Of Outlaws & Oligarchs: The cannabis space is evolving into both an underground economy and one dominated by big business – marginalizing the mom & pop store in the process

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California is the cannabis bread basket of the world yet 8 in 10 cannabis businesses operate in the black market, says Los Angeles cannabis business lawyer Richard Ormond in the eye-opening Netflix documentary The Business of Drugs: Cannabis.

Federal taxation is a key driver of small business collapse. Cannabis, remember, is still illegal under US federal law; the Nixon-era Controlled Substances Act, which places the plant in Schedule 1, the most dangerous drug category. As such, anyone who “traffics” in these illegal drugs – that’s your state-legal cannabis operator – is required to pay federal taxes, and pay under a taxation scheme designed to punish drug traffickers, i.e. take their profits.

The linchpin of this tax scheme is disallowing all credits and deductions. In other words, you pay Uncle Sam based on your gross profits thus you can’t write off things like salaries, employee benefits, payroll taxes, overhead, and so on. The upshot, according to an analysis by Bloomberg Tax (see below), is the cannabis operator pays something like 14 times the amount of a comparable non-cannabis business: a whopping $294 000 instead of $21 000, in their example.

And that’s on top of city and state taxes that run between 10 & 20% each, says attorney Ormond. Throw in fees – local licensing fees, state compliance fees, state licensing fees, distribution fees, testing fees, extraction fees – and the result is that the mom & pop operation is “being shut down or reverting back to the black market.”

And that leaves standing the likes of Big Tobacco, beer & beverage companies, pharmaceutical companies, and private equity firms & hedge funds, all of who can draw on vast stores of capital.

Ormond, who also teaches Cannabis Business and Finance Law at Loyola Law School, uses a poker analogy to explain how it works:  

Right now you have a game of poker. You have all these small farmers that show up with 100 dollars to play the game. And then you have a private equity group that shows up with 10 000 dollars. They may not be the best poker player but simply but because of their huge stake the odds eventually turn in their favor because they can outlast & out bet everyone. And eventually they end up acquiring all the other business and then consolidating them into their business.

Cody Stross (pictured above), founder and CEO of a legit California craft cannabis company, agrees:

What keeps me up at night now is big business coming in. Companies that can afford to have a crazy [financial] burn rate and operate in the red for years.  

It’s safer economically before to be in the black market because there’s so many fewer operating costs. They’re probably 10 times the costs in the legal market. A lot of people had no idea that going legit was going to be so difficult and so expensive.

Asked whether the entrepreneur has a future in the cannabis industry, Ormond concludes:

I think locally, maybe. It will be like going to a vineyard in Santa Barbara and sampling a fine wine that never made a big splash in the market place. There’s always winners & losers in any new industry and some will be consolidated, some will have great exit strategies and some will just die on the vine.

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