Two years in, California’s legal marijuana businesses struggle with financial woes as they battle illicit market

recreational marijuana california, Two years in, California’s legal marijuana businesses struggle with financial woes as they battle illicit market

(Photo by Bobby Cochran Photography)

(This is the first installment in a three-part series marking the two-year anniversary of the start of legal recreational cannabis sales in California. Part 2 takes a broader historical perspective about how and why industry watchers believe the state’s licensed adult-use marijuana rollout has gone so poorly.) 

Licensed California cannabis companies face a business climate that’s arguably more dire than ever before, despite the hope that came with the launch of legalized adult-use sales in January 2018.

Many feel as if they’re on a death watch of sorts, waiting to hear about more layoffs or company closures, stemming from a chaotic mix of high taxes, a lack of local buy-in, high barriers to entry, skyrocketing compliance costs and unforeseen complications – including the vape crisis.

The difficulties led to a trend of many licensed companies struggling to pay business partners and vendors for inventory they’ve already stocked or services received, because they’re strapped for cash.

The desperation Javier Montes felt in early 2018 helps illustrate some of the challenges the California cannabis market currently must navigate.

Montes’ concern didn’t stem from the fact his Los Angeles cannabis shop, Delta 9 THC, was losing customers, or worries about the hiccups of the big transition of California’s marijuana market into a new and complicated regulatory framework.

He was having trouble finding Rick Simpson Oil (RSO) – a cannabis extract – for his mentor, the man who introduced him to the world of medical marijuana.

Cannabis devotees have used RSO for the better part of two decades to treat everything from cancer to chronic obstructive pulmonary disease, and Montes’ friend was suffering from a terminal case of the latter.

While RSO was common and fairly easy to find in the gray California medical market, it had suddenly become scarce, as legacy marijuana operators opted in 2018 for the illicit market amid the crazy hustle into the new legal cannabis landscape.

“It was difficult to source. Not everybody was online, or not everybody transitioned over,” Montes said. “As easy as it was to find RSO back then, it was really difficult to find once the transition started to happen, and we started to lose a lot of patients because of that.”

For Montes, that difficulty is emblematic of the turbulent rollout over the past two years of California’s newly regulated medical and recreational cannabis market.

Where things stand

While California remains the largest marijuana industry in the world, with nearly $3 billion in sales in 2019 alone, an estimated 80% of transactions still take place in the underground market, according to a report by Boulder, Colorado-based BDS Analytics and San Francisco-based Arcview Market Research.

That’s a number that jibes with most California industry insiders, who say the illicit market is arguably stronger than it’s been since before the state initially legalized medical cannabis in 1996.

By that metric, Proposition 64, which legalized recreational marijuana in California in 2016, has been “the most colossal screw-up I’ve ever seen,” said Troy Dayton, Arcview’s co-founder and chief strategy officer.

The legalization initiative – which was a divisive ballot measure even within the state’s MJ industry – argued within the text of the measure itself that, if it passed, legal cannabis companies would “incapacitate the black market.”

While that might happen in the long term, the past two years have played out in the exact opposite way than what Proposition 64 backers had hoped to see.

“The perfect storm has occurred here in California, with taxes and regulations,” said Andrew DeAngelo, co-founder of Oakland retailer Harborside. “We learned that we got this very, very wrong.”

Not only has the number of businesses operating legally in California shrunk by tens of thousands, but in late 2019, cracks began to appear in the licensed market – a hint that many legal operators might not survive despite immense demand for quality cannabis in the state.

Bills going unpaid

After layoffs at both large and small companies up and down the supply chain – which included MedMen, Pax Labs, Cannacraft, Grupo Flor and others – reports surfaced that many businesses are delinquent in paying their bills.

That likely stems in part from sales lost to illicit marijuana dealers and a general lack of income.

“Going into the year, I’m not aware of any major companies that are profitable,” said Chris Coulombe, CEO of Pacific Expeditors, a Sonoma County-based distributor, and co-founder of the Cannabis Distribution Association.

“The money that retailers owe us is in the hundreds of thousands of dollars, and we’ve paid hundreds of thousands out of pocket to make sure that the revenue continues upstream,” Coulombe said.

He predicted a “seizing” of the cannabis supply chain in California by summer if retailers aren’t able to somehow obtain lines of credit or find new sources of income.

But he doubts that’s going to happen, in part because of the 2019 retreat of many investors due to the cratering of cannabis stocks in Canada.

Beyond that, Coulombe and others said, it’s common industry knowledge that many state-licensed companies are playing both the legal and illegal markets, but it’s mostly because they’re desperate for income to keep their businesses afloat.

‘Standing on stilts’

Coulombe predicted an industry “bloodbath” in 2020 unless California officials take drastic action to alleviate financial pressure on legal businesses, whether through tax relief, the opening of more legal retail outlets or other options.

The problem isn’t only with retailers, said Swetha Kaul, former chief scientific officer at Santa Ana-based testing lab Cannalysis.

Before she resigned from the lab in December 2019, Kaul said she conferred with many other labs and ancillary vendors such as software companies and concluded the nonpayment of bills had become an “epidemic.”

“Most labs I’ve talked to, most people are talking about more than a few hundred thousand (dollars). If you expand that across all the labs, it’s probably a few million just owed to labs,” Kaul said.

“If the basis of our entire market can’t even make ends meet, we’re kind of standing on stilts.”

The situation has become so fraught with fear that the California marijuana industry rumor mill has begun churning out premature obituaries as insiders wait for companies to fold.

One such incident occurred recently when Oakland-based East Bay Express reported that Coulombe’s company, Pacific Expeditors, had gone under when, in reality, the business is still operational.

