Cannabiz: The High Profits and High Risks of Legal Marijuana

Jared Wade


November 2, 2015

legal marijuana industry

When Colorado and Washington legalized marijuana in November 2012, a century-old black market turned into a legitimate industry almost overnight. Well over $1 billion of marijuana has already been sold in the two states since the laws were implemented in 2014, spawning what some call the “green rush.” Entrepreneurs are now pushing the industry to a level of sophistication that few could have previously imagined.

“In the past two years, I have seen a major shift in the business owner,” said Pat McManamon, the director of Cannasure Insurance Services. Many legal operators in Colorado and Washington are not new to the business, having sold marijuana for years—maybe decades—before an end to prohibition allowed them to emerge from the shadows. But now new players from industries that have nothing to do with cannabis are changing the landscape. According to McManamon, they are “bringing a level of professionalism that wasn’t there when I started in 2009,” when a fledging medical marijuana market “was the Wild, Wild West.”

Colorado is now swimming in so-called green-collar jobs, Washington is flush with investors, and companies are getting ready to sit back and watch green buds turn into greenbacks. Unfortunately, it is not that simple: The marijuana industry can be a minefield, and it is only getting more complex.

The Cannabis Catch-22

One of the biggest stumbling blocks to a viable marijuana business is also one of the most basic: It is still illegal. “All marijuana production and sale in the United States is prohibited by federal law,” said Denver University Professor Sam Kamin. “The first thing any good lawyer would tell someone getting into this business is that you could lose everything and go to prison for the rest of your life.”

Kamin began his career in 1999 as a criminal and constitutional law professor at the university. Somewhere along the way he started focusing on the consequences of the war on drugs. He wrote papers, was appointed to the governor’s task force for ending prohibition, and accepted a position as the Vicente Sederberg Professor of Marijuana Law and Policy at Denver University’s Sturm College of Law in May.

Although the actual risk of federal prosecution is minimal, Kamin said, it will not go away entirely until Congress changes the law. “On January 20th, 2017, we get a new president and a new attorney general, and anything is possible,” he said.

Marijuana is on the nation’s Schedule I list of banned substances, along with cocaine, heroin and methamphetamine. As long as that federal prohibition is in place, it will be the biggest barrier to creating a legitimate business based on marijuana, since banks will not deal with marijuana sellers until it is reclassified.

If a financial institution knowingly puts money made through drugs into its vault, it is technically breaking the law. While the feds have told banks they have no interest in prosecuting transactions made by compliant retailers in regulated states, banks and financial institutions are playing it safe. “If Visa and Mastercard find out your account is generating revenue off of the proceeds of marijuana, they will shut it down,” said Ian James of the consultancy Canna Advisors.

So, just like in the days of illegal drug-dealing, the marijuana industry in Colorado and Washington is still essentially a cash business. “It’s the biggest irony of the whole thing,” James said. “Here we are trying to legitimize this industry and stop the money from going to the black market. And [they have] set up this program so you can do it, but it’s cash only. It’s stupid.”

This policy not only makes day-to-day operations a logistical challenge, but also creates safety concerns. Marijuana sellers still share the market with criminals (who have not gone away entirely), so having so much cash on hand—along with a product that is worth as much as $2,000 per pound—increases the existing robbery risk.

McManamon thinks the industry has protected itself well so far, “going over and above what most businesses would do” by installing cameras, alarm systems and even traps that can catch bandits trying to raid a field. In addition to high-tech protection, however, he says companies need to train employees about the threats they may face in such unique work environments. Even an idle conversation about business in a bar could create risk if it is overheard by criminals.

Unsafe to Eat

Ensuring safety is not just about protecting employees and assets, but also about scrutinizing the products being sold. In the first year of legal sales in Colorado, customers bought nearly five million units of brownies, cookies, candies, beverages and other items classified as marijuana-infused “edibles.” The popularity took everyone by surprise, and has also created problems as many consumers know little about what they are putting in their stomachs.

“Most people know what a joint does to them, but they might not know what a marijuana brownie does. The onset is slower, the potency is higher, and sometimes the consistency from one bite to the next is not the same,” said attorney Brian Vicente, a co-author of Amendment 64, which legalized marijuana in Colorado, a former student of Professor Kamin, and a partner with the law firm Vicente Sederberg, which established the Denver University professorship. “We’ve had a thoughtful discussion in the state about how to educate consumers on the fact that it might take two to four hours for you to feel an effect from that edible.”

The issue became tragically clear when Levy Thamba, a visiting college student, fell to his death from a Denver hotel balcony three months after recreational sales began. He reportedly ate a marijuana-infused cookie that contained six times the recommended dosage of THC, the psychoactive chemical in marijuana. Its packaging indicated that the cookie contained 65 milligrams of THC and listed the serving size as 10 milligrams, but the high-profile accident convinced regulators that such labels were insufficient as a warning.

In February 2015, Colorado introduced strict packaging laws designed to prevent consumers from mistakenly ingesting unsafe levels of THC. For example, stores can no longer sell large cookies that consumers must cut up on their own before eating. Products also must be individually-wrapped or clearly scored into single-serving portions.

Legislative Uncertainty

Although few of the dire predictions made by legalization opponents have come to pass, Thamba’s death underscored a very real concern about product safety. That is why IT expert John Brown helped found Analytical 360, a Seattle-based testing lab designed to fill the market’s need for resources to keep marijuana users safe. What he did not anticipate was learning a lesson about the complex legislative risk that underpins the entire industry.

