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Growing Pains Part 2: Back to the Underground

Instead of welcoming the cannabis industry into the light, Oakland's new rules are putting many out of business, while others are disappearing into the illicit market.

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Brian Edwards stashed his company's equipment inside a storage facility until he can find a new location from which to operate. - PHOTO BY LANCE YAMAMOTO
  • Photo by Lance Yamamoto
  • Brian Edwards stashed his company's equipment inside a storage facility until he can find a new location from which to operate.


Ask the people who grow, manufacture, and sell cannabis about the end of prohibition and you'll hear two stories. One is that legalization is ushering a multibillion-dollar industry into the light. Opportunities are boundless and green-friendly cities like Oakland are going to benefit enormously. There will be thousands of new jobs, millions in new tax revenue, and a drop in crime and incarceration.

But increasingly you'll hear another story. The state of California and the city of Oakland blew it. The new state and city cannabis regulations are too complicated, permits are too difficult and time consuming to obtain, taxes are too high, and commercial real estate is scarce and expensive. As a result, many longtime cannabis entrepreneurs are either giving up or they're burrowing back into the underground economy, out of the taxman's reach, and unfortunately, further away from the social benefits legal pot was supposed to deliver.

Both stories happen to be true.

Legalization is playing out as a drama of contradictions, opportunities, and ironies for the people who built the cannabis economy up from what was once a purely outlaw culture to today's fully state-sanctioned, unabashedly capitalist green rush.

The new legal market is producing winners and losers by the bushel. Big investors are positioning themselves to dominate cannabis operations, from seed to sale. Simultaneously, in places like Oakland, lots of small, minority-owned businesses are getting an unprecedented chance to enter the legal market thanks to the city's equity program. But at the same time, many of the cannabis industry's existing businesses, especially small- and medium-size operators, are being squeezed out of the game because they lack the capital necessary to play by the new rules, or they don't qualify for subsidies meant to help the little guy and victims of the War on Drugs.

Consumers are fleeing the new legal market, too. Recent price spikes due to layered taxes and strict regulations are driving buyers away from permitted dispensaries and delivery services. Instead, people are purchasing pot directly from growers and dealers who are operating subrosa and happily profitable.

And Oakland's Measure Z cannabis clubs and collectives, many of which opened more than a decade ago and now operate in a legal gray area without official city or state permits, are continuing to flourish.

Finally, what's most contradictory and upsetting about the new legal era is that cops are still arresting some people for smoking and selling weed. Mainly, it's Black men getting busted for possessing and selling small amounts.

It turns out that legalization is producing all these contradictory outcomes at once. But some fear that legalization's successes so far could soon be overshadowed by bigger problems. Some industry insiders predict that unless regulators act quickly to streamline permitting and reduce taxes, there will be a crash.

Lots of companies — like edibles and topical makers, delivery services, and small growers — will be shut down or bankrupted. Prices will spike. More consumers will turn to the black market for goods. Cities and the state will crack down harder on these unlicensed pot dealers, and legalization will fail to deliver on what it promised.



What happened
to Brian Edwards is a case study in how legalization has affected small cannabis business owners. The 25-year-old New Jersey native moved to California partly to escape the East Coast's draconian drug laws, but mainly, he migrated west to take part in the new weed economy. Five years ago, he started what would become HigherVeda, an Oakland company that makes infused cannabis oil snacks out of raw, vegan, and gluten-free ingredients.

"We made them in our kitchen, packaged them in the house, and drove them over to the dispensary," said Edwards.

Patients loved the stuff. By 2015, HigherVeda's bars were in 30 different retail shops across the state, and the company was growing. Edwards was intent on expanding and hiring employees. And HigherVeda was already paying taxes to the city.

"We had a city of Oakland business permit," said Edwards, who estimates that he probably paid as much as $25,000 in taxes over several years. "Our intention was to be as regulated as possible."

2016 was their best year ever. They jumped from $80,000 in sales the prior year to about $200,000. Edwards was focused on complying with the recently passed Medical Cannabis Regulation and Safety Act, which marked the state's entrance into regulating medicinal marijuana. On the horizon was Proposition 64, the Adult Use of Marijuana Act. Although he was worried about the complex regulations the state would impose with this sweeping law, Edwards also viewed it as providing the certainty that the industry needed for long-term growth.

