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The Great Cannabis Crash of 2019

California is famous for its cyclical booms and busts: housing, dotcoms, gold mining. Guess which industry is next.



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To replace Eaze, DionyMed launched its own platform, Chill, to handle cannabis deliveries in the Bay Area. But just months after that operation was launched, DionyMed announced that it was in receivership and that its CEO, Edward Fields, had left the company. All operations were ceased last Monday, and the last workers laid off. It was a spectacular flameout reminiscent of some of the insane business failures of the dotcom era. (You can learn more about this in next week's issue of the East Bay Express).

At the same time, it's not like the entire cannabis industry is imploding. But parts of it are, and the industry as a whole is falling far short of what the forecasts told us. But those forecasts were made by legalization advocates and politicians intent on selling skeptics on legalization and the tax bonanza it supposedly would yield. Legalization proponents insisted that pot would put $1 billion a year into state coffers, starting in Year One. That number turned out to be just $288 million for the first fiscal year. For the second fiscal year, which we are still in, the estimated tax take will be just $359 million. Meanwhile, there are only about 800 dispensaries operating in the state, a far cry from the predicted 6,000.

But whatever the proximate reason for the cutbacks, the underlying causes are the same for the whole industry: taxes, regulation, overinvestment, lack of access to markets, and bad decision-making. Most of the industry's problems are traceable to government action or inaction.

There are two major problems: First a state excise tax of 15 percent, which is added to regular sales taxes and often-high local cannabis taxes. On top of that is the tax that pot growers pay at harvest time. In some cities, consumers are paying effective tax rate of more than 40 percent on pot that's already more expensive than what they can get from their local, law-breaking weed dealer — who has not gone away.

Second, and probably worse for the industry, most local governments remain hesitant to allow legal operators to set up shop. Nearly four-fifths of California jurisdictions have yet to issue a single license, leaving residents who want to abide by the law to either grow their own pot or, if delivery is even available to them, have it brought to their door. There are efforts afoot in the legislature to address both of these problems — to get taxes lowered and, perhaps, to force local governments to allow cannabis in. But the prospects for both efforts are uncertain at best, and it seems likely that the Legislature will seriously consider lowering the tax burden this year.

"The law is deeply flawed," said Debby Goldsberry, executive director of Magnolia Wellness in Oakland and a longtime presence in the Bay Area cannabis industry. Because of this, she said, many of California's small cannabis businesses have been closed or sold off to bigger companies. "And many people have chosen to operate in the underground marketplace, which has been thriving for 100 years in California, rather than to get involved in the complicated, near-impossible-to meet regulatory scheme."

It is now widely agreed by industry observers that Proposition 64, through which voters legalized recreational pot in 2016, was deeply flawed. "Hindsight is a great place to live," said Scott Hammon, cannabis practice leader for MGO|Ello, which provides accounting and advisory services to pot companies.

Not every flaw, though, can be pinned on any particular group of people — not even politicians. "The initiative contained compromise language right from the beginning," Goldsberry said. "It was designed to assuage the concerns of nervous voters and to make sure that big businesses, like the alcohol industry, did not get upset enough to fight it. Some of these compromises lacked common sense, surely, but more so, there were few models to follow at the time, and the designers of the original laws and regulations knew they would need to stay flexible over a number of years to create rules that would really work."

Unfortunately, Goldsberry continued, "the unseen side effect was that the underground market would continue to flourish and that the regulatory complications, and the fees and the taxes, would set the bar higher than most people, other than the biggest and most experienced companies. Lots of California small businesses are gone because of this."

Meanwhile, the continued illegality of cannabis at the federal level not only means that agents could swoop in and shut down a cannabis operator at any moment — highly unlikely now, but that could quickly change — but that it's still hard for the industry to do business. Pot companies don't have ready access to banking services, because banks would be running afoul of federal law by providing deposit services or making loans to pot companies. And of course, interstate commerce is a total no-go; any manufacturing company that wants to sell in another state is forced to "white label" its goods — that is, have their gummies or vape cartidges manufactured by someone else, and then slap their own brands on them. If California pot companies could ship products to Nevada or Massachusetts, it would make up in a big way for the fact that so many California jurisdictions won't let them sell here.


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