On-Demand: Current Landscape of the Cannabis Industry
- May 19, 2022
In this webinar, we discuss the current landscape of the cannabis industry from a legal, accounting and industry perspective.
Bella Brickle: Now, I am pleased to introduce today's moderator. Eric Altstadter. Eric is an Audit Partner at EisnerAmper LLP and Chair of the Firm's Cannabis and Hemp Practice. He has more than 30 years of experience working with both public companies and privately held businesses throughout the country. Eric is a frequent speaker on accounting, auditing, and business topics. He is actively involved in various industry events, host a monthly cannabis podcast called CannaCast, which deals with current topics that affect the cannabis community. And he was recently named one of the cannabis industry's power players by AM New York Metro. And with that, I'll pass it over to you, Eric.
Eric Altstadter: Thanks, Bella. And welcome to today's presentation. “High noon”, “The Current Landscape of the Cannabis Industry”. Joining me today are Hubert Klein and Rob DiPisa. Hubert is a Partner and Practice Leader for the Financial Advisory Services Group in EisnerAmper's New Jersey location. With over 35 years of experience, Hubert is frequently called upon as a technical resource in various litigation actions. As a strong proponent of professional development, Hubert frequently speaks to both business and civic groups on topics such as business valuation, forensic accounting, commercial damages, and fraud. Hubert is an active member of the American Institute of Certified Public Accountants where he currently serves on the National Accreditation Commission.
Rob DiPisa is co-chair of the Cannabis Law Group at Cole Schotz where he counsels clients regarding regulatory compliance, risk management, governmental affairs, licensing, and the leasing and acquisition of real property in connection with the cannabis related uses. He's a frequent presenter on health and economic benefits, lectures courses on cannabis law, and is a member of severable trade organizations including New Jersey CannaBusiness Association and CannaGather. Additionally, Rob is a regular contributor to national publications on this topic such as MarketWatch, Bloomberg Law, and Marijuana Business Daily. Welcome gentlemen.
Robert DiPisa: Thanks for having me.
Hubert Klein: Thanks for having us, Eric.
Eric Altstadter: The first question, the MORE Act, the Marijuana Opportunity Reinvestment and Expungement Act has been introduced by Democrats and passed by the democratic controlled house twice, the first time getting stalled in the then Republican controlled Senate. It would do many things and would effectively legalize cannabis by moving cannabis off Schedule I of the Controlled Substances Act. Republicans have offered an alternative, the States Reform Act. Do you see the MORE Act or the States Reform Act or some combination of both getting passed? Rob?
Robert DiPisa: It's a good question. There's a lot of conversation that you'll see if you look it up in the news. People are very excited about the MORE Act and the States Act. And by the way, if you don't really know, like Eric mentioned it deschedules cannabis from the Controlled Substances Act, it also has some retroactive social equity measures in place where it would expunge past offenses related to cannabis. I guess the one distinguishing factor between the MORE Act and the States Reform Act is the States Reform Act goes a little further and what it does is it actually expressly excludes cannabis from the Controlled Substances Act, and it puts it in the same category as other expressly excluded products such as tobacco, wine, other alcohol products.
I think that it's a likely possibility that this is the structure that we're going to see from a federal level when it comes to the legalizing of cannabis. I think it's unlikely that we're going to see the federal government come forward with some kind of regulatory structure where all states have to comply with. The federal government has kind of left it up to the states to decide what they want to do and what they do not want to do with cannabis. So, I think the structure makes sense, the MORE Act or the States Reform Act, whichever version eventually gets there. But I think we're a little further away than people think. I think what we might see on the front end are certain things such as deregulation, things that are going to permit banks, insurance companies, to jump into the industry. I'm not sure if the federal government is just ready for this just yet.
Something else to keep in mind is, while this structure is probably what we're going to end up seeing, a descheduling of cannabis on the federal level as opposed to federal regulations and leaving it up to the states, these acts also will permit interstate commerce between two states that obviously permit cannabis. But the problem there is, when you leave it up to the states, the states create their own regulations, right? Which vary from state to state. And even though they're going to be permitting states to transport product through interstate commerce, how do you transport one product created in one state pursuant to a completely separate set of regulations and then transfer it over to a different state? And how does that product then become compliant in the new state? So certainly, it's not without flaws and we're going to have problems along the way, but I do see something similar to this being passed, but I think it's more of like a five-year window or a little bit less. We'll see.
Eric Altstadter: Hubert, your thoughts on the matter?
Hubert Klein: I agree with Rob, and it's going to be not a walk before you run, but it's going to be more of a crawl before you run until we get to that place where it's everywhere and it's acceptable in the interstate issue. I mean, Eric, we had the conversation yesterday at the meeting about the special stamp that people now need to put on a product manufactured in a certain state, right? One to control the interstate transportation of the product. The other issue with these interstate laws is for interstate transportation, you got to go through some states that are more than five years, as Rob says, away from even accepting that being removed from the CDA list. And they have some very harsh laws and penalties. You got to break down a lot of barriers. It's a big country. There's a lot of diverse thoughts on the cannabis industry and other types of issues in there.
So, I agree with Rob, it's going to take some time. It's eventually going to happen. It has to start with the infrastructure with the banking industry and insurance and all that. I think once the infrastructure is in place, it's going to be an easier way to get the laws to more, because a lot of states right now, like Rob said, and I'm working in a few in doing some work in consulting is, they're having a lot of problems with just the state regulations. And the state regulations were set up with the best of intents but weren't being applied with the intent. So, there's a lot of flux in the market in the different states.
