06.26.2017
policy

Green Rush: Everything You Need To Know About The Economics of Cannabis

From what it costs to produce a pound of weed, to paying taxes, a look into the dollars and cents of legal dope.

There's more to modern “weed money” than you might think. Sure, briefcases are still filled with cash and exchanged for “fire product”––albeit via state-sanctioned cannabis deals. And despite hurdles, legal marijuana is on the rise. As revenues earned from legal weed taxes reach into the hundreds of millions of dollars, the economics of marijuana become all the more relevant. 

Keep scrolling to learn more about the challenges and opportunities awaiting legal weed. 


The banks aren't buying it 

Even with dispensaries and cannabis brands becoming more legitimate by the day, banks still can't reasonably touch weedy operations with a ten-foot pole. 

"In essence, banks view dispensary owners, or the industry at large, as possibly having connections to the black market,” Lamine Zarrad, who founded digital payment solution provider Tokken, which does business with marijuana-related clients, told KINDLAND. “For example, say there is a grower that has been in the industry for 20 years in an illegal capacity. Now they’re legal, but they’ve made those nefarious connections––the bank is going to turn them away, because it simply cannot know the risk that this person represents,” said Zarrad.

"It's crippling right now. You don't realize how important banking is until you don't have it”

Eric Fraser, COO at Wurk, an employee management software provider that works with marijuana brands so they may effectively navigate the 280e tax code, manage payroll, and stay compliant with local, state and federal governments, told KINDLAND that, "without banking, the process of paying employees becomes 50 percent to 100 percent more difficult and expensive for the employer, and 1000 percent riskier for the employer, [and] the employees."

In this inhospitable environment, simple, day-to-day tasks become a major headache. "It's crippling right now. You don't realize how important banking is until you don't have it,” Keegan Peterson, CEO of payroll and HR company Wurk said to Business News Daily. “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."

Though there's a reason the banks are spooked. At this point in time, if banks were to work with the weed industry as they do with others, the financial institutions risk paying heavy fines, or worse yet, catching federal money-laundering charges. In the eyes of the federal government, even legal marijuana operations are criminal enterprises. Indeed, legislative solutions––such as the 2017-proposed Federal Secure and Fair Enforcement Banking Act (SAFE Banking Act), which would protect financial institutions from federal charges that take on compliant cannabis industry clientele––are just now beginning to be brought to the table. If the legislation is passed, many of the financial barriers currently holding back legal marijuana would be lifted.

In the meantime, innovative startups such as Zarrad’s Tokken fill the void left in the absence of financial service providers who are currently unable to accept weed money. Other firms or individuals operating in the space find creative means of circumventing it altogether.


To invest, or not invest, in legal weed

Investment capital going into the legal marijuana ecosystem is closely tied to legislation regarding the space.

When President Trump took office, his noted anti-weed Attorney General Jeff Sessions made comments indicative of a possible federal crackdown on the legal cannabis industry, furthering any apprehension potential investors may feel. Indeed, the uncertainty of legal weed’s future makes investing in marijuana businesses a highly risky (yet exciting) venture.

“As with any regulated market, investing in cannabis comes with unique risks, but the industry will produce some massive businesses in the next 5-10 years,” James Conlon, a partner at Silicon Valley-based Bullpen Capital, which invests in early-stage startups, told Tech.Co. “Since 95 percent of mainstream [venture capitalists] won’t touch the category today, valuations are rational and you face little competition for access––so place your bets before the party gets crowded.”

Still, there's a higher risk associated with startups that touch the plant. As Conlon said to Tech.co,

“For example, growers, edibles producers, and dispensaries all touch the plant. That doesn’t mean you can’t find good investments in these categories, but they will be subject to regulatory uncertainty around licensing, taxation, operating fees, tracking, compliance, banking, and so forth. If those risks are too high for your appetite, remember that startups in software, hardware, media, ecommerce, and financial tech will capture major segments of the cannabis market without ever touching the plant.”

Even though the space represents a great opportunity for investors, deals fall apart all the time.

For instance, this month, the Winklevoss brothers––who famously got the shaft from Facebook's Mark Zuckerberg––were sued after backing out of an investment deal with weed delivery startup Eaze. The twins allegedly promised to purchase nearly $500,000 equity stake in the company from an earlier investor and reportedly even had term sheets in place before pulling out of the deal. 


