California is strangulating legal cannabis with regulation. The state’s floundering Track-and-Trace program threatens to push a massive portion of its legal business entities into gray and black market dealings. California’s missteps could even culminate in the collapse of legal cannabis, grievously wounding the support for federal legalization.

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Otherwise, legitimate operations are defaulting into illegality due to California’s inability to pass legislature controlling cannabis licensing. Every cannabis operation, from cultivators, to processors, testers, distributors, and retailers are being put at risk of tax errors, legal infractions, arrest, and financial ruin.

Businesses face the temptation to go gray for the time being. Because formerly-licensed businesses have all of the infrastructure for moving cannabis but are among the 1000’s of businesses (too many for the state to police individually) no longer required to report their activities,  shifting temporarily or even permanently into the illicit market is an opportunity for businesses and their staff.

California Dreaming of Seed-to-Sale

In January 2019, the state debuted its new California Cannabis Track-and-Trace (CCTT) system for METRC (Marijuana Enforcement Tracking Reporting Compliance). CCTT regulation and METRC tracking ensure that legal cannabis stays legal, supports accurate tax reporting, and helps pinpoint responsibility if and when a cannabis batch is recalled. CCTT-METRC replaced two years of emergency regulations put in place to initially launch and then maintain legal licensing in the cannabis industry until state legislature instituted a permanent licensing structure.

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Farmers switch from produce to hemp as a major crop after legalization. CBD oil and other hemp based products generate higher farm income. iStock / Seth-Michael

Three California agencies split duties for assigning Annual, Provisional, and Temporary licenses to cannabis businesses: The Department of Consumer Affairs' Bureau of Cannabis Control, the Department of Public Health's Manufactured Cannabis Safety Branch, and the Department of Food and Agriculture's CalCannabis Cultivation Licensing Division.

CCTT compels only annual and provisional businesses to employ METRC. Temporary license holders, which encompass the bulk of California’s cannabis businesses, do not contribute data and tracking information into the state  METRC trace-and-track software. 

When annual license holders work with temporary license holders, the annual license holder must supply additional man hours to input METRC information, which is not good business on either side. There are obstacles for temporary licensees who want to help out their annual holder partners by integrating METRC, independently.

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Software leases cost between $2000 and $25000 annually and the government offers its free training only to annual license holders. The legal cannabis market has been wrestling with these sorts of idiosyncrasies since METRC’s implementation, and other states deal with variously debilitating shortcomings.

In an ideal situation, California works out a process to get all business on METRC. This is an attainable future that California ought to pursue, but METRC costs man hours and money.

Some industry professionals see this as the new standard of operations in California: Clint Armstrong, CEO of GroStaff, a large cannabis HR firm, states that “If you’re expecting to open a cannabis business, expect for the capital requirements to be astronomical ... It doesn’t matter how much capital you have if you have weak standard operating procedures and insufficient employee training.”

Armstrong tacitly suggests that businesses struggling with the aforementioned problems are inadequately funded and poorly operated. The conspiracy is that small cannabis operations will go bankrupt and well-funded businesses, ready to work with the likes of GroStaff, will sweep in to consume the void in legal businesses left by California’s snafu.

Many point to the early involvement of Sean Parker and George Soros in the (now-expired) emergency legislation of 2017 - 2018 as evidence.

Trimming Medical Cannabis in California iStock / SpiritPeaks

California Cannabis: Cancelled Until Further Notice

Temporary Cannabis business licenses are expiring en-masse, faster than the state can renew them. The majority of California cannabis licenses are temporary, not annual or provisional. Temporary licenses issued during the 2017 - 2018 emergency regulations were intended to transition into annual licenses by now. California’s three cannabis agencies, however, have been unable to process the volume of applications. Because of the state agencies’ ineptitude,  legitimate cannabis businesses are seeing their licenses expire and their business threatened. 

Expiring temporary license holders have two options:  shut down until the state remedies its issues or keep the lights on by doing business in illegal markets. As time passes, law-abiding companies continue to pay maintenance costs, loan interest, and other operational fees. Unfortunately, California’s business licenses nightmare is not speculative and is already taking place.

So far in 2019, 2673 temporary cultivator licenses have expired and only 630 have been awarded. So far in the month of May, 154 cultivator licenses have been awarded and 178 have expired.

California state hopes to remedy its licensing crisis through the passage of Senate Bill 67. The desperately needed measure to immediately re-issue temporary licenses en-masse received state Senate approval but still requires voting in the assembly. Still, the passage of SB 67 would hardly assuage employees and businesses that have been bleeding money for months.

*No assembly vote on Senate Bill 67 has taken place as of publication.*

The Dangers of Shutdown

Cannabis businesses face a difficult choice: risk operating illegally with expired permits – or shut down. Freezing operations until applications process is a financial impossibility for most businesses. Cultivators who proceeded with planting their seasonal crop in April/May, despite expiring licenses, will reap an illegal harvest in September, should their applications remain pending or be denied.

Closed sign hanging in business window by a string - crooked with glob of glue also attaching it to window - some abstract reflections IStock / Susan-Vineyard

California’s robust gray-market will absorb business from expired licensees, further exacerbating problems with establishing California’s long-term legal market. So far, state law enforcement agencies have not made a dedicated effort to target businesses defecting from the legal market into the gray/black market. Enforcement officials have, however, raided illicit gray market operations and otherwise non-compliant businesses in 2019.

In February, California governor Gavin Newsom petitioned President Trump for National Guard soldiers to conduct counter-drug operations in Northern California. As long as the state is not specifically raiding and prosecuting businesses operating on expired licenses, temporarily working with the gray/black markets will be a viable opportunity with some risks. California biggest challenge, if it can figure out licensing, will be winning back gray market deserters.

California collected $345 million in cannabis taxes in 2018. The state budget, in 2016, projected that tax income as high as $643 million. Based on the disappointing results, the new 2020 state budget released on May 3, 2019, revised out $223 million worth of cannabis taxes.

The lack of expected tax revenue is a result of the prodigious growth of the gray market. The Archive Group estimated that, in 2018, Californians spent $5.5 billion in gray/black markets, as opposed $3.7 billion in legal cannabis. If illicit sales were theoretically added into taxable legal sales, the state would have reaped $876 million in taxes in 2018.

The state must, at all costs, avoid a looming worst-case scenario: the gray market assimilates business and achieves market reach such that it becomes so accessible and cheap that legal operations can’t compete. Such a development would serve as an example to states currently opposing federal cannabis legalization that the USA could never control a national legal market.