New MJ States: The Road to Recreational

More states are gearing up to legalize cannabis for adults. What regulations will govern the industry in these markets, and how will they define business opportunities?

by John Schroyer

The next generation of recreational marijuana is on the horizon. Colorado and Washington State paved the way for retail cannabis in 2014, laying down the first blueprints for a brand new industry. Now, two more markets that recently passed legalization measures – Alaska and Oregon – are gearing up for the launch of recreational sales, and additional states will likely join the list in the near future.

Ballot measures and legislative bills to legalize marijuana for adults have already been introduced in dozens of states across the nation, and insiders say eight of them stand a good chance of passing. Other states could pursue legalization this year or next as well.

All told, the number of markets with recreational marijuana could double or even triple in the coming years, which would lead to plenty of new players and hundreds of millions – possibly billions – of dollars in cannabis-related commerce.

All of which raises some big questions for entrepreneurs. What general legal framework will these states employ for the industry? What will future regulatory systems look like in terms of everything from taxes to residency requirements and business caps? And, more specifically, will the next states to legalize rec take cues from Colorado and Washington State or forge their own path and develop a completely different structure?

The answers to these questions will determine the overall opportunities for cannabis businesses and, ultimately, the size and strength of these new markets.

By all indications, it seems states will chart their own course in many areas but also cherry pick certain aspects of the regulatory framework implemented in Colorado and Washington.

“It’s not about whether the Colorado model is the thing or the Washington model is the thing,” said Ryan Agnew, a Seattle-based attorney who works with the cannabis industry. “It’s going to be very state-by-state.”

Common Threads

One way to get an idea of where the industry is headed is to look at legislative measures that have been introduced in various states recently, as well as examine proposed rules in Alaska and Oregon.

Though there are a lot of substantive differences, there are a handful of regulatory ideas that have gained widespread support.

For example, child-resistant packaging is a popular rule that’s being supported in proposed regulations for Alaska, Oregon, Vermont, Maine, Massachusetts, Nevada and Rhode Island. Along those lines, many proposed ballot initiatives and rules include further protective measures such as mandatory testing, single-serving packaging requirements for edibles and potency disclaimers.

Another issue that’s popped up repeatedly is the desire to undercut the black market by keeping taxes at a reasonable level. For example, the Ohio cannabis campaign that’s shooting to legalize both rec and medical marijuana this November would establish a special flat 15% tax rate on gross revenue for marijuana producers and manufacturers, and a 5% tax on retailers. A ballot measure in Nevada for 2016, meanwhile, would institute an excise tax of 15%.

Based on this evidence, it’s unlikely new recreational markets will enact the hefty taxes seen in Washington State, where a 25% rate is assessed at three separate stages of the supply chain.

Zoning is another topic that crops up repeatedly in bills and initiatives. The most common proposal on this end: Marijuana businesses will have to be at least 1,000 feet from schools and childcare facilities. (Alaska seems to be the odd man out on this one – a bill in the state Legislature to regulate the rec industry would only require businesses be 200 feet from schools.)

There’s also a desire in several measures to merge the medical and recreational sides of the industry to some degree, though not necessarily in an explicit way. Proposed measures in Nevada and several New England states, for example, would give first crack at recreational licenses to already-established MMJ dispensaries, which would allow shops to sell both rec and medical cannabis. That’s a staple of Colorado’s cannabis industry, but not part of the regulations in Washington State.

Big Differences

It’s clear, however, that states aren’t adopting a one-size-fits-all regulatory scheme, as the differences in proposals far outweigh the similarities.

“We looked at a range of options and regulations,” said Vermont state Sen. David Zuckerman, one of the prime sponsors of the Vermont rec bill. “There is no perfect model. We’re trying to create one that works for Vermont.”

Some of the biggest differences in proposals involve whether to cap the number of businesses, what types of permits will be granted and whether vertical integration will be mandatory – or even permitted at all. Each measure takes a widely different approach to application and licensing fees, with some proposals calling for much higher charges than others.

Take Alaska. After legalizing recreational marijuana last November, state lawmakers are now considering regulations on the industry that incorporate a few ideas from both Colorado and Washington, as well as some new proposals. The draft rules would create a whopping six types of business licenses: marijuana producers, processors, retailers, testing facilities, boutique producers, home growers and brokers – a very different structure than either of its two predecessors.

If the Alaskan bill passes as introduced, it’ll contain an excise tax of $50 an ounce for flower, along with a $5,000 fee for business licenses. Notably, the state would not implement a cap on the number of business permits it issues, if the regulations pass.

Other states are taking a different approach.