Brown and his team were ready to open their lab as soon as Washington passed a 2011 bill legalizing medical marijuana dispensaries. Previously, the sector was largely unregulated and, along with other developments, the new law would ensure all the cannabis sold was subject to stringent testing. But then-Governor Christine Gregoire vetoed the part of the legislation that Analytical 360 had based its business model on, due to concerns that the feds would prosecute the state if she authorized medical dispensaries. A type of clinic known as a “safe-access point” survived the veto, but this did not ensure business for the lab. “They weren’t required to test,” said Brown. “So we had to basically build up our company by getting people interested in testing since it wasn’t mandated… We thought it was going to be nice and easy, but it was a struggle at the beginning to build our consumer base.”

Analytical 360 has not been the only victim of such legislative and bureaucratic uncertainty, and it continues today. In May, for example, after necessary business licenses were unexpectedly delayed, Shawn Phillips, owner of nine marijuana stores in Colorado, was forced to put major expansion plans on hold and fire 65 employees—almost half his workforce.

Analytical 360 was more fortunate. It was able to shift its business model to provide voluntary testing for mold, fungus, E. coli, salmonella, and other potentially harmful organisms while it waited for marijuana laws to change. Once voters legalized recreational marijuana, mandatory testing requirements were reinstated and the lab went from surviving to thriving.

Today, its core business is still in safety, but the company is turning next to genetic testing, which Brown believes can give marijuana growers a competitive advantage. Early in the process, they will be able to tell growers whether a plant is male or female, which is key to maximizing the number of plants. They will also be able to definitively tell sellers what strain of marijuana they are growing. Currently, identification is something of a guessing game. As each strain has certain psychoactive or medicinal properties, having proof in plant DNA could allow shops to differentiate themselves among an increasingly savvy customer base. “When you go into the store now, you’re going to see 100 different strain names,” Brown said. “Some of them may be true, some of them may not be. So we’ll use technology to say that this plant here is an OG Kush—and can verify it actually follows the generic traits of OG Kush.”

Here Comes Everybody

The green rush is proving to be both a gift and a curse. For Brown, legalization has vastly expanded the potential for growth. “I wouldn’t say everyone is rich yet, but the prospect is there for a lot of people,” he said. Like the California gold rush of 150 years ago, however, it is also bringing out-of-state prospectors trying to strike it rich. For example, after surviving years of uncertainty, Analytical 360 has found itself awash in competition. Since the legalization of recreational marijuana, he said, the number of testing labs in the state has jumped from three to 30. “We thought we won, and now we’re back to the beginning,” he said. And that is merely one front in the all-out war looming in the industry at large.

With venture capitalists entering the market and the wholesale price of cannabis dropping dramatically in Colorado, many small-time shops are struggling to stay in business. Some will profit as they bow out to larger firms, while others will go under. “As prices continue to drop, more people will get squeezed,” James said. “We’ll see a round of consolidation, which is to be expected in any industry. It’s just happening here at warp speed.”

Kamin agreed, “We’re probably going to see the number of stores and growers in Colorado drop. We just don’t need 600 stores to do $700 million in business.”

Those that are already struggling have more trouble on the horizon: national legalization. Nobody knows if or when it will happen, but many see it as inevitable. Oregon and Alaska have legalized recreational use, with sales to start next year in Oregon. Polls project California and several other states will follow suit at the voting booth in 2016.

If the national prohibition is lifted, some predict a “Walmart of Weed” will emerge. A company like cigarette maker Phillip Morris could leverage its economy-of-scale and distribution network to run mom-and-pop sellers out of business. States that have legalized marijuana currently require that it be grown, distributed, sold and consumed within state lines. This is a barrier to entry for large corporations, which can look at the relatively small profit potential in states like Washington and Colorado (with populations of seven million and five million, respectively) and choose to forego the hassle and any possible reputation hit from selling cannabis.

But that could change with national legalization or even by simply removing marijuana from the Schedule I list of narcotics. “When we move off of Schedule I, that’s going to open up research [funding], it’s going to open up banking and, theoretically, it could open up interstate commerce,” James said.

Kamin used the analogy of beer production. “All the hops for all the beer in the United States are grown in a few very small plots in Washington, Oregon and Idaho,” he said. “Even though we produce an enormous amount of beer, we don’t need to grow hops all around the country. We grow it where it grows best, and then we ship it around the country. The difference between the hops plant and the marijuana plant is not that profound. If this was a legal, nationwide industry, we wouldn’t be growing marijuana all around the country; we would be growing it in Humboldt County [California], Pueblo, Colorado, and maybe somewhere in Tennessee, and that would be it.”

While the end of marijuana prohibition—at least in a few jurisdictions—draws apt comparisons to alcohol’s re-legalization in 1933, James sees another angle. He looks at those entering the industry now as gamblers, and considers the cannabis industry just another in a long line of young, promising sectors that have come and gone over the years. “It’s a bet,” he said. “This is typical business-lifecycle stuff. With any new industry that comes online, you have your early adapters. Those that get in really early have the potential for really big returns, but they’re taking on a lot of risk.”

Jared Wade is a freelance writer and a former editor of Risk Management.