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Budding Industry Battles Black Market

by Jun 8, 2020Agriculture, Magazine

Startup costs, complex permitting, and black market prices challenge legal marijuana business

Cannabis growing at Top Hat Cannabis in Juneau.

Top Hat Cannabis

A robust licensing and permitting process offers protection from federal prosecution for the Alaska cannabis industry, but the time and expense of participating in that process has created a market in which licensed businesses are vulnerable to being undercut by black-market prices.

When Alaska legalized cannabis for recreational use in 2015, the industry was able to quickly secure two prominent segments of the market.

“We were able to wrest very many individuals from the black market when the legal industry started. These were people who just wanted the convenience and could afford the higher prices, the people who really didn’t like only being able to go to their guy and just have whatever bags he had that day,” Good Titrations COO Brandon Emmett says. “And then we created a smaller but new consumer group: those individuals who like substances but are also very law abiding.”

Emmett estimates that those two segments only make up about 60 to 70 percent of the consumer base in the state; the rest of the market is composed of people who are making purchases based completely on price.

“Those consumers are almost impossible to capture; the black market is significant competition,” Emmett says. “Essentially, there’s 30 percent of the consumers—I’m speaking as a concentrate manufacturer—that we just cannot capture because you can go on Facebook right now… you could go on to many of these cannabis forums and identify and ultimately purchase cartridges and hard concentrates that are roughly 50 percent the cost of what you could if you were to purchase one of my products in a legal facility.”

The Price of Starting Up

One of the major hurdles Emmett and others faced getting their cannabis-based companies off the ground was the significant startup costs.

“[Three years ago] if someone didn’t have half a million dollars, they’d be crazy getting into this thing. If you wanted to get in now… I’d say unless you have a million dollars, don’t even try,” Emmett says, speaking directly to the costs associated with the permitting process.

One key difference between Alaska and other states where recreational cannabis is legal is that all parties involved in the business must be state residents, which exacerbates the challenges of launching a cannabis-based business.

“In Alaska, the regulators wanted to limit the economic opportunity to the citizens of Alaska, so they imposed the Permanent Fund Residency requirements as a baseline requirement to hold a State of Alaska issued marijuana license,” explains Jana Weltzin, an attorney who specializes in Alaska and Arizona cannabis law. “This means that you need to be an Alaska resident for the entire calendar year preceding the date that you applied for the dividend and intend to stay here indefinitely. The basic nuts and bolts of licensing requirements, other than residency, remain fairly constant across the board: adequate security measures, ability to show you understand the complex set of regulations you must follow, adequate business plan, camera storage, ability to connect with the state tracking software system on a real-time basis, et cetera.”

While the intention was to preserve the industry for Alaskan entrepreneurs, the significant start-up costs associated with entering the market means that Alaskans who do not have enough capital within their social circle to start the business are unable to secure out-of-state funding, according to Emmett.

“My counter-argument was, ‘No, you guys want it to be old, rich Alaskans only,’” Emmett says. “There’s only a narrow sliver of individuals who are allowed to get in: only Alaskans and only those Alaskans with significant resources.”

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Licensing Requirements

Despite the challenges of acquiring a license, a robust licensing system can benefit the companies that are able to see it through.

“As cannabis production and sale is still illegal on a federal level, the federal government still can come down on any state program or state actor for the illegal production and trafficking of a Schedule 1 substance,” explains Weltzin. “The states and the industry understand this fact and understand that, if there is not a robust state regulatory scheme protecting and safeguarding from the federal priorities, the state and its licensees are at risk for federal prosecution.”

Acquiring a cannabis industry license in Alaska requires interested parties to secure and be in possession of the premises they plan to use to grow, process, sell, or test cannabis. The building must meet all zoning requirements and be a certain distance from sensitive use facilities such as schools, churches, and rehab centers.

“Then you need to initiate the license, run your local notice ad, do your public posting, complete all sections of the application, pay your licensing fee, submit your fingerprints, and submit all your application documents to the licensing office for review,” Weltzin says.

Part of this process also includes securing permission from local government bodies, such as a city council or a borough assembly. In cases such as Kodiak City, where the city and borough jurisdictions overlap, entrepreneurs are required to go before both bodies to garner permission to establish their business.

“Alaska businesses have sort of a Wild West history—maybe it is up to code, maybe it isn’t, if it’s not, whatever,” Emmett says. “Not so with the marijuana industry.”

Even if a business is not required to get approval from a local government, the Alaska Department of Commerce, Community, and Economic Development’s Marijuana Control Board requires a cannabis business to be up to code.

“Once the licensing staff deems your application complete, you will be scheduled for one of the four yearly Marijuana Control Board meetings, and then your license will be considered by the control board for approval,” Weltzin says. “If the Marijuana Control Board approves your license, then you need to build out the facility in a manner that matches the diagram you submit as part of your application and have it inspected by the enforcement division of the state’s control office. If you pass that, you can start legally growing.”

However, before an interested party can begin growing they must also pass a federal background check and have approval from the Alaska State Fire Marshal.

The Tax Issue

In addition to startup costs and wading through the robust permitting process, legal marijuana operations are challenged to compete with black market prices because of the state’s tax structure, Emmett says.