Taxes: The good and the bad

For cannabis businesses, there is no greater financial barrier than Section 280E of the Internal Revenue Code. This particular passage of the tax code, which was added in 1981 at the height of the drug war, has those who earn a living selling controlled substances as unable to claim the same tax deductions (based on incurred expenses) as traditional business owners.

Volteface’s Deej Sullivan breaks down the implications of Section 280E:

“Imagine two businesses in, say, Colorado. One is a cannabis dispensary, the other an off-license. Both make $1,000,000 in gross revenue over the course of a year, and both expect to be taxed at 30 percent of their taxable income after deductions. The problem is that since the dispensary is classed as a drug trafficking organisation by the IRS, the deductions they can make are drastically reduced. Under certain readings of 280E, they can’t make any deductions at all.”

Though this tax certainly hinders otherwise earned profits for legal pot businesses, many weed ventures still find themselves well above water.

In California, regulations regarding the state’s recently passed recreational initiative Proposition 64, are to be finalized by January 1 next year, and will include even more tax-related provisions. 

“Testing taxes will be applied to marijuana purchased at any legally licensed shop. Recreational products can be taxed from 7.5 to 10 percent per California state sales tax, but other marijuana taxes can also be applied to the herb, which can have it selling at a 15 percent increase of its normal price. And for marijuana businesses to pay taxes, a designated office will be opened north of San Francisco.”

But the taxation of weed varies depending on your state. 

In Colorado, for example, which legalized recreational use in 2012, recreational sales are taxed at the rate of 2.9 percent, while consumers also pay a 10 percent sales tax. Medical marijuana transactions are also taxed at 2.9 percent, but medical marijuana patients don’t pay the sales tax. 

Still, the state brought in nearly $240 million in tax revenue in 2012 alone. And in April 2017, Colorado had already seen $185 million in tax revenue for the fiscal year-to-date, according to The Cannabist. Recreational sales in Oregon, however, are taxed at 17 percent, with local municipalities able to add an additional 3 percent tax. The Evergreen State legalized recreational sales in 2014, and by January 2017, saw only $60 million in tax revenue. In Maine, recreational weed sales will begin next year, and will see a 5.5 percent tax, but edibles will be taxed at 8 percent.


The cost of growing dank herb

In regard to marijuana cultivation, the most relevant associated costs of production are labor and overhead. These numbers can fluctuate widely depending on location––the rent for an industrial warehouse to-be-used for growing weed at commercial scale will be different in California than it is in Colorado, or Nevada. This number is also made different depending on what type of growing technology and technique is being employed––indoor, outdoor, hydroponic, soil-grown, etc. 

Still, most legal commercial grows spend anywhere between $500 and $1,000 to produce just one pound of cannabis. And depending on a fluid demand and fluctuating supply, a pound of outdoor cannabis sells on wholesale markets for around $1,500, while indoor, warehouse-grown weed can go for upward of $2,200 per pound.

Screenshot via Leafly

According to John Sidline, who heads marketing efforts for Smart Grow Systems, his company’s vertical vision and lighting technology can bring this cost of raising indoor weed, down to around $200 per pound. On top of that, he says the company's take on the vertical farming––which is also employed in growing sustainable food supplies–– is more environmentally sound. 

But down the line, as state regulations mandate the increasingly growing rank of producers currently supplying the market, to raise cannabis using more sustainable methodologies, both the cost of production, and the price of the final product, could level out after seeing an initial decrease. Which is why it makes sense that in 2016, fertilizer producer Scotts Miracle-Gro Company––the corporation behind cannabis industry-favored fertilizer Black Magic––paid $136 million to acquire Gravita, which specializes in lights conducive to hydroponic cultivation. 

Similarly, niche market sectors such as concentrates, edibles, and other such marijuana derivatives each have associated costs unique to the product

For instance, extracting rosin, which requires expensive equipment to make at a commercial scale, might have producers barely breaking even as the yield of such efforts is less than that achieved via the use of closed-loop or solvent-based methods.

Ultimately, legal weed is an open book that is still being written. Virtually everything about the space is amenable to change, and could indeed change drastically over the next few years. To be sure, the marijuana industry is already profoundly impacting state and local economies where it is most active. But to speculate on the potential impact of a policy shift at the national level, in regard to marijuana laws and the greater economy, is a numbers game we'll gladly play, should the opportunity ever present itself. 

Tagged: