Thinking About Going Into the Cannabis Business? Sell Shovels Instead
I have worked in the legal cannabis industry in Oregon for the past 2 years. While I am not a cannabis consumer at this stage of my life, as long as a business is legal, I am willing to help that business succeed.
The cannabis industry has a lot of handicaps. In Oregon, though legal to sell for both medical and recreational purposes there are still very significant state regulations imposed on the industry. Yes, I believe those regulations are necessary but the state’s “learn as we go” approach to regulating the sale of this drug makes compliance with each new regulatory change financially difficult for the legitimate business. Here’s the paradox: Without the resources to strictly enforce the regulations, each new restriction, fee, tax or other constraint placed on the legal business makes it easier for the black market dealers to prosper. Take away the constraints and regulations and you will see some very nasty products enter the market.
State regulation and a strong black market make operating a legal business difficult. Many legal businesses maintain ties with the black market. That certainly wasn’t a goal of the voters when they approved legalized cannabis.
Add the Federal regulations to this mix and you’ve got a real mess. Because Federal law classifies marijuana as a Schedule 1 drug, banks are fearful of dealing with legal cannabis businesses for fear of being prosecuted. That means that most cannabis businesses are operating as all cash operations. Meaning they do everything with cash. They get paid by their customers with cash. They pay all their bills, including payroll with cash. No big deal you say? Try operating a $10 million business using only cash. That’s tough.
But you say, $10 million is a lot of money. Why feel sorry for them? Well, add 280E to this stew. IRS code 280E says this: If you are selling a Schedule 1 drug, the only deduction you can take is Cost of Goods Sold. That means a pot business can NOT deduct rent, power, phone, advertising—not even payroll. (Note: There are ways to squeeze some deductions on a Schedule C but not much) If your business lost all of its deductions except COGS, would it survive? And if you couldn’t put money in a bank?
In time, these severe constraints will be resolved. I take no strong position on that at this moment. My job is to help legal businesses.
That said, there is one more thing to consider.
Many of the people that have taken the plunge into the cannabis industry lack business experience. Because having piles of cash can easily make it feel like your business is doing very well, you may discover that you owe hundreds of thousands of dollars at the end of the year. Most cannabis businesses are poorly run and headed for financial disaster.
Need more bad news about this industry?
If a cannabis business fails, it cannot file for bankruptcy protection. If the business goes under, the owner could be ruined for life. Why? Bankruptcy is a matter for Federal Court—and Federal Law prohibits the sale of cannabis. You can’t get bankruptcy protection for a business that the government classifies as illegal.
I offer advice to 2 different people who may read this.
If you think it is an automatic win if you get in on the ground floor of a cannabis business, think again. The chance of ever seeing a return on your investment is very slim. The industry is somewhat delusional. They always paint a rosy picture. The businesses that will succeed must operate under very strict internal discipline. Be smart. You can tell by looking at a business whether it is truly successful or “fly-by-night”.
Get someone who understands the industry to analyze the business for you! Be VERY careful about investing in the cannabis industry.
If you are in the cannabis industry, I plead with you to get a business specialist on retainer immediately if you cannot afford to hire a full-time professional. No kidding around. It takes an expert to get a business into profitability. Very few businesses will make it and failure is heartbreaking.
During California’s gold rush of 1849, it was the folks who sold shovels that made the most money. Keep that in mind as California is about to open the largest cannabis market in the country.