Eric Altstadter: And just to follow up on that, we think of New York and New Jersey as being so close to each other and almost being the same item and have the same rules. And the rules are dramatically different and you really can't take product across the state lines as Rob you were mentioning earlier.
Robert DiPisa: And you know what? Before the COVID-19 pandemic, there was actually a collaborative group of governors in New York, New Jersey, Connecticut, and the surrounding area that were meeting to try to create uniform regulations. But as COVID occurred and everyone retreated back to their states and they obviously had a lot more on their hands, those meetings stopped. And as a result, we see these very varying regulations between these close cluster of states. So, it's going to be interesting to see how it works out if interstate commerce is permitted one day, how we're going to be able to do that. And don't forget, these regulations are always a work in progress, right? A lot of these states, they're trying to fly a plane at the same time they're trying to build it. So, the regulations we have now, they already vary and the states are going to continue to amend and try to improve upon them, and they may end up varying even more. So, I guess we'll have to kind wait and see what happens.
Hubert Klein: Right. And on the revenue side of it, Eric, there's an article out last week, that in the state of Colorado they took in a couple of months, five to seven times the amount of taxes on cannabis than they did on alcohol. So, the states are going to figure out, as the cigarette taxes have been dropping and some of the alcohol taxes dropping and the cannabis is generating another source of funds without having to raise the tax or the tax base, they're all going to figure out it's just going to take time. They see the dollars, they're just thinking, "How do we capture it?" And they still have to wrestle with the illegal market, right, Rob? I mean, that's a big thing out there now because the price points in different states are a problem.
Robert DiPisa: A significant price point. A significant price point between the legacy market and the regulated market, but the numbers are starting to trickle in New Jersey. And for instance, one dispensary reported that they are bringing in $170,000 a week. So, it's roughly a $62 million operation at just one of their dispensaries. So even though there is this great disparity between the price in the legacy market and the price in the regulated market, people are still showing up. At least you always see this on the front end, but people are still showing up to purchase the regulated product. So, it remains to be seen whether or not the legacy market will be eliminated or subside or whether it's here to stay.
Hubert Klein: Right. Well, I always liken it to the show Moonshiners on Discovery Channel, right? There are still guys who make bootleg whiskey, but their market share is so, so small now. We just got to wait for the regulated market to pass that pivot point. It's going to come down to safety and quality of product, which it always comes down to the end. And that's going to be in the regulated market.
Robert DiPisa: Absolutely.
Eric Altstadter: That's actually a really good point, Hubert. Safety. Especially in this day and age, safety, knowing where the product is manufactured, knowing the standard’s its manufactured under, are so important for consumers I believe.
Hubert Klein: Rob and I, Rob's an attorney, I work in litigation don't forget. Now you can hold somebody accountable for bad product.
Robert DiPisa: Absolutely.
Eric Altstadter: Gentlemen, cannabis companies have historically had a problem obtaining a banking relationship. Another piece of legislation that's been kicking around for a few years now is the Safe and Fair Enforcement Act known as the SAFE Banking Act. This act would've provided protection for banks that provide financial services to cannabis and cannabis related businesses. Do you see this legislation passing anytime soon? And if it does, what effect will it have on the industry, Rob?
Robert DiPisa: Honestly for lack of a better word, the Safe Banking Act has just been floundering for years. I think that it's probably more likely that we would see the Safe Banking Act pass before something like the MORE Act like we were discussing previously. Honestly, I think it's almost at the point where it's kind of bizarre that the Safe Banking Act has not yet passed. I mean, if you think about it, what it really does when you break it down, is that it prohibits federal regulators from restricting, penalizing, or discouraging banks from just providing banking services to state licensed cannabis operators, right? All it's saying is, "Hey, federal regulators, you can't penalize the banks from doing this."
In addition to that, what a lot of banks are concerned about is that they're taking funds in from federally illegal activity. And they're concerned about triggering anti-money laundering laws. And don't forget, if you're FDIC insured and you are taking in funds from technically federally illegal activity, what does that mean? It's almost just a basic business right to have access to banking services. I feel like the Safe Banking Act doesn't go as far as the MORE Act or the States Reform Act. All we are doing is we are saying, "Banks, if you choose to provide banking services to these operators, the federal government is not going to come after you and penalize you for doing it."
Another big concern for the banks is civil asset forfeiture. So, the Controlled Substances Act permits the department of justice to come in and seizes cannabis plants, cash, and even real property that's used in connection with federally illegal activity, right? So, what banks usually have collateral on when they're providing a loan on a piece of property, it's usually the property itself. So, if that piece of property is subject to civil asset forfeiture or the funds from that business, obviously that's going to be a concern to the bank and it's going to discourage the bank from providing any kind of lending services or depository services to those operators.
I'm more cautiously optimistic that the Safe Banking Act or some form of the Safe Banking Act will pass sometime in the next few years. I mean you would think that this would get done sometime by 2023, but especially with each state turning, the more states that come online, the more of a demand and more of a need there is for banking services. And although there are state chartered banks that are coming in and they're filling the void, and I can talk a little bit more about how they're doing it, this has also created this whole little boom in the private lending sector where private lenders are taking advantage of this gap of services to the cannabis industry. And they're providing the loans that are required to these operators for equipment, for real property. Obviously, they're taking advantage of it and the rates are very high, much higher than they would ever be at the institutional level.
So, I think that business is starting to get a little short-lived. I think that once the Safe Banking Act or some form of it occurs, you're going to see obviously those private lenders probably either get out or there's going to be a much fewer of them than there are now. But yeah, I'm much more confident about the Safe Banking Act occurring in the near term that I am about the MORE Act.
Eric Altstadter: Hubert?
Hubert Klein: Well, again, Rob and I are on the same page. I'm here at a conference, at The New Jersey State Bar Conference. All the lawyers in New Jersey, or most of them except for Rob, he's not here yet, but also there's a lot of bankers here. And when you talk to these people, they see significant growth and opportunity if the reins are taken off and they're allowed to fund these operations.
And I understand the issue with civil forfeiture and all that. People are trying to figure out workarounds. You'll see groups of people now who just want to buy buildings for grow operations and just rent the building to an organization that's going to lease the building so they kind of insulate the building from the operational side. So, things are going on. And these private lenders in their marketplace, I've seen them refer to as like private incubators, equity incubators, people with money or throwing money into these things, they see that opportunity.
Until there's a shift in the dynamic of who can provide the funding, they're going to get those good returns on their money. But as soon as the banks are involved that's going to help the regulated market, their cost of borrowing is going to go down and are going to become more profitable. But something's going to give, because while they won't say it openly and nobody's writing articles, this is what they want in certain industries. The banking and insurance industry are two of the largest lobbying groups in Washington, DC. They want this to happen, but they have to tread lightly to get it to that point. But it's coming. And I agree with Rob, not 2023, but it's going to come shortly thereafter. Because what I'm seeing in the landscape, even in states where there's a lot of opposition, you can talk about red/blue and I don't want to get into the politics of it, but in a lot of states where it was persona non grata for a long time, people are loosening up and it's becoming more acceptable. So, it's just waiting the clock out.
Robert DiPisa: I mean, to that point, look at the Carolinas who are now... They're dipping their toe on the water with medical, right? I didn't think we would see that anytime now. So, to that point, we do have this ripple effect that's occurring along the east coast now. As more states come online, like I said earlier, the bigger the demand and the need is for banking services. Something that I forgot to mention a little earlier, but what's also going on is there's predatory lending going on in the cannabis space.
Hubert Klein: Right.
Robert DiPisa: Because the institutional lenders are not able to really come in. It's a bit of a social equity issue. I think that if the Safe Banking Act or some form of it is actually passed, then the institutional lenders come online and then you don't have these operators who might not have the capital going to individuals who are going to take advantage.
Hubert Klein: Right.
Robert DiPisa: So, I think that's another problem that's associated with not having these institutional lenders being able to be involved in the industry.
Hubert Klein: I think that rolls right into the infrastructure development. Once that infrastructure development is allowed, people are going to fill that void. It's going to force the high return people out of the marketplace, or they have to find something else. I mean, you just talk about changing mindsets. Oklahoma. Oklahoma has over 1,700 retail licenses out there, right?
Robert DiPisa: Yep.
Hubert Klein: That is a substantial amount of licenses for a state with that population. So, they have 1,500 recreational licenses out there, recreational sellers.
Robert DiPisa: It's a very business friendly program as well, Oklahoma. Yep.
Eric Altstadter: In addition to banking and financing, there's other aspects to it as well, is having a checking account. Being able to pay for goods and services without having to use cash, protecting your employees by not being able to write checks, being able to take credit cards. These are all aspects of the Safe Banking Act, which will hopefully evolve the industry dramatically.
Robert DiPisa: Yes, 100%. I can't tell you how many of my clients who have had bank accounts closed, transactions prevented from going through. It's just such a disruption to your business. Think about any business that you run. And if you could wake up one day and all of your bank accounts are closed, what happens with your accounts receivable, accounts payable? How do you make all of that work? We're kind of at this point, we're putting a Band-Aid on the issue, I mean, if you think about it, if you've ever got into a dispensary in a legal market, what they're doing now is they have to have essentially their kiosks that you would normally see at, let's say a CVS, but what it is, it's almost like a portable ATM machine. And while you go up and you might swipe your debit card and purchase your cannabis product, what's going on behind the scenes there is you've actually gone to an ATM machine, you've swiped your debit card. You've taken out cash in the amount of cannabis you're purchasing, and you've made that purchase with cash.
So why do we need to set things up this way? It's solely because we don't have something in place as fundamental as the Safe Banking Act, which permits banks to actually enter the market. The amount of time and money that has gone into the sophisticated AI to identify transactions at dispensaries and reject it, it's silly that we're still doing it at this point instead of just fixing the problem.
Eric Altstadter: Gentlemen, in 1981, the IRS enacted code section 280E. This resulted from a cocaine trafficker who was fighting to deduct ordinary business expenses from his overall taxable income, which was derived from illegal sources. Now business owners selling Schedule I or Schedule II controlled substances under the Controlled Substances Act are denied the deduction of most business expenses related to their illegal business activity, making their effective tax rate anywhere from 60 to 70% of net income before taxes. Cannabis, as we've mentioned before, is still on Schedule I. How burdensome is this? Can companies avoid the tax bite of 280E? Hubert?
Hubert Klein: Okay, that was the Edmondson v Commissioner case in 1981, where there were relying on Section 162, ordinary and necessary business expenses were deductible. The tax court allowed it and quickly Congress said, "Well, we don't want that to happen. If all they have to do is come up with their cost of goods sold, or their net profit, we're not going to basically turn people away from doing this." So, the Congress came in after that case came down and came up with 280E. It's very burdensome on the cannabis industry and all the businesses at all levels, whether it's the growers, the craft growers, the transporters. Everybody has an issue, anybody who touches the product. It increases the tax rate like you said from 60 to 70%.