Voters passed Prop. 64 in November 2016, ushering in new rules that went into effect Jan. 1. Key among them is dual-licensing. Marijuana businesses must obtain both state and city permits in order to operate.

Oakland officials used their authority under the dual-licensing system to put in place an equity program intended to prevent the city's cannabis market from being overrun by big, out-of-town companies to the exclusion of locals harmed by the drug war, especially Black people who reside in heavily policed parts of the city. To accomplish this, Oakland only hands out one general permit for every one equity permit it issues. To qualify for an equity permit, someone has to have lived for 10 of the past 20 years in a police beat area that experienced a disproportionately higher number of cannabis arrests, or prove they're an Oakland a resident whose income is less than 80 percent of the city's median average, or show they've been convicted of a cannabis crime.

If someone doesn't qualify for an equity permit, the only way to jump ahead in the process is to "incubate" an equity business by providing them with space to operate.

Depending on who you ask, Oakland's equity program is either a game-changing social justice intervention or a business-killing injustice that's punishing mostly smaller operators. What's irrefutable about the program is that it's been highly divisive and fomented jealousy and frustration within Oakland's cannabis scene.

Edwards sees it as both essentially good and fundamentally fucked up. "This is the problem," said Edwards about the city's system. "They didn't try to find a way to legalize the existing industry. Instead, they imposed regulations on it that we could never comply with."

Under the equity program, Edwards' chance of getting a city permit to operate has been reduced to almost zero because he doesn't qualify as an "equity applicant" and he's too small to incubate equity applicants. His own business doesn't even need 1,000 square feet of space and his profit margin is too thin to afford the going rate for 1,000 extra square feet of real estate in Oakland's green zone — the areas concentrated in East and West Oakland's industrial flatlands along I-880.

He questions why there weren't other measures included in the equity program with which smaller companies like his could reasonably comply.

"My idea was to add a consultant level to the incubation process" that would allow business owners to help other entrepreneurs with financial management, product innovation, and regulatory compliance, said Edwards. His idea never went anywhere with policymakers.

In December, the city sent Edwards a cease-and-desist letter accusing him of operating an unpermitted cannabis manufacturing business at a small commercial space he'd recently leased. Edwards insists that he wasn't operating his business there yet. His equipment was boxed up, and over the previous six months, he'd sold all of his inventory to dispensaries because he knew he was going to be delayed getting permits. He would need the income to survive until the permitting situation got sorted out.

Today, Edwards is living off the cash flow of that dwindling inventory that can still be legally sold in dispensaries, but he can't sell them new product until he's permitted and has a space. Money is tight and time is running out. He says he's going to have to leave Oakland.



Gina Golden
is another small cannabis manufacturer who is struggling to navigate the state and local regulatory maze. "They actually put a lot of people out of business, and dispensaries are having trouble keeping products on the shelves," she said about city and state regulators in a recent interview.

In 1996, when she was a college student, Golden collected signatures to put Proposition 215 on the ballot. Later, she grew her company, Golden Goddess Botanicals, which focuses on therapeutic tinctures, butters, balms, and edibles. She's been in operation for 10 years, thriving, but the new costs of legalization and permitting hurdles are threatening to extinguish her business. "I'm in a really vulnerable position," she said.

One of her bigger problems is finding space. Golden takes issue with how Oakland and the state have classified cannabis food and topical activities. Companies that make THC-infused honey and chocolate, for example, can't lease a kitchen in a commercial zone. They're required to locate in industrial areas near auto shops, plating factories, and other heavy industry, places where small affordable spaces are harder to find.

Golden said she supports the equity program but says it has had unintended consequences and wishes city councilmembers would reform it. "They're trying to undo the damage that's been done by the War on Drugs and create regulations that serve the community," she said, "But honestly, it's really shutting out a lot of people like myself."

One strategy Golden is pursuing to stay afloat is expanding her line of non-psychoactive CBD-only products that she might be able to sell as holistic therapeutics that aren't regulated by state and local cannabis authorities.

Another business owner who has run a cannabis delivery service for several years said things are so bad in Oakland that he's looking to make a full exit. He asked not to be identified because he's currently in talks to sell his firm.

"Seeing [Prop. 64] pass at the state level was definitely good," he said. "There was a whole campaign about bringing people out of the shadows and into the light."

But he said that high taxes, difficulty getting state and local permits, and the prohibitive costs of participating in Oakland's equity program as an incubator for small- and medium-size companies mean that lots of the people who built Oakland's existing cannabis market over the past two decades are fleeing. Some are leaving Oakland to go legal elsewhere. But many more are now catering to the flourishing illicit market that legalization has ironically strengthened.

Golden has already watched a lot of her colleagues — other edibles and topical manufacturers, small- to medium-size growers, and marijuana flower retailers — give up on going legal and dive fully underground.

"It's thriving under the current situation," she said. "People are going to a sesh," she said, referring to the informal and secretive pop-ups that serve as cannabis bazaars where consumers can sample unregulated products and buy them, untaxed, directly from growers, dealers, and makers. "Or, they go to a friend who grows, and they get an ounce from them, instead of paying a much higher price at a dispensary."

The owner of the delivery business said it's a rational business decision that small- and medium-size cannabis industry participants have no choice but to make. They can't afford to go legal.

"There is no one in my position that could feasibly incubate someone," he said about Oakland's equity program. According to the property website Loopnet, it can cost about $12,000 a year to lease 1,000 square feet of industrial space in Oakland's green zone, but most industrial spaces are much larger, and it's hard to rent just one or two thousand square feet at a time.

"The only way you can play in this market is if you're a big company that can drop that kind of cash," he said. "For big companies, it's just an additional tax."



Chip Moore
, CEO of 4&20 Blackbirds, had big plans for legalization. He and his business partners were hoping to expand their weed delivery service into a brick-and-mortar center where consumers can learn about, buy, and use cannabis in a safe and friendly space. To do so, they needed a general dispensary permit, but Oakland's rules — which limit the issuance of new dispensary permits to only eight per year — have foiled this plan, for now.

Under Oakland's permitting scheme, four of the annual eight new dispensary permits are reserved for equity applicants. "We got dinged because I'm not an Oakland resident," said Moore, who lives in Berkeley.

His business partners didn't qualify either, so to bolster their chances and comply with city rules, 4&20 Blackbirds partnered with two equity program-eligible businesses and pledged to incubate them in their warehouse space for three years. Moore views the equity program as a major commitment of time and resources, in addition to real estate.

In the end, 4&20 Blackbirds lost out to other applicants — some from out of town — who signed up more equity partners, thereby earning more points in the city's scoring process. Moore, however, is skeptical of the claims made by other general dispensary applicants that they can genuinely incubate numerous small equity-eligible companies while running their own businesses.

"When they say they're doing six or eight equity companies, and they're supposed to provide business advice, to mentor them, I don't think so," he said.

"Every week, I hear about a company that is being bought out, or they're leaving Oakland, moving to Hayward, Richmond, Vallejo," he added. "We got an offer to move to Vallejo last week."

Although he's frustrated, Moore said he has no plans to leave Oakland. Part of what's keeping 4&20 Blackbirds in Oakland is their West Oakland warehouse, which they bought last year.

Amber Senter also hopes to keep her cannabis business in Oakland but said she is actively looking at what a move to Hayward or Berkeley could save her in terms of tax rates, real estate, and other costs. Senter runs Leisure Life, which manufactures pre-rolls and infused popcorn. Her company employs five people. Along with Nina Parks and Tsion Lencho, she's also a co-founder of Supernova Women, an organization that advocates for women of color in the cannabis industry.

Oakland's equity program, said Senter, was well intentioned but poorly designed and executed, and now it's killing small companies or driving them into the underground economy. "What kind of business can pay someone's rent for three years?" she said about the 1,000-square-foot-incubation requirement, adding that this is more space than most currently existing companies need for themselves. Senter's company, for example, operates out of a 600-square-foot space.

