Insights for the Aspiring Cannabis Entrepreneur
Anjali Oberoi | The appeal is understandable. In 2017, legal cannabis became the fastest growing industry in the US’s modern history, with a 25% increase in sales from 2016 to reach $9 billion. And, the prospects for 2018 are looking even brighter, with giant California having just joined the group of now nine states that have legalized recreational cannabis.
Even more compelling is the amount of money that has been poured into the industry. By Q3 of 2017, total investments in North American cannabis had increased by 150% from 2016, and the average size of raises had doubled to $6.7 million.
So you want a piece of the space cake? We’ve compiled a few thoughts that you might find useful as you prepare to jump into the weeds!
No, weed is not the internet
Heartened by the industry’s explosive start, several observers have predicted that cannabis would be the “new internet” (here for example), implying that we are only at the beginning of a long period of exponential growth, with herds of unicorns about to get unleashed. This comparison misses fundamental differences between the two industries, foremost their scalability.
If you’re interested in the concept of scalability, Nassim Taleb’s The Black Swan is the book you should read. Simply put, a scalable business is one where increasing revenue does not require increasing resources or efforts. A typical example is writing. It takes a writer the same time to produce a 500-page book whether she sells it to a thousand or a million readers. A lot of businesses in “the internet” are scalable.
In a non-scalable business, increasing revenue does require increasing resources and efforts. Food businesses generally fall in that category. In order to double the number of chocolate bars you produce, you have to double the amounts of cocoa and sugar. The same applies for most activities along the cannabis production chain: farming, processing, distributing, etc.
Scalability is important because it is tied to the amount of investment that is required to start and operate a business, as well as the amount of time that it takes to break even. To get a sense of how this will apply to the cannabis industry, your best benchmark might be the organic food industry. Organic food has also been booming for years, with double-digit growth figures. Yet, it generally takes a good five to ten years for an organic food business to turn profitable. Besides, off the top of your head, how many organic food unicorns can you name?
Neither is it a proverbial green field
There is a common belief that the cannabis industry is at an embryonic stage – a wild west of sorts that anyone with an entrepreneurial spirit and some capital could participate in shaping. Alas, this notion is mostly a romantic falsehood.
While it is about to experience major transformations, the cannabis industry is already quite developed and professionalized. This is not just in reference to the people who were formerly involved in black-market businesses, and have stepped into the light although that trend does speak to the abundance of know-how that has fueled the industry’s uptake. More importantly, it is oft overlooked that a number of cannabis giants have been around for a while, having developed legally for years under the banner of medical cannabis.
The US’s medical cannabis legalization wave started more than twenty years ago - unsurprisingly spearheaded by California in 1996 - and the ever-shrinking group of states that have upheld a ban on all forms of cannabis is now a minority. MedMen is perhaps the best example of a business that took advantage of that context to secure a head start before the recreational cannabis legalization movement took off. The California-based company, which started as a chain of dispensaries in 2010, became the first US-based cannabis unicorn a few days ago.
What to keep in mind about medical cannabis products is that, often, the only thing that makes them “medical” is the purpose of their consumption. Take for example Kiva’s confections or incredible’s gummies. Both brands grew and established a solid market positioning through medically prescribed sales. From their perspective, the legalization of recreational cannabis better resembles a sudden expansion of customer base than the birth of an industry.
To conclude this point, if you are approaching the cannabis industry with the mind of a forty-niner gearing up for a wondrous journey to the Golden State, you might be in for a disappointment. But this piece is not meant to discourage you. You will see that everything you have read so far was intended mostly as a caveat before the good news, and boils down to this simple advice: Put aside the hype promising easy money in cannabis, and look instead towards the organic food industry to get a sense of what’s in store for the cannabis entrepreneur.