It also is burdensome because even certain states aren't in line. Like we know that New York just decoupled from the federal provisions and doesn't hold it to 280E. But across the river into New Jersey, 280E still applies here. So, it's very burdensome and it really digs into the profit from what we'll call the regulated growers. I mean, they're on the same playing field from a financial standpoint and running their business with a license, a state approved license, as the, I'll use Rob term, the legacy market. They get no bump up for being in a regulated market versus a legacy. It's very burdensome on the owners. Its also driven the prices up for the consumers, which in turn is really driving them back to some of the legacy market purchases.
Eric Altstadter: Rob, any thoughts about 280E?
Robert DiPisa: I mean, obviously Hubert really summarized it very well. I think that the whole point of a lot of the programs throughout the states are trying to... It's the legacy and the legal story, right? We want to incentivize the legacy operators to come into the regulated market, because honestly, if they continue to operate within the legacy market in an environment where obviously the profits are higher, there's no regulations, they're making a lot more money.
280E is just another obstacle they need to deal with. You need sophisticated accounting firms, like I started to kind of guide you through things like that. I've been involved with deals where we've restructured the entire deal to try to address 280E issues. I've had clients come to me and decide not to apply for certain license classes to try to avoid 280E issues. We shouldn't be putting operators in these types of positions because of something like this. I mean, again, it's been going on just a bit too long and we should be incentivizing people to come from the legacy market into the legal market. And this is just another obstacle that we put in their way.
Hubert Klein: Right. Well, Rob, you talk about incentivizing, right? Because that's the whole idea.
Robert DiPisa: Right.
Hubert Klein: If you don't have a Safe Banking Act and you have 280E, there's almost no incentive for a legacy entrepreneur, if you will, to come into the regulated marketplace, right?
Robert DiPisa: Absolutely not.
Hubert Klein: "I want to be legit. I can't use a bank. I can't do certain things, my funding." All that stuff, it doesn't make it any easier. So, the financial incentive and also the administrative incentive just isn't there. And that's really the issue here.
Robert DiPisa: I mean, if you're a legacy operator in New York City, I mean, you're making a million dollars a month. And it's tax free, right? And unregulated.
Hubert Klein: Right. On that issue, Rob, what happens, right? Because listen, Eric, the IRS comes in, they're not happy, right? Or you get a civil forfeiture action. versus an IRS levy for an see accountable, legitimate business. A couple of phone calls and a couple of letters for an IRS Levy and "Hey, maybe they'll release the hold here." On a civil forfeiture action, there's a legal action, right? There's generally a prosecutor, somebody else involved that's not a pick up the phone and "Hey, my guy isn't as bad as you think he is." It's a longer, drawn out more expensive process. So, if you're the legacy retailer, you're weighing that, and now you're, "Listen, I'll take my chances."
Robert DiPisa: Correct.
Hubert Klein: Everybody sometimes likes to roll the dice.
Robert DiPisa: Correct. You've hit it right on the head. We've put these legacy operators in a position where they've seen the obstacles that we've put in front of them and they see the amount of money that they're making and they're saying, "Well, you know what? I see where you're offering up. I'm going to take my chances and continue in the legacy market until the point in time where maybe I get caught, business shuts down. But I'm making so much right now that it doesn't justify me to play by your rules." Because they're not just rules. There are true obstacles every step of the way for you to become operational. And listen, every state and every municipality also has their hands out for a portion of tax revenue.
Robert DiPisa: So, it's all part of the cocktail that we got to figure out the right mix that makes sense for a legacy operator to transition into the legal market.
Hubert Klein: I would liken it to the intent is there.
Robert DiPisa: Correct.
Hubert Klein: The intent to get people to transition is there. The infrastructure and the regulations are the roadblock, and they're significant.
Robert DiPisa: Correct. Each state tries to improve on the last... People look obviously at California first. I know New Jersey was looking at Illinois. And they try to improve on it. It's like in math, that litmus test, where the curve keeps getting close and close to that line, but it doesn't exactly touch it. We need to get to the point where we can actually touch it and we figure out a way where we've created regulations that protect consumers, but at the same time don't create roadblocks for operators, and also social equity measures to make sure that we don't have people sitting in jail while we have very well-funded operators and states collecting a significant amount of revenue from something that the exact same thing that someone else did who is still in jail.
Hubert Klein: Right.
Robert DiPisa: We have to kind of correct that as part of this whole cocktail.
Eric Altstadter: Many new businesses go into this and they say, or they think, "We can get around 280E." And I'll tell you, you can't get around 280E. In fact, the IRS loves 280E cases and they don't really lose many of those cases. So, you got to be very careful and you got to structure. As Rob said earlier, you have to make sure you maintain your books and records in such a way that you take advantage of the deductions that the service gives you. You don't miss those deductions and take what's available to you.
Hubert Klein: But Eric, that's an important point. The books and record keeping issue, right? Even the regulated businesses, it's an added cost which isn't deductible. So, any of their accounting fees, their legal fees, and some of these other things, "Catch me if you can. I don't need to hire all these people to help me."
Eric Altstadter: Hubert, New Jersey recently started sales of adult use of recreational cannabis. What have you seen as a result of the new legislation?
Hubert Klein: Well, I've seen a lot of interest. Everybody now wants to be a cannabis entrepreneur in New Jersey. I have two sons in their 20s. They have friends who all graduated college and they all now think they're going to be cannabis entrepreneurs and get into the licensing. What I'm seeing is there's a lot of interest. I've done some valuations for people in the space. I'm seeing that people are interested. They have their plans, they want to get their licenses, but there's still a big disconnect as to what they're actually getting into. For instance, I was working with somebody who was looking on evaluation of their growing operation and they weren't aware of the 280E issue. And they had a consultant on staff who was advising them. So, I see there's a lot of interest. There's a lot of infrastructure developing, but also, I think there's a market out there where people are going to start getting taken advantage of because of their lack of knowledge of the state specific laws, things like 280E and all that.
