It’s not easy selling green. Around 20% of small businesses fail within the first year, but when that venture is in the cannabis sector, the chances of folding are even more likely, experts say.
Following New Jersey’s legalization of cannabis for recreational use, a growing number of entrepreneurs are looking to enter the nascent industry. Forecasted to hit $2.4 billion in annual sales within the next three years, the Garden State’s legal marketplace may appear to have limitless potential, making it ripe for get-rich-quick thinking. However, experts warn, the very nature of being involved with a product that is still illegal at the federal level and subject to an ever-shifting regulatory landscape can make it very difficult for aspiring cannaprenuers to pursue their dream.
Just because the opportunity is there, it doesn’t necessarily mean sustainable profits and long-term success will follow, and about half of all new cannabis businesses won’t make it to the five-year mark, according to cannabis accounting firm Green Growth CPAs.
Moreover, operating in a highly regulated industry that comes with many above-average cost burdens can make it tough to turn a profit, with more than 58% of business owners saying they are not breaking even or are losing money, a March 2022 survey by the National Cannabis Industry Association found. Hurdles identified by the 396 respondents include competition from illicit growers, state and federal taxation, limited investment capital, dominance by large multistate operators, and lack of access to banking and other financial services. Other challenges include complex regulatory structures and unpredictable consumer behaviors.
Although the sector isn’t for everyone, industry stakeholders believe there are steps aspiring cannabusiness owners can take to improve their chances of success.
During a June 27 NJBIZ virtual discussion, participants reflected on the highs and lows of the industry that is emerging in the Garden State. Moderated by NJBIZ Editor Jeff Kanige, the panel featured:
- Michael DeLoreto, director of the government & regulatory affairs group at leading law firm Gibbons PC.
- Art Hance, president and chief executive officer of Hance Construction Inc., a Franklin Township-based firm that specializes in cannabis construction, offering design and build services for cultivation facilities and dispensaries.
- Peter Murphy, a partner with Saul Ewing LLP, a Ewing-headquartered law firm with a booming cannabis practice, helping clients navigate the complexities related to an evolving industry.
- Amy Peckham, chief executive officer of Etain, a family-run, women-owned vertically integrated agribusiness and medical cannabis dispensary in New York that plans to open a cultivation site and medical dispensary in North Jersey.
While panelists represent different parts of the industry, they agreed that trying to establish oneself in New Jersey’s cannabis space is not easy and that opening such a business requires serious thought and serious planning.
Putting it bluntly
Hance admitted, “I have an experienced cannabis team behind me and we often say that you’d be better off starting a fast-food restaurant. It’s a very tough industry to get into because of the cost and time required. It’s typically much more than most people understand.”
Though the obstacles may sound “discouraging and gloomy,” DeLoreto said, “there are ways forward.”
“You just have to be smart, in terms of how you approach it and really have a good plan. This is not something where you can just wing it,” he said. “If you’re smart and you have a plan, and you work with the right people, and you have good guidance and advisors, there is a way to come out the other side of this being successful. It is individuals who just kind of think that it is going to be easy, and then, once they get into it, realize how difficult it is that it becomes problematic. If you go into it eyes wide open, knowing what the situation is, there’s a potential for a good outcome.”
However, DeLoreto believes there’s generally “an underappreciation for the regulatory requirements that exist” in New Jersey under state law, as well as an unrealistic idea of just what will be needed to set up shop, including capital and location.
“And once you go through some of those issues [with new clients], you realize people aren’t as prepared as they once thought that they were, and I think part of our job is as attorneys is to counsel people on what not do to instead of what to do in order to save them from themselves,” he said.
Murphy echoed the sentiment that potential entrepreneurs don’t always grasp the time, money and energy associated with launching. “In a general sense, the momentum is such that there’s no going back on this. And I think people see it as like, ‘Well, you’re in cannabis and that must mean you’re a multimillionaire or you’re on your way,’” he said. “… There’s also this effort by the states [with legalized markets], in particular, New Jersey, to encourage people to get into the industry, which is not a bad thing in and of itself, but it might not really help them to go into it with open eyes, understanding what it really involves.”
When it comes to starting a cannabusiness, DeLoreto stressed the importance of squaring away the capital component first and then securing a location.” Without that, you’re going to be stuck in a really bad spot,” he said.
“And, you can never have enough capital. I’ve seen cultivation facilities in the state where you’re talking $25 million to $30 million dollars. For a retail facility – even a small one – you’re still talking about probably $1.5 million to $2 million as a minimum. So, this is not something where you can come in with $5,000 and think that you’re going to get up and running,” DeLoreto stated. “That’s not the way the regulatory system works, it’s not the way the licensing system works and it’s not the way that the industry is designed to operate here in New Jersey.”
Community buy-in
Within the state, about 400 of the total 565 municipalities have opted out of allowing cannabis sales, despite nearly 70% of voters backing the legalization of marijuana in a 2020 referendum. And, even after an applicant finds a place that allows such businesses to operate, that doesn’t necessarily mean it will be a smooth process.