“We have some pretty egregious tax policy and just really overbearing regulation, not just on the state side but on the federal side, as well,” Emmett says.

For marijuana to be legally sold in Alaska it must be produced and processed in the state. Flower, commonly called bud, is taxed at a rate of $800 a pound; immature flower is taxed at $400 a pound; and trim, the excess leaves cut off after a harvest, is taxed at $240 a pound.

“As new firms came into the market and competition increased, the laws of supply and demand drove prices down,” Emmett says. “We started to drive prices into this [pre-set] price floor—and you’re crashing headlong into this tax burden which is immobile. So, it’s not a percentage of cost of goods sold that’s recalculated by the government quarterly or yearly. It’s just a flat tax.”

The federal government still classifies marijuana as Schedule 1 drug as defined by the Controlled Substances Act, so Alaska marijuana companies face a significant burden due to federal tax Code 280, also known as the Eliot Ness tax, which was designed to capture revenue from illegal businesses. It prevents federally prohibited businesses from writing off anything other than the direct cost of goods sold.

“Operators pay lots of taxes. Cultivators pay state taxes, retailers pay city taxes, all of us pay federal taxes, so we pay into the economy in a big way with taxes alone,” Alaska Marijuana Industry Association President Lacy Wilcox says.

When recreational marijuana was first legalized in the state, prices were as high as $6,000 a pound, making it easy for businesses to turn profits despite the hefty taxes, Emmett says.

However, since then competition has become fierce, despite the barriers to entry.

Industry Growth

“As of April 10, 2020, there are 7,033 marijuana handler card holders; assuming that not all those with a card are currently employed—let’s just say for grins that half of them have jobs—that is 3,500 Alaskan jobs, and that helps the economy,” says Wilcox.

There are six different types of licenses issued by the Marijuana Control Board for businesses in the cannabis industry: retail marijuana store, standard cultivation facility, limited cultivation facility, marijuana product manufacturing facility, marijuana concentrate manufacturing facility, and testing facility.

Alaska’s climate has forced nearly all of the about 200 growers in the state to operate indoors, Emmett says. Their operations run similar to those of other indoor growers in the Lower 48. However, one major difference is that the facilities can’t smell like marijuana, which requires very effective ventilation systems.

Many of these growers are giving their strains of weed an Alaska touch.

“You can name a strain anything you want, that is why you will see common worldwide strains blended and genetically fine-tuned then ‘Alaska-fied.’ For example: Matanuska Tundra, [ATF], Glacier Berries, Alaska Thunder Grape, Purple Aurora, et cetera,” Wilcox says. “Call it what you want, but certainly, Alaska is known for its quality flower; we have had a long history with growing with relaxed home-grow laws in the state as long as I have been alive.”

MTF is an Alaska strain of legend, according to Emmett, who is doubtful that a pure version of the strain still exists today.

“It was a strain that was very popular in the ‘90s. And a lot of people think that it was stamped out… legend has it that there were some seeds that were brought back from Vietnam to Hawaii, and that became the Maui Wowie strain,” Emmett explains. “Then, a gentleman during the pipeline boom brought the Maui Wowie strain to Alaska and found a phenotype, found a cultivar, of that Maui Wowie strain that you could grow in greenhouses here and it would actually survive. And it was just incredible stuff.”

Emmett points out that it’s still possible to buy seeds or bud labeled MTF.

“There’s very many people that think that the strain may have gone extinct or may have been hybridized with others to the point of nonexistence. But Alaska is definitely thought of throughout the world and cannabis circles as having produced one of the very best strains of all time,” Emmett says.

Another carryover from Alaska’s history is less beneficial to the cannabis industry.

“We are still combating the reefer madness stigma. It still exists. There’s a small but very loud portion of the country, the community, that really thinks that marijuana is the devil’s lettuce,” Emmett says.

Cannabis law in Alaska continues to evolve even as one segment of the population pushes back against legal recreational use and another segment welcomes it.

“The main evolution has been the tinkering with the regulations to fit the real functions of how the cannabis industry and the regulations intertwine and work. The regulations were drafted with imaginations: how we think it would work; what we thought made sense; how we envisioned the regulated world of marijuana,” Weltzin says. “As with everything, real life is sometimes different than one imagines, and there are constant tweaks and modifications, which often have their own unintended consequences, that are being flushed out. We are also starting to see some consolidation between operators and mergers between companies.”

One such evolution is allowing marijuana use in retail cannabis shops; Alaska is the first state to do so, Emmett notes.

Alaska’s marijuana industry is still quite young, but changes in tax regime and regulations are the standard for every industry, no matter how well established. The construction industry contends with changing build standards, and the only sure thing about oil taxes is that someone wants to change them.

That said, this industry is in its early years and can grow to be a larger part of the state’s economy. Emmett says one of the best things lawmakers could do to support the marijuana industry is to review tax rates and policies to de-incentivize the number of individuals choosing to operate illegally.

“As a business person and as an industry association leader, I have championed reducing that tax burden with the argument not just so people in the industry can make more money but so we can be competitive,” Emmett says. “If we lower the taxes, and we’re able to out-compete the black market through economic principle and ultimately capture that extra 30 percent of revenue that’s not coming into the industry, then we can not only have profitable marijuana businesses, but the state can capture just as much or more revenue.”

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