But it's taking hold, it's going to grow. You can see the signs on the highways everywhere. Stop here and all this other stuff. So, it's changing. New Jersey hopefully catches up with New York soon on the 280E issue. Hopefully the Safe Banking Act comes down in the next couple of years. But New Jersey is ready. The pump is primed. They're ready to hit the market hard.
Eric Altstadter: Rob?
Robert DiPisa: New Jersey's interesting. It's really the first truly densely populated state to legalize adult use cannabis. But New Jersey, in particular, is very challenging in the sense that in the New Jersey legislation, in regulations they gave, a tremendous amount of authority to the municipalities to control not only whether cannabis is going to be permitted in their municipality, but what types of cannabis. So, the legislation in New Jersey allowed a municipality to choose, "Okay, I only want cultivation," or "I only want manufacturing," or "I'll take manufacturing, cultivation, distribution, but I don't want retail." And what resulted from this... Obviously this is also part of cannabis is still the devil's lettuce, right? So, there's a lot of misconceptions and lack of education. It's difficult for people who have been told their whole life that cannabis has no medical purpose and it's bad, which was a result of probably one of the best propaganda campaigns the country has ever created.
I mean, I encourage everyone to look up Henry Anslinger and the Bureau of Narcotics where cannabis became illegal, where you used to be able to pick it up in your local pharmacy. But the result of that is that there's a lot of people who still believe that this is bad and there's no medical benefits.
Hubert Klein: Right.
Robert DiPisa: While people's mindset are changing, there's still that sentiment. So, what happened was, you had, I think it was 70 municipalities in the state of New Jersey who just outright banned cannabis. Those that permitted cannabis, very few permitted retail sales. I just think it's viewed as probably the most invasive of the license classes and uses. So, what's happened in the state is it's created this land grab because there's so few properties that are actually permitted for retail specifically. So, you have a situation where it's a post COVID environment where people, I can't tell you how many times have told me, retail is dead and you have multiple bidders bidding on properties that are zoned for cannabis in a particular municipality. And usually, there's few municipalities and there's only one property.
Hubert Klein: Right.
Robert DiPisa: You have a property owner who woke up one day and realized that he or she was sitting on a lottery ticket. So, I think that's been incredibly challenging not only for the residents of New Jersey, but for a lot of the operators and other jurisdictions who want to break in. I'm on calls all the time where they're scratching their head, they're like, "Wait. What do you mean we can't just find the property we want and set up shop there? What do you mean we're limited to these municipalities and only these properties?" And the challenging part is it has actually kept a lot of sophisticated operators out of it. I've had some operators I've been on the phone with that said, "You know what? We'll pass on New Jersey. We'll wait for New York," because while New York gave some power to the municipalities, the municipalities could only choose to ban retail and onsite consumption, right. They could not ban cultivation, manufacturing. And why should they, right?
Robert DiPisa: Those uses are usually buried in an industrial park, in a large gray building that looks similar to an Amazon building. You would never know it was there unless someone told you. So, I think that that's resulted in a lot of challenges in New Jersey. Of course, the regulatory structure isn't perfect, but I didn't expect for it to be. The licenses are being given out on a much slower pace than we anticipated. I think originally it was supposed to be 90 days. There's two license class: conditional, annual. Conditional is fast tracked review process. But I think originally, we were told that it would be 90 days for an annual application to be reviewed and to receive a response from the CRC. The first annual applications were submitted on December 15th in New Jersey for adult use. And here we are about 150 days after and no word from the CRC on those annual licenses. So, I think those delays are frustrating, especially for operators and other jurisdictions who are ready to deploy capital and get going.
Hubert Klein: So, I guess that's a time game, right? Because other municipalities are going to pick up on that. They're driving up the price in the few. But the other thing I always look at when I talk to people too about it is, someone once said to me, "Remember, telephone poles and cell towers were once banned by towns. And the legislature figured it out and said, 'No, you have to allow them, but will let you determine where they can go'." especially with the cell tower. So I would think at some point the real estate's going to be like a cell tower. It's coming in. We'll let you define the parameters and where you want it to be, but you're going to have to allow a legitimate business operate, because at some point you might get into state constitutional issues for that restriction.
Robert DiPisa: Well, it's just such a great point that you brought up, because especially when you look at it through the scope of a patient, right? If you're not permitting... And this was already dealt with and this was discussed, "Well, if the town's prohibiting it and they have medical patients in the municipality who have a prescription for cannabis, then you're at the point where you're denying patient access to medication," right? If you're banning it, especially someone who maybe has stage 4 cancer, unable to travel. Now, New Jersey corrected this quickly, obviously, because they saw an exposure point and now they're permitting the deliveries to medical patients. Obviously it's going to be deliveries for adult use. But it's a good point.
I don't even know if we're going to have to get to that point because I think that the municipalities that are banning it are going to realize that, "Well the municipality right next door to me permitted it. So the dispensary is a block away from my town and that municipality's collecting 2% of the sales from that dispensary and I'm not." I think as the market becomes a little more saturated... And I'm already seeing it now that those municipalities that have once banned are now coming in.
Also, one of the, I guess problems, is the municipalities were given a deadline to either ban or permit it before the regulations even came out, which sounds a little peculiar, right?
Hubert Klein: Right.