“Local approvals can be just as daunting as state approvals. In fact, they can be more daunting,” said DeLoreto, who noted that the rules can vary from town to town.
“Each town does it a little bit differently and you need to know what the rules are,” he said. “What’s the baseline? Do they have an open slot for me or are they at their capacity for what they’re going to permit? Am I in the right spot within that town?”
DeLoreto went on to warn that an opt-in “doesn’t always mean the residents are going to be accepting” of a proposed cannabis business. That’s exactly what happened to Peckham.
“The setback on executing my New Jersey license is that we had a town whose ordinance accepted it. We had a property that was within the ordinance and about 250 people showed up [opposed to it],” she said.
And while Peckham has the right to appeal, she said there “was no point in returning to that town” because the community was so against it.
“I did everything I should have with the town board and they indicated everything would be fine because it had already opted in. Not so,” said Peckham. “All of that money was lost along with the eight months of prep that it took.”
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As a developer, Hance has gone before many land use boards and local governing bodies in New Jersey, which, he said, can be a tough crowd regardless of what your application is for. For instance, Hance is currently working to get the OK to construct a doggy day care center in Central Jersey and it’s proving to be a lengthy endeavor. “By the time we’re ready to build, it’ll take a year,” he said. “And, I don’t have people threatening me in the halls when I go for a planning board meeting; and everybody likes dogs.”
For cannabis, he said, “You have to realize the process has an added step — you have to go to the town governing body and get approved to operate at a particular location in that town and a resolution has to be passed.”
Then, prospective cannabusiness owners need to seek out land use approvals and develop a site plan application to go before either a planning or zoning board.
Hance warned, “It’s going to take a certain amount of time. I’ve worked with people from all over the country – we’ve spoke to over 400 licenses or conditional licenses, particularly those that that come in from out of state – even California. And they’re amazed at the process here in New Jersey. New Jersey turns the difficulty of land use approvals into an art form.”
“It’s a long process and you have to go through it,” he said. “You should familiarize yourself with it so that you’re not so upset when someone like me comes in and tells you what it’s going to take to do. I think everybody makes the towns a villain, but this is our process in New Jersey, right in writing. You can read the ordinances and get familiar with it, because that’s what you’re up against. It’s not that you’re being singled out as a cannabis company.”
“If you’re going to apply for cannabis use in New Jersey, make sure that you address the things that have been problems for other cannabis companies – get on the odor, get on your water usage and get on your traffic control. These are things that towns are concerned about,” Hance explained. “Also, explore getting the towns that have opted out to opt in and go to them with a proposal of what a cannabis use would look like.”
Like any company, operating in a mindful way is critical after the doors open, but for cannabis businesses, it’s crucial, Hance said.
After noting the expense associated with building out a storefront or grow facility, he remarked, “For some reason, everyone building a dispensary lately is trying to build a destination dispensary and they’re doing it in places that aren’t really going to sustain that kind of a facility … [I]f you’re putting a dispensary in an industrial part, chances are you’re not going to attract a certain group of people that are going to come in and make it a destination.”
Hance added, “It’s got to be sustainable … whatever you design, whatever you build, whatever approach you take, make sure you run your numbers with worst case scenarios and make your design be as absolutely as efficient as possible in cultivation – that means energy, efficiency and labor efficiency.”
Balancing the marketplace
Since the legalized adult-use market launched a year ago, enrollment in New Jersey’s medicinal cannabis program has declined steadily, prompting a growing number of medical-only dispensaries to expand into adult-use sales. Between April 2022 and June 2023, the number of patients seeking treatment dropped from 128,548 to 105,060, according to the state.
DeLoreto said, “When you look at the CRC [Cannabis Regulatory Commission] registration numbers, there’s been some [decline] but it hasn’t been as significant as people thought … Colorado, for example, saw a dramatic shift and in some states it’s been as high as 65%.”
“I think part of the reason why you’re not seeing that shift here in New Jersey is because prices are better on the medicinal side than they are in the recreational side,” he said. “… There’s no tax on medicinal, so there’s a little bit of an added savings there.”
“And, I do think that there is a cohort here in New Jersey that does view cannabis as medicine and are continuing to use their medicinal marijuana cards. We’ll never trade them in for anything. We’ve also expanded the list of [qualifying] ailments. There’s been a lot that was done in that space and I think there’s a strong medicinal cannabis following in New Jersey where that’s just not going to change, at least for the time being,” DeLoreto remarked.
Additionally, participants weighed in on efforts by state officials to set up an equitable marketplace, saying they think things, overall, are moving in the right direction but that business owners need to be aware of the realities of dealing with regulators.
With growing awareness around a lack of both gender and racial diversity in the rapidly developing and expanding cannabis industry, the CRC – the state board that regulates the industry and oversees licensing – says its working to address gaps. As part of that mission, the board continues to prioritize granting licenses to dispensaries run by minorities, women and disabled veterans or applicants with prior marijuana convictions, as well as to ventures located in impact zones, which are defined as communities disproportionately affected by the war on drugs.
DeLoreto said, “I think for the CRC it’s been a focus of theirs. I don’t think anybody can say they’ve just given it lip service and have moved on.”