"It's set up so that to be in Oakland, you have to pay to play," she said. Senter estimated that in some parts of the green zone, real estate can cost as much as $36,000 per year for 1,000 square feet.

Other local costs include city-imposed security requirements that add thousands onto business expenses annually. New state-imposed cannabis testing requirements are also hitting small businesses hard, especially growers. Senter said that prior to legalization, testing would cost about $200 and only require a couple grams to complete. Now, testing services require multiple ounces of fresh flowers and can run as high as $1,000, and if flowers test dirty for pesticides, herbicides, or other impurities, an entire batch worth tens of thousands of dollars can be destroyed.

She also questions whether many of the equity businesses will actually survive their incubation period. To make it, many will need technical assistance and business counseling, but Senter said the city and bigger companies might not provide this as promised.

Last year, Supernova Women implored the city council not to enact the equity program as it's currently designed. The group said that rather than limiting the number of general permits available to run a cannabis business by pairing them one-to-one with equity permits, the city should adopt better measures to address the ongoing racial inequalities stemming from the drug war. Among their ideas were stronger local hiring requirements, fast-track approvals for equity businesses, and tax exemption for equity businesses.

"All our input was ignored," she said. "But I'm not surprised."

Senter now sees Oakland's legal industry as splitting into two streams. One carries the major companies that have obtained permits, often by pledging to incubate a large number of equity applicants. The other stream is the equity applicants, many of whom may not survive their first year or two of business.

Left out or diving underground are small- and mid-size companies that don't qualify as equity applicants and lack the ability to "pay to play."



Cannabis tax attorney
James Anthony has come up with an acronym to label the winners under Oakland's regulatory framework. Large firms and investors who have the ability to incubate multiple equity applicants are BETIs (pronounced "bettys") because they're Big Enough To Incubate.

"BETI means you're rich," said Anthony. "Equity means you're poor. But what about all those smaller businesses, the too small to incubate? Oakland is being polarized between large businesses with money and real estate, and the poor businesses, but there's no middle class."

He said that while he supports the cannabis industry in doing "its part" to address racism and the drug war, he thinks Oakland has made significant policy mistakes by not creating a system that can usher already-existing businesses into the legitimate economy.

"If the expectation of the city council or city staff is that 500 years of racism in the United States is going to be remedied by legalizing pot in Oakland in 18 months, I think that's an ambition that's a setup for disappointment," he said.

But the policy fight around what form the equity program will take has been decided, and so Anthony's biggest concern right now is taxes. He sees companies struggling to stay in business because state and local taxes compound across the supply chain, adding as much as 40 percent to the cost of cannabis products in the regulated market. The state and city are to blame.

Prop. 64 created two new statewide cannabis taxes. Growers have to pay $9.25 per pound of dried flowers, the most common raw product from the plant. Leaves, or "shake," and fresh wet plants are taxed at lower rates. Then for every retail sale of a cannabis product, the state imposes a 15-percent tax.

That would already be an incredibly high tax rate, but on top of this, the city of Oakland taxes medical marijuana sales at 5 percent and recreational cannabis sales at 10 percent. Then Oakland imposes a gross receipts tax on every stage in the cannabis industry's cycle, between 5 and 10 percent depending on whether the goods are intended for medical or adult-use. Growers pay. Manufacturers pay. Delivery services pay. Testing companies pay. The result is that companies can pay twice as much in taxes in Oakland as they would in Richmond, for example, and many times more than if they located in Berkeley or Santa Rosa or other more cannabis-friendly jurisdictions.

The short-term consequence, according to Anthony, is that a lot of patients seeking medical cannabis have already fled the above-ground market and are now buying nugs and edibles and hash and oils in the underground one.

"You have patient demand that's gone underground because it's more price sensitive and the combination of state local taxes is devastating," said Anthony. Medical patients are more concerned about prices because they generally buy larger quantities. "At the same time, you have these people in Oakland who were a ready-made underground supply, but they're being pushed out of the regulated market. They're like, 'dispensaries won't buy my stuff anymore, gee, do you think it's possible to sell marijuana underground? We've got 40 years-experience of doing it.'"

