cannabis flowers, extractors are required for harvesting oils, and ongoing research provides insights into the specifics of cannabis for medical treatment. Glass blowers, vape purveyors and edibles creators are also in high demand. [Want to find out more about where the opportunities lay? Check out the tips from these industry insiders.]

"I believe there is plenty of opportunity," Titus said. "It's the very, very early stage [for] everything from medicinal to recreational, support industries and infused products. Creative minds, unique products and delivery methods will just continue to move along as time goes, and I think there's ample opportunity for people to make a significant business opportunity in this incredible industry."

Regulatory landscape

The state of the industry remains very much in flux. Beyond the federal prohibition, or perhaps because of it, varying state frameworks have led to a fragmented industry that looks very different based on geography. Everything from licensing to reporting can be vastly different between states, making it difficult for a company to expand. Experience gained in Colorado, for example, does not necessarily translate to the New York market.

"Since we're not a federally recognized industry, there are many things that are affected," said Sara Gullickson, CEO of DispensaryPermits.com, a consulting service for marijuana entrepreneurs. "In terms of regulations, every single state program varies. They're crafting programs specifically for their environment. So, things that are important in Arkansas might not be as important in Ohio, and so we're seeing that kind of flesh out."

As knowledge of the industry improves, newer markets are including mandates that don't exist in older markets. For example, Gullickson said, Arizona's legal cannabis program includes no mention of testing, while newer markets mandate testing to ensure that cannabis is a safe, quality medical product for patients to use before it hits the market.

The lack of federal policy has created a sort of experimental period, where states are borrowing what works from one another and trying to scrap what doesn't, Gullickson said. While the federal prohibition creates a lot of confusion and many problems, this trial-and-error period has been a good thing for the industry's evolution in her estimation.

"I'm a little bit more optimistic than most," Gullickson said. "I almost think if the feds stepped in and pushed something down everybody's throat, there'd be a lot of resistance. How could the feds come up with something that's uniform, implemented across the U.S., that works in every state? It's something that's necessary but also scary, because we do know what we're doing in different states and there are some really good programs. We don't want something to come into play that diminishes what good we're already doing."

Taxation

Since cannabis remains federally illegal, cannabis companies face different taxation challenges from other industries. Most notorious of these challenges is the Internal Revenue Service's Section 280E, which does not allow cannabis companies to deduct ordinary business expenses from their tax bills.

Section 280E was born of a 1981 court case in which a convicted drug dealer successfully wrote off his business expenses related to his illicit activities. Shortly after, Congress enacted Section 280E to avoid a repeat incident. Section 280E stipulates that any expenses related to the "trafficking of controlled substances" shall not be eligible for deductions or credits. Since cannabis remains a controlled substance under federal law, state-compliant legal cannabis businesses are subject to this tax rule.

The result is that cannabis businesses pay a larger amount in taxes than they would if they sold a federally legal product. Cannabis companies must pay taxes based on their gross income, rather than their income minus cost of goods sold. The result is an average effective tax rate of 55% on cannabis businesses, compared with an average effective rate of 30% on similarly situated non-cannabis companies.

Beyond the federal tax code, cannabis companies must abide by various state tax plans. Some states charge excise taxes on top of their normal tax structure, such as Washington, where cannabis companies owe an excise tax of 37% on all sales. Your tax obligations as a cannabis business owner are significant and sometimes complex, so be sure to familiarize yourself with both federal and state tax policies.

Licensing and permitting

For businesses that touch the plant, licensing and permitting is essential. The process varies by state and can be rather arduous. In addition to outlining policies and procedures, applicants must provide an overview of who comprises their organization and to prove that what they say is true. According to Gullickson, balancing a level of detail in applications of limited length has become a skill set of its own in the consulting industry.

"About three or four years ago, when you were sending applications, everyone threw in the kitchen sink – thousands and thousands of pages to confuse people and hope they wouldn't read it," she said. "Now, the application process is often to describe in five pages what your operation looks like. You need someone to communicate to an uneducated audience what your policies and procedures look like. We had to sharpen our skill set to be as granular as possible in limited characters."

Ultimately, cultivators and dispensaries looking to score a license should be prepared to spend between $150,000 and $200,000 navigating the process, Gullickson said. For larger companies aiming for a sort of "super license," costs balloon from $500,000 to $750,000.

Banking and finance

Another problem caused by the federal prohibition centers on banking. Many banks are hesitant to do business with cannabis-related companies, while others refuse outright. Working with cannabis businesses is a risk for banks: On one hand, it opens the bank up to additional oversight and liability; on the other, there is a palpable fear that a federal crackdown could result in seized assets and a business catastrophe.

The lack of conventional banking options has led cannabis entrepreneurs, especially those who touch the plant, to work primarily in cash. Not only is that dangerous – cannabis entrepreneurs are regularly targeted for robberies – but tracking cash payments for tax and regulatory purposes is incredibly difficult.

"It's crippling right now," said Keegan Peterson, CEO of payroll and HR company Wurk. "You don't realize how important banking is until you don't have it – just giving employees a paycheck is just brutal. In a cash environment, it's difficult to even prove you paid [your employees], or your vendors, or your tax liability."

Moreover, cannabis businesses are often unable to open a traditional line of credit, limiting a common early-stage option for additional growth financing. That means bootstrapping or raising money from friends, families and angel investors is the most common way young companies gain a foothold.

Luckily, the industry has developed some workarounds in the meantime. Angel investors willing to take the risk provide a lot of startup and growth capital, and several startup accelerators and incubators have burst onto the scene to help their cohorts get to the next level.