Robert DiPisa: Wouldn't you want the regulations to come out so the municipalities can review them, see what they entail and then decide? But that's just not the way we did it. So what a lot of municipalities did as a protective measure is they banned it, they banned cannabis on the front end so that they could have an opportunity to pour through the regulations and then decide on the back end. Because if you opt out, you could always opt back in. But if you fail to opt out, there's a five-year blackout period where you can opt out for. So that's just another result.
Eric Altstadter: And Rob, just to clarify, that's opting in and out of sales within that municipality. The state cannot prevent people from having their own cannabis and using it themselves.
Robert DiPisa: Correct.
Eric Altstadter: It's just preventing the sale within certain parameters.
Hubert Klein: Right.
Robert DiPisa: Correct. And I'm glad you brought up that clarification. They can't prohibit cannabis from being within the boundaries of their municipality. It just has to do with whether they're actually going to permit an operator to operate within their municipality. In addition, a town cannot prohibit a delivery driver from passing through their town with cannabis delivering it from a dispensary to the home of a medical patient or so.
Hubert Klein: Right. I think one of the disconnects a lot of people have in certain municipalities is they don't even know what they're opposing. I mean, I know there's a municipality in Bergen County where I think a grower wants to do an operation in an old Sears building. Everybody's up in arms about it because they think they're going to open the doors and it's going to be a candy store and the kids are going to see it. I think it's going to be an educational end on the industry itself, the business, that people need to know what they're banning. A lot of these grow operations are going to happen in places where there's old abandoned factories, in Camden, in Patterson, in Newark, in Passaic. That's where a lot of the people are looking to open them.
But even in some of these other towns, if you had a building sitting vacant for 20 years, not contributing what it should to the tax base, in most places around the country, you don't even know there's a growing operation. Like Rob said, it could be operating right next to an Amazon warehouse. It looks no different. Inside it's much different, but on the outside you wouldn't even know it's there.
Robert DiPisa: I had a municipality implement... And this kind of goes to your point about just the lack of education item. A municipality implement a thousand foot setback for a cultivation facility from churches and schools. Usually, you see those setbacks for retail establishment, similar to a liquor store. You just don't want a liquor store across the street from a school or church, right?
Hubert Klein: Right.
Robert DiPisa: And then as I began to speak to the municipality, I said, "Well, usually I see that for retail establishment. Why did you impose it?" She's like, "Well, we don't want people smoking outside and for the smell to travel to the churches or schools." I said, "You realize this is a cultivation facility. No one is smoking outside. No one is purchasing cannabis here other than dispensaries. And they're usually loaded out on vehicles that actually look similar size to like an Amazon vehicle. There is going to be no smoking. And in fact, the odor mitigation techniques have got so sophisticated now that I don't think you need to worry about it," but it just shows. And then once those conversations started, they realize they didn't even really know what the license class permitted or prohibited. It's just the lack of education. I think as the education spreads and people learn more, they're going to be able to make better decisions for their municipality and also the people who live there. So we'll see how it shakes out.
Hubert Klein: Time will tell.
Eric Altstadter: Rob, going back to what you talked, you talked about the view that cannabis is the evil weed. You can go back to the old movie, “Reefer Madness”. That's usually a midnight show around various places that will show you what the feeling was way back when.
And just to clarify one other thing. Hubert, you mentioned decoupling earlier, New York State has decoupled from 280E.
Hubert Klein: Right.
Eric Altstadter: And I just want to clarify for our listeners what that means. 280E is the 600 pound gorilla in the room for cannabis companies. If you're a cultivator or a grower, you can deduct the costs that go into your product, your cost of goods sold. So all the salaries you're paying for your people to work on the field, the water, the electricity, the field itself, all those are part of cost of goods sold and all those are deductible.
Hubert Klein: Correct.
Eric Altstadter: When you get to a dispensary, all a dispensary can deduct is the cost of goods sold. So the purchase of the product from the grower is deductible, but all the other expenses, which could be the rent of the dispensary, it could be the sales salaries, it could be advertising, all those are non-deductible expenses. And that's where 280E really hurts. And that's why the effective tax rate, we talked about an effective tax rate of 60 or 70%, that's where that comes into play. The decoupling that New York has done and California has done, and New York's decoupling just happened earlier this month during the governor's budget plan when that was released earlier in April where New York kind of said, "If it's legal in our state, these expenses should be deductible." So while the federal government is not allowing these companies to deduct those expenses, New York and California are allowing you now to deduct those expenses. So you still get hit on the federal level for the tax burden of 280E, but if you're in New York, you can get help a little bit on the New York State level.
Hubert Klein: How about interstate tax filings, Eric? Company in California, New York, New Jersey and Oklahoma. That's going to be a fun one for the apportionment.
Eric Altstadter: Now we've got a question from our audience. Rob, I want to address this to you if I can. New York is a bit behind New Jersey. Some in New York have claimed that the criminalization of cannabis means they can open up a retail store or a growth facility without a license. What are your thoughts about that?
Robert DiPisa: I'll be the first to tell you that that's not what it means. I do get phone calls from time to time. You'd be surprised how many times people ask that question. And what they see is they see that someone else has done it, and they said, "Well, I'm going to do it too." So decriminalization is very different, right? If a police officer finds an individual and they're in possession of a certain amount of cannabis, well that specific amount of cannabis, if it's below a certain threshold, is decriminalized. So police officers will no longer be pulling you into the police station and booking you for that possession of cannabis. That is very different from you setting up a retail establishment and selling cannabis to consumers without a license to do so, right?