If drastic systemic changes aren’t enacted in 2020, Kaul fears other companies might follow The Guild, a San Jose retailer that was auctioned off last year after creditors foreclosed.

The court-appointed receiver in that case, Scott Yahraus, told Marijuana Business Daily he’s already been selected to manage a deeply indebted retail shop in L.A. and is about to be chosen to run a second in the same city.

That’s not to suggest that California’s legal market can’t be saved, Kaul and others said.

But some companies might already have crossed the point of no return.

John Schroyer can be reached at [email protected]

13 comments on “Two years in, California’s legal marijuana businesses struggle with financial woes as they battle illicit market
  1. uck on

    Hell yes there are way too many regulations and taxes to be compliant in the legal market. Testing regulations mean that product on the shelves is roughly 6 months old, it’s lower quality than the consumers are accustomed to and at a 25 % + markup than prices were before prop 64. Cdfw and the waterboard are a cash grab joke they only care about fees fines and extracting cash from cultivators. Everyone who went legal in 2016 is trying to sell out and no one is buying because they don’t make money. Distribution companies are fly by night they come and go and rip retailers and cultivators off all the time with no recourse. Im a long time commercial scale cultivator from northern California been deeply involved in the gray market for the last 14 years. There is no incentive to go legal, it’s a bureaucratic nightmare every single legal company that I know of is definitely operating in the traditional market still because there’s no money in the legal one. They need to get rid of the cultivation tax and get rid of the 28% excise tax I don’t know why the state can’t just be happy with receiving sales tax I don’t know why the state needs to overly regulate and overly tax every single new industry. The way things are going The industry is going to be concentrated in just a few hands and I think that’s by design.

    • Pat on

      Can’t disagree. The state is a disgrace. But, they keep going with it; with all the evidence before them that it’s just not working. They were hoping to “buffalo/intimidate” their way through it. But, they ignored the population of folks that they were dealing with. And, the constitution of this bunch has been known for well over 1/2 a century. Just like the French’s failure in Vietnam 1940’s-1960’s, the U.S. thought they could p/u where the French left off. Even with supersonic jets, the best artillery, well ( over ) funded and advanced military, the U.S. Federal Gov. persisted for 10 godamm years. And for what? Oh yeah…For the big military contractors ( big oligarch pot businesses ) to sell their stuff. But at what cost to the tax payer?? The U.S, soldiers ( mom/pop shop’s pushed out and then prosecuted for con’t their operations ) killed/maimed. Same story.

    • Rod Gass on

      You’re correct UCK in what I hear you saying. There’s even more.

      The mistaken mindset that “The Industry” is anything but an obstruction, is the failing foundation of “legalization” or $64. What industry? It’s ALL a farce.

      The Cannabis Culture is still alive and doing very well in California. Cannabis and it’s consumers don’t like “The Industry”.

      Sure, sure eventually we’ll see the biggest players absorb their own “Industry”. But our real and honest Cannabis Culture will continue to be the only relevant voice speaking. The “Industry” will talk to the regulators and demand more armored troops be sent out into the populations to prohibit honest operators.

      We’ve been treated to a slow motion lesson on how bad law ($64) can’t rise to control the natural order. Cannabis doesn’t require regulations. Taxation and enforcement require regulations. Nobody wants nor needs this huge mistake to continue.

      No, it’s time to eliminate the darkness of $64. Repeal is coming.

  2. J Burnside on

    California is failing because they did not follow the successful model established by Colorado. Like everything in California they over-regiulate to squeeze as much tax revenue as possible. Way to go!

  3. Harold Baker on

    Why would I want to pay 2 and 3 times the price plus tax for your products when I can get the same stuff from a friend. Once the novelty of buying legal weed wears off you go where the bargains are.

  4. Erik on

    The above board industry has been fractured since it started in the late 90’s early 00’s.
    and we have been picked apart. I don’t know if unity among the Cannabis industry is possible, but until it can happen, people can put their ego’s aside, and us long term operators can get the systemic reforms we need regarding over burdensome regulations and taxation, It will only get worse. And the current system is unsustainable.
    People need to get involved. The Southern California Coalition is a group that has been punching above their weight, and are trying to get taxes lowered.
    More people need to step up and be part of the solution.
    just a lot of endless complaining about how tough the regulated side is. But very few people actually kicking in on making changes happen.
    until more do, the industry will remain crippled.

  5. Elmer on

    It sounds like a dilemma you greedy retailers created for yourselfs. Now you want the state to step in and stop the illegal pot dealings. You all are a bunch of idiots because all you was seeing was the profits you could line your pockets with. Nobody looked at the long term effect of an over supply of weed. No problem, file bankruptcy, then kick back and enjoy the BUZZ. By the way; if you aren’t a pot user you shouldn’t be allowed to sell it. Pot is like gas the more abundant supply the cheaper it is. BE HAPPY that you can light up without fear of going to jail. I live in 1 of the sorry ass States where the governor says pot will never be legal as long as he is governor.

  6. BoomAndBusted on

    How long can California claim its impossible to eliminate a black market with legalization when its already been done in three states before us? It’s pathetic, and the people who will lose out are all of the small farms that were tricked into believing that if we came into the light and paid to go legal, the state would hold up its side of the bargain by shutting down illegal operators. And the whole time, the regulators nod sagely and say, “yes, all is going just as planned!”.

  7. Jack Velez on

    I am in Philadelphia/ New Jersey an lookin to get into the business as i have associates in the business but lookin to Network outside of my circle. Please call or text 856-882-2888

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