“The CRC was a creation coming from the Department of Health,” he added. “It’s been staffing up and there is a real growth need there in terms of their staff. I think they’re trying to get that. It’s easy to blame someone and sometimes they do get the blame. That’s why it’s important for applicants to be prepared. The best thing to do is to make sure you give them everything upfront that they need, so they don’t have to come back and ask for things.”
For businesses that don’t qualify as one of the priority categories, Murphy said it is important to be cognizant of many factors.
“You need to consider – how is my application going to be supported? Where am I going to fall in terms of the buckets when the CRC does your review? That was done intentionally by the CRC – to give smaller businesses, social equity businesses … advantages in terms of their application review, but that does create jam ups for other businesses,” he said. “I would say the bottleneck at the CRC is a massive impediment to getting your business. If you’re that far back in the line, you’re burning those monthly costs and that’s a huge hurdle.”
Both attorneys also praised the state’s efforts to try and address those social equity issues, such as the New Jersey Economic Development Authority’s recently launched Cannabis Equity Grant Program, which will provide grants of up to $250,000 to aspiring entrepreneurs.
According to the CRC, 1,301 of the 2,084 applications submitted for licenses have been approved, with the majority of them conditional. Additionally, 315 conditional license holders have gone on to secure the necessary local approvals and have since applied to convert to annual licenses so they can open.
Currently, there are 23 medicinal dispensaries and 33 recreational dispensaries in the state.
And while prioritizing social equity applicants “was a well-intentioned idea,” Murphy said it doesn’t “necessarily jive with the realities of the cannabis marketplace.”
“There was a time when a license in somebody’s hand had a certain value. And now, it’s really more like a bill,” he said. “It’s a bill for a couple million bucks and without support you can’t realize what the value is in there. I commend New York and New Jersey for trying to get people licenses to give them that opportunity but it really requires more … if there’s no access to capital, a social equity license is going to have a hard time getting all of the promises of prioritizing them.”
DeLoreto agreed, saying, “There was this well-intentioned effort to try and redress the past wrongs, but ultimately it ended up being the multistate operators for the most part, that were able to come in, get started and get going right away for all of the reasons that we’ve been talking about and that is apparently still the case.”
How taxing
New Jersey’s legalized cannabis industry recently received some relief after the governor signed a law decoupling the state’s corporate business tax provisions from federal rules prohibiting such deductions and credits for cannabis businesses.
According to Section 280E of the Internal Revenue Service (IRS) code, cannabis-related ventures are blocked from deducting typical business expenses on state and federal tax returns since marijuana is classified as a Schedule I narcotic by the federal government. In May, New Jersey joined a growing number of states to decouple from the provision – including New York, California, Hawaii, Michigan, Colorado and Oregon – and allow licensed cannabis companies to deduct certain expenses on state tax returns.
Murphy said the move is “definitely a boost to New Jersey operators” but warned “it’s limited.”
“I think the figures are something to the effect of maybe 10% when you calculate it out,” he said, encouraging businesses to find an accountant who “really knows the cannabis industry” to make sure the best tax strategy is in place.
While panelists said they’ve seen slight improvement in banking and lending options for the industry, there’s still much progress to be made there stemming from marijuana’s continued classification as an illegal substance by federal regulators, as well as the overall public sentiment of cannabis.
“There are banks out there that we work with that are financial cannabis projects – they are looking for real deals that are going to be sustainable and are not going to go for a high risk, but there is money available,” Hance said.
At the same time, he continues to encounter negative public perception when it comes to the cannabis landscape. “We are still seeing a lot of banks shying away from cannabis. I had to change my banking relationship because my bank found out I built cannabis. So, they didn’t want my money anymore,” he stated.
Peckham agreed, saying, “It has gotten better … but it’s still challenging. One of the first tests of whether somebody is a real operator is if they can figure out their banking.”
“Just as an operator, my daughter and son-in-law, who work in the industry, had a mortgage refuse and all of us have had our 401(k)s booted out of institutions … it used to be more of a badge of honor – ‘oh you got your bank account closed.’”
“There’s always going to be people that are going to come out and oppose something,” DeLoreto said. “Do I think that federal legalization will help? I do, for a variety of reasons. One is, I do think there’s a lot of people out there that are like, how can the state allow for something that’s illegal under federal law, and that disconnect causes people a lot of discomfort.”
“The other thing, too, is, if it’s legal at the federal level, and you remove the restrictions on banking and financing. That’s going to free up a lot of capital for businesses who may be able to withstand two or three land use hearings and the legal fees that are going to go along with that as opposed to the current status right now, which makes it very, very difficult for companies to get financing as it is, and then burn money going through hearing after hearing or negotiation after negotiation trying to find the right spot.”
Peckham said, “Legalization on the federal level would do so much to mitigate the economics of the cannabis industry … There is risk aversion, and there is risk. But there is without question greed. You also have to look at the stigma of cannabis and say that there is just plain fear.”
“People look at the economics and they want the short-term return on the investment, too, because that’s the only way they know they can securely extend the credit to an operator,” she said.
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