Robert DiPisa: So New York creating an adult use program and an adult use market provides that, "Yes sure, cannabis is legal, but cannabis is legal if you purchase from a licensed entity in the state who has produced regulated cannabis." A similar thing was going on still in New York and New Jersey where because it was decriminalized, websites were popping up where you would purchase cookies and someone would drop cannabis off to your house. This is not legal. It's not permitted. The only way that you can consume cannabis legally within New York and New Jersey is if you purchase that cannabis from a state licensed operator and you consume within the state. That's it. And I think there is confusion over decriminalization and legalization. They are separate and apart from one another. Decriminalization provides that we are not going to prosecute you for small amounts of cannabis in your possession. Legalization means you are permitted to purchase and consume cannabis within the state, but only from these state licensed operators. I think that's important for people to know.
Hubert Klein: So it's more of an educational program that still has to continue out there as to what you can and what you can't do. I mean, people just will take it to one extreme for the decriminalization. And that's really where, again, educating the consumer of the product as to what you can and can't do. I mean, everybody's going to push the envelope, right? But that was not the intent of the whole process in any of the state legislatures to basically say "Everybody's got free reign to do what they want now."
Robert DiPisa: And think about it this way. There is a certain cost and time commitment that's associated with applying for one of these licenses, obtaining that license and then becoming operational. We've talked about it, the roadblocks, the cost associated with it. So we're in this kind of in between gray purgatory area for New York where I guess they have given out some cultivation licenses, but it's not really fully operational.
So what do you think is going to happen at the point in time when New York does become fully operational, they're firing at all cylinders and you have these state license operators who have gone through the correct protocol to get their license get up and running and they spent a lot of money to do it? Do you think they're going to be happy about having these legacy operators still operating an unlicensed retail location? No. And they're going to probably voice their concern to the Office of Cannabis Management. I'm sure it's going to flow up. And I'm sure that if New York really wants to end the legacy market, that they are going to start paying more attention to those legacy operators that are operating unlicensed retails and retail establishments and onsite consumption matters. So it's short --
Hubert Klein: While decriminalization is around, they could be a lot harsher on the legacy operators with the penalties, right? It's the intent, the motive, and how do you motivate somebody to move from one platform to the other.
Robert DiPisa: Correct. Correct.
Eric Altstadter: I think a lot of these companies that they haven't received it yet should be expecting a cease and desist letter from the various authority. I think that's coming. Or if it hasn't come yet, it should be coming.
Eric Altstadter: I guess, Rob, is it similar to somebody that their manufacturing alcohol out of a still in their house? It's illegal. I'm not sure it's much different than that.
Robert DiPisa: Correct. I guess home grows is a big social equity argument, right? We've talked about the price of cannabis in the regulated market when compared to the legacy market and how much of a differential there is there. So there's a lot of advocates who are fighting for the ability for individuals to grow up to six plants in their home for their own personal use as a way for them to be able to afford cannabis. A lot of people push back on this. I mean, from my perspective, first of all, if you think that you're going to be able to grow six plants in your house and you're going to successfully do it and you're going to be able to create... Good luck. This is very difficult. This is very sophisticated work. If individuals feel that this is a way that they can access cannabis at a much lower cost and they want to spend the time and commitment to growing it for themselves at home for their own purposes, from my view, provided that they're consuming it themselves, let them do it.
I think they're going to have a very difficult time doing it to begin with. If they are very committed to this, I think they're going to take a long time to educate themselves. Eventually, they will be successful and they'll have a yield from a plant that they can consume themselves at a much lower cost than it would cost for them to purchase it at a regulated business. But that just kind of goes to your bathtub booze example there. I just wanted to bring that up that that is something that is discussed a lot. It's more of a social equity measure.
I don't know if the home grow of cannabis will ever go away. Certainly it's discussed. People would like to see it implemented into the regulations. But here's the key factor. If someone wants to home grow their own cannabis and consume it themselves, that's one thing. But if you're going to grow cannabis in an unregulated market and give it to another consumer, I mean, that is the whole purpose of these programs, right? Get these products into consumer's hands, but it has to go through this regulated process where there are testing protocols just to make sure that everyone's getting the same product.
Hubert Klein: And taxes and excise tax protocols to go through.
Robert DiPisa: Well, of course. It's all about the taxes of course. Let's not forget about that small little detail.
Robert DiPisa: I think it's naive to think that taxes aren't the driving force behind all of this.
Hubert Klein: Right.
Robert DiPisa: Certainly, social equity is important. Certainly, the fact that it's taken this long for cannabis to be legalized is... But don't mistake it that the taxes and the dollars that will be going to the states and municipalities are a big driving force behind everything that you're seeing with this ripple effect going from state to state.
Eric Altstadter: We had another question from our audience and I'll paraphrase it a little bit. With New Jersey now having legal sales within the state and New York to do so soon, what do you see as regarding the surrounding states, what states are next?
Robert DiPisa: Do you want me to start? I'll start with this one.
Eric Altstadter: Sure, sure.
Robert DiPisa: From my perspective, I certainly see Connecticut, Pennsylvania, Delaware. I mean, obviously we already have it in Florida, but I mentioned earlier the Carolinas. I really see that you're going to see this wave now... I mean, certainly in the clusters of the Northeastern states. And then I think you're going to see this wave go down the east coast of the United States and then begin to travel back west to scoop up states such as Texas and things like that. But I think that's the progression that I'm seeing occurring. And usually, when you see a state go medical, that's almost like the first flag in the ground that you can almost calculate, "Okay. How many years before that state goes adult use?"
Hubert Klein: Right.