Venture capital firms tend to play it closer to the vest but are also intently watching the industry and making some preliminary investments. Still, the industry is holding its collective breath in hopes that the federal prohibition will soon be lifted, opening access to traditional banking and improving cannabis's already immense growth prospects.

David Goldstein, CEO and co-founder of medical cannabis software company PotBotics, told business.com it's important for a startup to allocate resources effectively, whether conventional banking becomes available soon or not. He also advised newcomers to bring in people with professional expertise elsewhere who can apply their knowledge to the cannabis industry.

"What we see is that it's been tough to get institutional investment," he said. "Wealthy individuals that are passionate either because they went through chemo and cannabis helped or because they see the growth potential – those are the two types of investors we see. I think institutional money is coming … but it's important for a startup to run lean but at same time bring in people who maybe worked in other industries … so they can add their expertise to bring this out of [the] black market into white collar."

Frequently asked questions about starting a cannabis business

Looking for information not provided in the above cannabis industry startup guide? These FAQs might help you get started on the path to opening your own cannabis business, whether it's plant-touching or ancillary.

What is an ancillary cannabis business?

The term "ancillary cannabis business" refers to a company that provides needed services in the cannabis industry without actually touching the plant. These can be marketing agencies, professional advisors, payment processors, security companies and more. Ancillary businesses tend to provide B2B services to other cannabis companies.

Ancillary businesses tend to avoid the onerous licensing and permitting requirements of plant-touching businesses. Many entrepreneurs entering the cannabis industry are pivoting their existing skill set or business and adapting it to the industry to provide necessary services.

How much does it cost to open a dispensary?

The cost of opening a cannabis dispensary depends on many factors, including your location, the size of your dispensary, and your state's application and licensing process. In some cases, opening a cannabis dispensary could be a multimillion-dollar process, while in others it could cost a few hundred thousand. The bottom line is that opening a cannabis dispensary isn't cheap. Moreover, it is a detailed and complicated process that requires meticulous planning.

If you're considering opening a dispensary, it is important to line up the right partners, obtain funding and familiarize yourself with your state's application process. Every state will look for slightly different things, so it's important to optimize your plan based on what the state is looking for in an applicant.

How much does it cost to start a cannabis grow house?

Similar to opening a dispensary, launching a cannabis cultivation operation is no cheap endeavor. Estimates for the total initial investment for a 7,700-square-foot facility with 1,000 plants suggest it could cost more than $800,000, and certainly many cultivation operations become multimillion-dollar investments. Also similar to opening a dispensary is navigating the licensing process; it's important to understand what your state is looking for in an applicant and then building your team and business plan to suit those needs.

Where do you obtain a cannabis cultivation license?

To obtain a cannabis cultivation license, you will have to go through the regulatory body in your state. Typically, this is some kind of marijuana control board, but the exact process varies from state to state. Some states require your operation be vertically integrated, for example, meaning that you cultivate and sell your cannabis products from start to finish. Other states separate cultivation and dispensary licenses, meaning your company can only do one or the other.

What other permits does your marijuana business need?

Depending on where your business falls in the cannabis supply chain, you could require some other permits or licenses as well. In addition to cultivation and retail licenses for grows and dispensaries, there are processor licenses for value-added companies like extractors or edibles businesses, research licenses, and transportation licenses. Before launching your business, be sure to familiarize yourself with all the requirements of your state's law and to obtain all necessary licensing and permits before beginning operations.

How can I guarantee my cannabis business will be licensed?

There is no guarantee your cannabis business will be licensed but following your state's guidelines to the best of your ability will increase your chances. A strong team and good business plan are a must, backed up by realistic financials and a source of funding that makes your project credible. Some states prioritize social justice and diversity, giving a boost to teams led by minorities and veterans. Identifying the specific priorities of your state's regulators and tailoring your company and plan to suit them greatly increases your chance of getting a license; however, obtaining a license is never a guarantee.

How can entrepreneurs learn the cannabis laws?

Besides conducting your own research, it is critical to engage an experienced attorney when starting a cannabis business. Ideally, you will want to develop a relationship with an attorney who helps educate you on the applicable laws. Entering the cannabis industry without legal counsel is especially risky given the ever-changing laws from state to state and the uncertain future of federal policy.

How do you start a cannabis transport or logistics business?

To launch a transport or logistics business for the distribution of cannabis and cannabis products, you will likely require a transportation license. In some states, direct-to-consumer cannabis delivery is legal, while in other states it is not. Regardless, every legal cannabis company will need transportation for moving harvested product to processing facilities and dispensaries. Again, every state has its own specific rules and regulations regarding cannabis transport, so do your homework and follow all available guidelines.

What types of financing are available for cannabis businesses?

Traditional loans are rare in the cannabis industry, because the FDIC will not back any bank that lends money to a business that breaks federal law, which all state-compliant legal cannabis companies currently do. While conventional loans can be nearly impossible to come by for cannabis businesses, funding sources are available. In addition to angel investors and venture capitalists, cannabis-specific funding companies have launched to fill the gap left by banks too hesitant to provide loans to young cannabis companies. Many ancillary cannabis companies are also bootstrapped, started from the owners' own savings or personal financing options.

Some source interviews were conducted for a previous version of this article.

Adam C. Uzialko
Adam C. Uzialko
Adam C. Uzialko, a New Jersey native, graduated from Rutgers University in 2014 with a degree in political science and journalism and media studies. He reviews healthcare information technology, call centers, document management software and employee monitoring software. In addition to his full-time position at Business News Daily and Business.com, Adam freelances for several outlets. An indispensable ally of the feline race, Adam is owned by four lovely cats.
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