One cannabis patient, whom the Express agreed to not identify because she buys unregulated weed at an unlicensed club, said the prices in the black market are sometimes half what they are in the permitted dispensaries. "And the quality is better," she said about the women of color health collective she frequents. "They have to move around a lot to avoid getting shut down," she said. But the collective's customer base is growing.

Anthony said Oakland needs to fix its tax situation fast, or even the big companies and equity businesses that are licensed and moving ahead with their plans will be damaged. He also expects to see a slight dip in retail sales for the big, established dispensaries as more consumers choose to go back to the underground market.

"The No. 1 thing the city can do for that equity program is adjust that tax rate and make the city competitive so both general and equity can stand or fall based on how competitive the jurisdiction is," he said. "Oakland is not in a good position."

As for the equity program, Anthony wishes the city would reconsider how it's created a bottleneck that prevents most of the existing market from becoming legalized. Combined with the taxes, it's a formula for building up the underground, and in the long-term, the city will lose tax revenue and find itself unable to shape the marijuana markets in ways that advance the public interest.

But on a more fundamental level, critics of the equity program question why the city has put the burden on the cannabis industry, rather than the state, to address the racism inherent in how the War on Drugs was enforced.

"I think the city council might want to look at its racist policing practices," said Anthony.



Linda Grant
knows a lot about racially unequal marijuana laws. She sold cannabis in the early 1990s when, even in Oakland, it was a felony. She sold cannabis without a permit during the city's medical-only era. Born and raised in The Town, Grant, who is Black, has seen many of her friends and acquaintances, also mostly Black, arrested and prosecuted for cannabis.

"I lived in one of the police beats where they harass and arrest people for selling weed," she said.

Last year, Grant submitted paperwork to the city and state to obtain permits to legally operate her cannabis delivery business. She's one of the people trying to come out of the underground and join the legal economy. Because she qualifies as an equity applicant, Grant was quickly granted a permit. She said that city staffers like Nancy Marcus and Greg Minor, who handle Oakland's cannabis licensing program, have also helped her navigate local and state requirements.

Even so, it hasn't been easy. Initially, the city required documentation proving residency and income to qualify for the equity permit. But for many lifelong Oaklanders, proving they've lived here for decades and proving their income falls below 80 percent of the area average is no small task. Because lower-income people rent and move around more frequently, many don't have proof of residency going back a decade. Others don't have tax returns for some years, especially if they've been selling cannabis under the table for a living.

Grant and others raised these issues and helped realize that a broader range of documents proving income and residency would be adequate. This includes things like school attendance history, general assistance payments, Section 8 housing program vouchers, and food stamp records.

In Grant's case, the GummiCares company, a large manufacturer of chewable, THC-infused edibles, agreed to incubate her company, Herban Collective, inside its warehouse near the airport. It's much-welcomed assistance.

But Grant says the equity program is lacking in several fundamental ways that requires more than just small changes. "I've had my permit for four months and haven't started anything yet," Grant said. "I don't have money. There are no resources for someone like me yet."

Grant said she's been in talks to raise capital for her delivery service, but lots of investors want to take control of her company and just use her to gain access to Oakland's market. Although she has her own business plans, the people who have capital won't invest and trust her to grow her own business. "The hardest part is finding investors who want to invest in you, not their program," she said.

Because of ongoing barriers like these, she predicts a lot of cannabis entrepreneurs in Oakland's low-income communities will remain in or go back to the underground economy. Despite the city's efforts with the equity program, there still isn't really a viable path to becoming legal for a lot of cannabis dealers. A lot of this underground activity that will continue to thrive in Oakland involves African Americans and Latinos selling and delivering small quantities of cannabis on the streets.

Near the intersection of 90th Avenue and MacArthur Boulevard, Grant watched recently as a warehouse underwent extensive renovations and security upgrades. She's also seen unfamiliar white men going in and out of the building at odd hours. She suspects it's a grow operation.

Across MacArthur is an open-air cannabis market that's operated for years. Young men, mostly Black, stand near a liquor store and barber shop and sell grams, eighths, and ounces to customers, who are also mostly Black and from the same neighborhood.