Robert DiPisa: What I'll tell you is, follow the MSOs. It's like the way people say, "Follow Warren Buffet's investments." So follow the MSOs. What the MSOs usually like to do is they like to position themselves in a position where they can get into a market when it first comes online for medical, because they're willing to play the waiting game to become fully operational so that they are the first to be able to sell to the adult use market within that state. And what we're seeing, or what I've seen at least over the course of the past 10 years, is a shrinking in the time period between which a state goes medical to them converting to adult use. It used to be a much longer period of time. But if you look at the states now, you will see that time period has now shrunk. The time period between medical and adult use is a much shorter period of time, which is much more advantageous to an MSO because they don't need to wait as long now.
Hubert Klein: Right. What I think you're going to see, Eric, too, the track that Rob outlined is what it is, but what I've seen and I've heard this too, Michigan and Illinois both have the laws but the price points are much different between the states. So people are going from Illinois to Michigan to buy product albeit illegal to bring it back across the state line. But border states are going to start figuring this out, that people in their states are consuming it like that border in the Northwest and all that, that "Hey, we better get on board with the medical or do something because our population's already purchasing this product from someone else" and they're missing out on the financial end of it. So everybody's going to figure it out over time. Like Rob said, it's going to happen quicker than it happened in the past.
With all these other states online, it's just going to be a mindset change within the population. If you talk to people under 30 and you explain... I mean, I'm in my 50's, the world I grew up in and the acceptance of this is much different in the world that they grow up in. That mindset is started to permeate into some of the more advanced ages, people in their 30's and 40's. Well, you get to 30 and younger, they're like they don't even know why there's opposition to it. So as that mindset changes throughout the country, the legislatures are going to catch up.
Eric Altstadter: I think just as this follow up to the two of you gentlemen spoke about, correct me if I'm wrong, there are only about a handful of states that I could think of that don't have any type of medicinal program in place. I mean, the environment has changed so much over the last few years.
Robert DiPisa: The group of states that have nothing in place has significantly shrunk. There's a great map that I would love to circulate. I guess I could find it. But MJBizDaily created it. It's a map that shows a time lapse. It shows each state converting to medical and then to adult use. It's interesting because they'll show it obviously starting with California. And California sitting there for a little while and then you see Colorado, Washington pop up, and then you see these states just all light up. And at the end, it shows present day of 2022 and where we're at. It's fascinating to see.
Hubert Klein: There's one online. I did a presentation last year for Kansas about that. I showed them the map, two 365-day apart maps of where it was, where it wasn't, and then present day. And it was just like it went from being blank in a lot of spots, but heavy darkened on the coast, to like, wow, it's everywhere and there's speckles of white where it isn't yet.
Hubert Klein: But then though states can have a lot of the medical, it's highly restricted though. There's not a lot of licenses in those states.
Robert DiPisa: Correct. New Jersey was like that. Go ahead.
Eric Altstadter: What's interesting also is there are enough states out there that have had a recreational use program in place for a while. Massachusetts has been selling legal cannabis for six years. Any state that's looking at the results and what's happened as a result of legalization within the state can look at Massachusetts as an example. I think that helps other states make this decision and move forward.
All right, gentlemen, we've got time for one more question before we call it a day. This is a great question. It wasn't put up by us, so I appreciate somebody asking this question. How important is it for a cannabis company to hire the right professionals, whether that be professionals at legal, accounting, insurance, or otherwise? Hubert?
Hubert Klein: It's probably one of the most important things that they can do. Having sound the legal advice throughout the process is very, very important. I mean, you, Rob, and I spoke offline about some of the trials and tribulations that we see people enduring. Spending the money is important from an accounting point of view. If you have to comply with the regulations on the excise tax to sales tax and 280E for the income tax, you're going to need some guidance. And finding the right insurance broker is very, very important because, Eric, you know a few people who are really, really focused on this industry.
Buying the right product for your business. Talk about business interruption. A lot of this. Rob talked about people growing stuff in their yard. It's not like having a vegetable garden growing some cannabis plants. It's a very pretty sophisticated thing. You're subject to weather and all these other things. So having the right advisors. Unless you are an expert in all those areas, you should hire some advisors. Eric and I have seen sometimes where people have hired advisors. The Information that they got didn't match up with what they were being charged. So, finding the right people and getting advice, or at least a listening board. But start always with good legal advice, because whatever happens, when it hits the proverbial fan, it's more of a legal issue first. So, I would say, get legal, then get accounting and insurance advice. But hiring the right advisors is paramount to a successful operation.
Eric Altstadter: Rob?
Robert DiPisa: I agree. I think a very important thing that you need to know is you never want your professionals cutting their teeth on your diet, right? So important questions to ask when you're interviewing professionals, how long have you been doing this? Where have you been doing this? When you're practicing in states that come online, there's a lot of professionals who start their practices at that point in time. You want to focus on those who have been doing it prior to that time, right? EisnerAmper. Just examples of people who have already seen this program progress. They've seen the bumps in the road before, and they're not going to be learning on your dime. They're going to be able to advise you on those obstacles so you could avoid it, which is going to end up saving you a lot more money in the long run as if you had to go and fix everything on the back end. Because I've seen that. And it's very costly, it's very time consuming.
Eric Altstadter: Well, before I turn it back to Bella, I want to thank everyone for joining us here today. I want to thank Hubert and Rob for joining me. Please keep your eyes open for follow up webcasts and related cannabis topics. This industry is just starting and there's a lot to discuss, so thank you.
Hubert Klein: Thanks, Eric.
Transcribed by Rev.com
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