Opportunities are in supply and product innovation
On July 1st, 2017, recreational cannabis became legal in Nevada. By July 13th, dispensaries had run out of supplies, compelling the state to take emergency measures. The debacle was mostly the result of a twisted legal setup, by which dispensaries could sell but not source cannabis directly from producers. To an extent, it also highlighted gaps along the cannabis supply chain. Farmers are farming, retailers are selling, but the channels between these two ends of the chain are not yet equipped to accommodate the exploding consumer demand. The opportunity is considerable!
To address this issue, large cannabis businesses have tended towards vertical integration, in an apparent race to build larger and larger farming and processing facilities. Mid-2016, GFarms started developing seven acres in Desert Hot Springs into cannabis greenhouses, only to be one-upped a few months later by AmeriCann with the announced creation of a 1 million sq-ft cultivation and processing facility in Massachusetts, at an estimated cost of $10 million.
This trend has not been without worry for small cannabis businesses, fearing that “Walmart weed” would soon flood the market and drive prices down. Before California’s legalization kicked-in, independent farmers lobbied the state’s Food and Agriculture Department to cap the acreage that a cannabis license holder could cultivate. That did not happen. But even if it had, there is generally little that can be done in a free market to stop the spread of low-cost generic products.
This is not to say, that mass production and vertical integration is the only viable model for the cannabis industry. In fact, we are likely to see a diversification of the business landscape driven by an increasingly informed, mission-minded, and health-conscious consumer base… just like - you guessed it - what has happened in the food industry over the past ten years.
A fascinating study by Miner & Co. Studio recently revealed the changing face of the cannabis consumer. As it turns out, cannabis consumption is increasingly sophisticated and mostly about wellness. Intoxication, on the other hand, is becoming a fad of the past. Consumers are showing an interest in craft products, exploring the different “varietals” of cannabis, and factoring in health impact in selecting forms of consumption.
The popular perception of cannabis is undoubtedly shifting. Before we know it, cannabis might be thought of as a gourmet product, alongside wine and chocolate. And if your cannabis startup is betting on that vision, the tea leaves might well be spelling success for you.
Who’s afraid of Mr. Sessions?
I could not close this piece without addressing the elephant in the courtroom. Especially given that Attorney General Jefferson Beauregard Sessions III has made it his life’s purpose to protect you from the devastating impact of cannabis on your health. On January 4th 2018, the US Department of Justice issued a memo that essentially said “Recreational cannabis remains illegal under federal law, and violators will be pursued, no matter what individual states say”. The states quickly responded “Back-off Jeff!”, and have worked to neutralize the Attorney General’s directives.
The memo nonetheless sent a jolt through the cannabis world. Within a day, the US Marijuana Index dropped by more than 20%. Many investment conversations were suddenly put on hold, dealing a critical blow to hopeful startups. Fearing to get embroiled in the legal standoff, banks stopped serving cannabis businesses, which had to turn to local credit unions instead for basic financial services.
As Mr. Sessions’s war on cannabis quickly proved to be mostly quixotic, the industry got back on track and cannabis stocks recovered. Still, it would be an exaggeration to say that investors’ confidence in the industry is at its pre-memo level.
So what to make of this? In the long term, it would be hard to imagine that the march of cannabis legalization could be brought to a stop. There is mounting evidence that cannabis is not more harmful than alcohol or tobacco, and support for its legalization among US citizens has been on a constant rise for the past forty years, reaching an all-time high of 63% in 2017. In the short term however, zealous policy makers could drop more hurdles to disrupt the industry and this could play out in two different ways for the small cannabis entrepreneur. On the one hand, being smaller often means being more vulnerable to market disruptions. On the other hand, market disruptions tend to keep the bigger, generally more conservative players out. So, putting all the elements together, from the exploding demand, to the shifting consumption patterns, to the uncertain legal developments, really, there has never been and might never be a better time than now to launch a cannabis venture.
Acknowledgement: Writing this piece would have not been possible without the contribution of Catherine Ross, chef and owner of of several emerging cannabis brands. Practical insights from industry leaders like Catherine are essential to Bernoulli Finance's work.