The Vermont Legislature, which is expected to legalize rec either this year or in 2016, would likely back a version of an already-introduced bill that would contain a limit of 42 rec vendor licenses. The bill would establish an excise tax of $40 an ounce on flower, $15 an ounce on “any other marijuana,” and $25 on immature plants sold by cultivators. The proposed annual fee schedule ranges from up to $50,000 for large-scale cultivators to $30,000 for rec shops to just $5,000 for testing labs and infused products manufacturers.

That’s just one example of the disparate taxes, fee structures and other limitations the industry can expect to grapple with in coming years.

In-state residency requirements for ownership of marijuana businesses is another that’s gaining traction, though not everywhere. There are varying versions of such requirements being debated in Alaska, Maine, Massachusetts, Oregon and Vermont, but not in Nevada, Ohio or Rhode Island.

“The (Alaska) Legislature will almost certainly try to include some sort of residency requirement,” said Ben Adams, a California-based attorney who’s moving to Alaska to set up a cannabis-specific practice. “They’ll try to protect the industry for Alaskans.”

That might not be such a good thing for the industry, some argue. Residency requirements can sometimes hamper business development and investments, not to mention expansion opportunities for existing marijuana companies.

Oregon, which legalized recreational marijuana last November through the passage of Measure 91, seems to be on the other end of the spectrum in this regard, though the state’s Liquor Control Commission is recommending a residency requirement for recreational marijuana business license applicants and companies.

“What’s in (Measure 91) is to allow a whole lot of money to come in to fund a whole lot of production that’s going to have the lowest tax out of any state’s proposal that I’ve even heard about, especially in comparison to Washington and Colorado,” Agnew said.

Another hot-button issue: Vertical integration.

Forcing or allowing businesses to grow their own cannabis and sell it via retail stores is on the table in Alaska, Oregon, Rhode Island and Maine. But in some proposed regulatory structures – most notably Ohio’s – vertical integration isn’t even a consideration.

If Ohio’s ballot measure passes this November, in fact, recreational stores and dispensaries (the proposal would legalize both rec and MMJ) would have to purchase their inventory from just 10 large-scale cultivation sites. The state would have the flexibility to authorize further cultivation facilities if it finds that the initial 10 can’t meet demand. But the same ballot measure would also allow for more than 1,100 rec shops to be licensed across the state and a yet-to-be-decided number of MMJ dispensaries.

There are also occasional eyebrow-raising ideas slotted into otherwise-dense regulatory language. For example, the Ohio measure would establish a “marijuana innovation and business incubator” in Cuyahoga County, which includes Cleveland. The incubator would be dedicated to research, development, economic development and generally supporting the cannabis industry.

Notably, some states are considering legalizing on-site consumption at rec shops, and some are toying with the idea of legalizing cannabis lounges.

A bill in the Massachusetts General Assembly, for instance, would legalize “cannabis cafes” where “adults may purchase marijuana and marijuana products, and, in the company of other adults, consume them.” The Vermont bill would legalize “marijuana lounges” that would also be allowed to sell non-alcoholic food and beverages. Customers could purchase rec cannabis at a lounge and either partake on-site or take it home with them. In Maine, one of two dueling ballot measures would allow for “retail marijuana social clubs” that could sell rec cannabis, but customers would be required to consume what they purchase at the club.

Looking to the Pioneers

Most states and advocates crafting legalization proposals are taking a hard look at regulations in Colorado and Washington for guidance.

There are significant differences between the two markets. For one, Colorado has no cap on the number of marijuana businesses that can be licensed, either for rec or medical, while Washington has a statewide limit of 334 rec shop licenses, but no cap on cultivators or processors. And in Washington, no vertical integration is permitted, while in Colorado, it was originally required, and many businesses still employ it today.

But perhaps the most notable difference between the two is in the tax structures. In Colorado, there’s a 10% sales tax on recreational marijuana sales to the consumer, along with a 15% excise tax. Washington’s (as mentioned earlier) is much more dramatic, with a 25% tax assessed at three parts of the supply chain. Most of these costs are passed on to consumers, meaning higher prices. That, in turn, makes it harder to drive people away from the black market.

One loophole in Washington that some cultivators and processors have exploited is that companies are allowed to hold licenses for both of those operations, though not retail licenses. In coupling growing and processing, some companies can cut out one step of that 25% excise tax and undercut competitors on prices offered to rec vendors. Still, the overall tax burden can be stifling.

Because of the tax structure, Washington State’s model is widely viewed as a “disaster” by those in Oregon who are involved in the cannabis trade, said Portland attorney Amy Margolis.

