Any start-up has its risks and challenges, and the cannabis industry is no exception.
If you’re thinking of launching a new cannabis cultivation business in 2022, consider the following ten points before you make the leap.
1. Cannabis becomes illegal in the US (again).
Although unlikely, a regression in cannabis policy is possible—especially in the United States. Unlike Canada and Uruguay, where cannabis is federally legalized, regulations governing cannabis in the United States differ from state to state. Every cultivator operating within state laws is still in violation of federal law, so a retreat to country-wide criminalization is still conceivable, and any excuse could push lawmakers in that direction. A cannabis-related health scare or changing political majorities could force the progress made towards cannabis normalization backward again—placing all cultivation businesses at risk.
2. The legal situation remains unchanged in the US.
Section 280E of the Internal Revenue Code does not allow cannabis businesses to deduct ordinary business expenses from gross income since they are associated with the trafficking of a Schedule 1 substance. Instead of deducting expenses and paying taxes on profit earned, cannabis businesses must pay federal taxes on gross income. As a result, cannabis cultivation businesses are much more expensive to operate than other legal businesses in the US. In the absence of federal legalization, banking will also continue to be an issue for cannabis businesses. Most can’t open bank accounts, accept credit cards, or apply for bank loans.
3. Cannabis becomes federally legal in the US.
Ironically, the complete legalization of cannabis in the US could also pose a business risk for cultivation entrepreneurs. Once large pharmaceutical, alcohol, and tobacco companies enter the US cannabis industry, this will pressure smaller companies to survive. Currently, interstate transportation of cannabis is prohibited, so everything sold in a dispensary must be grown and processed within the same state as that dispensary. Federal legalization will permit interstate transport, allowing companies to cultivate in massive facilities and distribute throughout the country. This scenario could force smaller cultivators out of business.
4. Exorbitant taxes drive consumers back to the illicit market.
Cannabis sales in the US are subject to excise, cultivation, distribution, city, and state taxes. They are higher for recreational sales, and in some states, they can increase in lockstep with the concentration of THC in the product sold. These taxes can be prohibitively high for the consumer. For those new to cannabis, dispensaries are the best option, but for someone with “connections” or at least access to the Internet and some creativity, the illicit market is a more economically attractive option. One gram of cannabis on the US illicit market costs $5-10 per gram, while legal cannabis can run between $15-25 per gram. Factor in taxes and the dealer on the corner could be your biggest competitor.
5. Laboratory production of active ingredients could render cultivation unnecessary.
Cannabinoids are the chemical compounds in the cannabis plant that affect the human body when consumed. Over 100 different cannabinoids exist within the plant, although THC is the most commonly recognized since it produces the psychoactive “high” when consumed. Scientists have developed a method for making these cannabinoids inside of the laboratory by using yeast to turn sugar into cannabinoids. Production is a fraction of the cost of a typical greenhouse or grow room with a much smaller carbon footprint. The race is on to produce lab-grown cannabinoids on a commercial scale—potentially putting commercial cultivators out of business.
6. Government delays leave licensed cultivators in limbo.
Once a state or federal government legalizes cannabis cultivation, it’s not always a smooth ride to the first sale. In the US, it takes 2-3 years from the day a law is passed before consumers have access to medical or recreational cannabis. In some countries, governments quickly accept cultivation license applications (and the accompanying fees) but then drag their feet when granting permission to cultivate, sell, or export. Government delays can squash a cultivation entrepreneur’s chance of launching a profitable business.
7. Medical cannabis patients choose a caregiver model over dispensaries.
In some US states where medical cannabis is legal, the government approves a medical caregiver system. When a patient receives a prescription to use medical cannabis, it is usually specified in grams per day. Or, if they choose to cultivate their own plants, the state allows a plant limit per person. If the patient chooses not to cultivate, they can elect a “caregiver” to grow their plants for them. Caregivers charge the patient a “donation” per gram of cannabis grown, and the personal relationship and low caregiver prices can be much more attractive than the services of a dispensary. This diversion of market share could leave commercial cultivators without a customer.
8. Price instability leaves cultivators at the mercy of the market.
When a country or state first legalizes cannabis, dispensaries can’t keep products on the shelf. Initial demand is always greater than supply, and the inaugural crop that took five months to grow sells out in a week. Demand is high, supply is low, and available cannabis sells at a premium. But once supply eventually meets and exceeds demand, oversupply creates downward pressure on prices. A pound of wholesale cannabis in a hot US market can sell for more than $4,000, whereas a saturated market will pay about $500. Seasonal outdoor harvests only aggravate the issue, making price control hard for cultivators.
9. Raising money becomes difficult for cultivation businesses.
Raising money was easy for the first few years of legal cannabis in Canada. People with no experience raising funds quickly acquired millions of dollars on business valuations that made no sense. Today, this run in Canada is over, and large cultivators that are not yet profitable are forced to sell assets, lay off staff, or face bankruptcy. In the US, investors are cautious not to repeat the Canadian example. This capital crunch could restrict a cultivation entrepreneur’s ability to acquire the start-up funds critical to launching their business.
10. There may be significant crop failures.
No commercial grow operation is perfect—whether it’s cannabis, corn, or cucumbers. Business owners should anticipate crop losses of about 5-8% in an average year, but insects, disease, and a lack of growing experience could force losses much higher. Even healthy plants can be damaged in a matter of days if the crop is not harvested and processed correctly. Repeated crop failures can place a new cultivation business at risk of going under if enough capital is unavailable to keep the company afloat until production is stabilized. For centuries, crop failures have been an operational risk for farmers, and the cannabis cultivation business is no different.
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