Grant has recently watched Oakland police make drug busts there. She's also seen recent arrests near Arroyo Viejo Park. "The police label them as 'gangsters,' but I know some of these boys personally," said Grant. "I grew up with them since they were babies. They don't sell anything but weed, and they make good money. People come through there faithfully."

Oakland and state authorities have no plans or procedures to legalize this kind of entrepreneurial activity. According to data compiled by OPD, Black people account for 79 percent of citations and arrests for cannabis crimes. White people account for only 5 percent. In 2016, the most recent year's data available, police arrested 286 people for selling cannabis. Most of these arrests, 70 percent, were of Black people. On top of this, Oakland police cited 190 people for possession and personal use of less than an ounce of marijuana — again mostly Black people.



According
to Matt Hummel, current chair and longtime member of Oakland's Cannabis Regulatory Commission, legalization isn't on track to solve some of the really big problems created by almost a century of prohibition. The fatal flaw is that the state and city have created a regulatory regime that's unrealistically trying to contain the sprawling cannabis market. "The actual demand wants a way bigger market," he said.

Nobody knows for sure, but most industry insiders and consumers interviewed for this article estimate that the number of unlicensed Measure Z clubs, where people can purchase and use cannabis in Oakland at much cheaper prices, far outnumbers the handful of permitted dispensaries. Counting the quantity of cannabis that's sold at seshes and by individual dealers and growers in the underground, it's almost certain that Oakland's black market dwarfs the legal one.

This is why Jake Sassaman remains a staunch defender of Measure Z, which was approved by Oakland voters in 2004 and made "investigation, citation, and arrest for private adult cannabis offenses the city's lowest law enforcement priority." It also spawned numerous private clubs and collectives in the city, of which many still exist and now operate in a legal gray area.

Sassaman, a former member of the Cannabis Regulatory Commission, said Oakland's new policies under legalization are contradictory and don't fit the behemoth marketplace and pervasive culture that existed around cannabis long before the state ever thought about regulating and taxing it. "People are turning to the black market; dispensaries are hurting," he said. "The city had a stupid plan."

In recent months, several permitted dispensaries have raised complaints about Oakland's Measure Z clubs, saying it's unfair that they've had to spend tens of thousands of dollars on taxes and the city's complicated permitting process, while Measure Z clubs have continued to operate unfettered, free from having to shoulder extra costs. Minor has responded by sending cease-and-desist letters to several Measure Z clubs in the city.

Sassaman worries that as Oakland's underground market grows against the artificial constraints and high taxes imposed by state and city rules, city officials might try to undo Measure Z, and regulators might more aggressively enforce pot laws.

The worst-case scenario is that most cannabis activity will remain in the underground market, untaxed. Cities and the state won't benefit from increased revenues. Consumers won't be guaranteed safe, quality products. And unpermitted businesses, from street corner dealers to big growers, will continue getting busted by cops and regulators instead of being able to make a go at operating a legitimate business.

Ironically, all after legalization.

Sassaman's proposed solution is simple: lift the cap on dispensaries and other cannabis business permits, let the market figure out what the right number is, and stop citing or arresting anyone for weed crimes.

Hummel said his commission has recommended lifting the cap on dispensaries for years. But the existing handful of dispensaries have grown wealthy and powerful, operating somewhat like a cartel with control over the legal market.

So far, the city shows no sign of reconsidering how it's trying to shrink the already massive cannabis industry. For now, there are only 16 dispensary licenses in Oakland, and the number of other types of permits, to grow, manufacture, and deliver cannabis, are constrained by the one-to-one matching requirements of the equity program.

Taxes are perhaps the only area where there might provide some relief. Next month, the Oakland City Council will consider measures to reduce cannabis taxes across the board.

But for small businesses like Oakland's HigherVeda, the city's regulatory scheme has already done damage. "I'm at a place where I'm willing to move anywhere in California," said HigherVeda's owner Edwards, "just to get my operation back up and running."


This is the second of a two-part series on the many challenges facing small- and medium-size cannabis businesses in California's new highly regulated market.

Correction: We erroneously stated that Alex Zavall is a co-founder of Supernova Women. Zavall was actually an attorney who helped draft a letter from Supernova Women regarding Oakland’s cannabis equity program. This version has been corrected.

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