“There’s that perception about Washington because we know what the tax situation is,” Margolis said. “We’re hearing so many negative things about what’s happening. We’re hearing that black market dealers are sitting in the parking lots of dispensaries. People from Washington aren’t coming here and saying, ’This is working really well.’”

The chairman of the Oregon Liquor Control Commission – Rob Patridge, who has been knee-deep in coming up with workable state regulations for rec – also agreed that his state will likely be looking more to the east than to the north for suggestions.

“We really believe that marijuana in Colorado is the better model, and the closer model to what we’re going to emulate,” Patridge said.

He also hedged his analysis, however, adding that the agency is “going to do this Oregon’s way.”

Leaning on MMJ

One reason for Colorado’s largely successful rec rollout is the fact that the state already had a carefully-crafted medical cannabis system in place.

“Because we already had a successful model of a regulated medical industry, we did the right thing as far as initially allowing those medical licensees to move forward on getting rec,” said Meg Sanders, a managing partner of Mindful, a medical and recreational cannabis chain in Colorado.

Sanders is also a former member of the task force that Colorado Gov. John Hickenlooper appointed after recreational was approved in 2012, and helped put together recommendations for the state Legislature on possible rules for the new rec industry.

For example, she said, giving existing MMJ shops first crack at rec licenses was a good move.

“They already knew what they were doing” when it came to labeling, producing product, and more, Sanders said. That made the rollout much smoother than it may otherwise have been.

That led to at least 37 recreational stores (all of which began as MMJ dispensaries) opening their doors to customers on New Year’s Day in 2014. And hundreds more sprung up in the months following.

Washington, however, had no statewide MMJ regulatory framework in place before its voters approved recreational in 2012. That was at least partly to blame for months-long delays before recreational sales finally began in July 2014, a full seven months after Colorado’s rec industry was up and running, because state legislators had to come up with new regulations from scratch instead of just relying on a system that was already in place.

“Washington and California are more aligned with what we’ve done in the absence of a state-controlled program, and it’s elongated the implementation and success of adult use, because we had nothing to build on,” said Greta Carter, CEO of the Washington cultivation company Life Gardens. “So other states, get your regulations in place for medical, and then move into the legal world. Don’t try to do the reverse.”

That’s a lesson that policymakers in states like California should take to heart. Although California pioneered medical marijuana, with voters first approving it in 1996, state lawmakers have continuously failed for years to agree on a regulatory system that would apply to all existing MMJ businesses. That’s left the state with a patchwork of rules and laws that vary from city to city, and will likely need to be reconciled at some point. If that doesn’t happen, California could be in for a major regulatory headache, and probably plenty of lawsuits, if recreational cannabis is passed by voters next year.

Although Washington stumbled in many areas, some professionals are pleased with several regulations it employed.

“When I look at medicine… to know that it’s pre-packaged and it had to go through some pretty stringent testing, makes me feel really good,” Carter said. “Plants used to have dog hair on them, and you used to have to pick it off. Not anymore. Those days are gone.”

Colorado requires testing for recreational cannabis as well – a step most future rec states are likely to take.

What to Improve

States that start recreational cannabis program in the near future will likely avoid – or look to improve upon – other aspects of the regulations in Colorado and Washington.

When asked where Colorado could have done better, Sanders cited concerns over how the state tracks marijuana from “seed-to-sale.” Instead of tagging and counting plants, she suggested a better system would be to track what actually goes out the door to customers.

“People also don’t understand the expense of tagging plants,” Sanders said. “What’s important is what leaves the facility.”

Colorado also probably could have done better on various packaging requirements, Sanders suggested, simply based on the environmental impact of having, for example, “exit bags” that are required by many local governments for customers who make a purchase. Those customers have to have an opaque plastic closable bag with them, or they need to purchase one at the store so that what they leave with is obscured to the general public.

The bottom line, Sanders said, is that “there’s still room for improvement.”

In Washington there are numerous problems, aside from the high tax structure.

Carter warned that the peril of over-regulation is very real. She pointed to Washington requirements on security cameras and trash removal as two examples; rec shops are required to have high-tech security systems that they can’t afford to actually monitor, and are forced to bury unusable cannabis trim.

“In some states, there’s a fallacy that more is better,” Carter said. “I’m cautioning people from other states that more is not always better. You just have to be smart about regulations.”

Whether that actually happens is another matter entirely.

The unalterable truth is that government officials – not those who know cannabis the best – will wind up writing the rules. And that’s because it’s impossible for a given ballot measure or bill to include unalterable regulations for an entire industry – at some point, an overseeing agency has to be given the regulatory wheel.

Carter’s advice: Try to work with regulators instead of against them. If officials are willing to listen to reason, that could produce the best possible outcome.

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