Cashing In on the Michigan Marijuana Business
The team at Future Grow Solutions, a consulting company for the cannabis industry.
By Paul Natinsky
Even before the 2020 election that featured a national explosion of approval for ballot proposals legalizing marijuana production, processing and sales, the industry had taken off, with Michigan among the most lucrative states for cannabis crop sales.
However, the lure of marijuana money comes with a set of steep regulatory hurdles and a prohibitively expensive price of entry into the business.
In November 2018, a ballot proposal made recreational marijuana sales legal in Michigan. Prior to that, medical marijuana sales were legal through a “caregiver” program that evolved into legalized medical marijuana dispensaries. But the true boom came with the 2018 ballot proposal. The first recreational businesses opened after a year of regulatory ramp-up.
Through a name change and byzantine series of rules, regulations and legislation, the Marijuana Regulatory Agency emerged as the administrator of all things marijuana in Michigan. The MRA created a board of five members that considered medical marijuana applications.
Mike Bahoura is an attorney who specializes in cannabis licensing issues. He also operates a marijuana dispensary in the city of Lapeer. Bahoura opened for business in Lapeer in August 2019 and was approved for recreational sales in December 2019.
“It wasn’t an easy process. They were throwing out denials left and right, so it wasn’t easy to get approved,” said Bahoura.
The board considered a broad range of criteria from applicants, including litigation history, criminal history, bankruptcy history and moral character.
“The most memorable denial that was issued was Calvin Johnson of the Detroit Lions getting denied because of some unpaid parking tickets in Georgia like a decade prior,” said Bahoura.
The MRA dissolved the board at the end of 2019, holding its last meeting in December of that year. With the approval of recreational sales, the process has evolved from being very restrictive to being more like applying for a liquor license.
“They started granting approvals unless you had something on your record,” said Bahoura. “They were looking for ways to approve you rather than ways to deny you.”
Licensing, The Tip Of The Iceberg
With the loosening of the state licensing process came the rush for real estate. The state grants licenses, but city governments establish the zoning rules governing where marijuana growers, processors and retail dispensaries can operate, and under which conditions and caveats.
Local regulations vary wildly. Harrison Township does not allow retail sales, but permits growing and processing facilities. Ferndale allows retail sales, but not growing and processing.
There are also conditions attached to where marijuana operations can do business. Restrictions on how close the facilities can be to schools and neighborhoods are not uncommon. And grow and processing operations are often restricted to areas of cities zoned for industrial activity.
Properties that meet the requirements for growing, processing, and dispensing marijuana products have come to be known as “green zones.” The prices for qualifying industrial and retail space have exploded along with the industry, leaving would-be marijuana merchants with a shortage of business locations and an inflated cost for their facilities.
Further squeezing budding entrepreneurs, some cities limit the number of facilities that can operate within their borders. Bahoura said Royal Oak okayed two locations. He said the city has received close to 50 applications.
Even if license applicants receive approval and manage to find properties on which to ply their trade, they face daunting costs, including a $6,000 application fee and annual state licensing fees ranging from $7,000 to about $40,000, said Bahoura.
Future Grow Solutions owner Mark Savaya made the move from the convenience store industry to marijuana a few years ago, when “caregiver” operations were permitted to grow a limited number of plants. Before dispensaries. Before recreational sales.
Savaya saw the potential in the industry and moved to North Carolina to learn about hydroponic towers that feature vertical towers to maximize space, water recycling and no soil. The grow operations are located in repurposed industrial spaces, much like standard indoor agricultural set-ups, but the towers allow for about eight times the number of plants in a standard configuration, taking advantage of the building’s cubic (three-dimensional) space rather than just its square footage, or floor space.
Application, licensing and building costs are only part of the picture.
“Everybody underestimates how much money you need to get into this business. There is no traditional financing or bank loans,” said Bahoura. Marijuana is still an illegal controlled substance under federal law, so federally regulated banks and credit card companies cannot work with those growing, processing or selling marijuana.
That takes bank loans off the table and makes marijuana a cash-only business. Bahoura said building costs of $1 million with build-out costs of another $1 million are not unusual for grow operations. That is not inclusive of added costs for water, light and equipment or operating expenses. If a crop becomes infested, fails to pass inspection, or other difficulties occur, an entrepreneur can sink very quickly.
On the retail side, a busy store requires upward of $1 million in inventory to remain competitive. Retailers are also hampered by IRS Code 280E, which classifies marijuana retailers as controlled substance sellers and takes away the standard expense deductions available to other businesses.
Double Dipping
Adding to the cost of entry is the emerging business necessity of obtaining both medical and recreational licenses and the fact that everyone involved in the product—from growers to retailers, including those who transport product—must be licensed. The license requirements are parallel processes, said Bahoura, meaning that those who move into recreational marijuana must pay those substantial fees for recreational licenses in addition to their ongoing expense on the medical side.
All of these factors contribute to the high price of entry, $3 million or more for growing or retail operations—sometimes less in rural, outstate areas.
A Sense Of Urgency
From the time the first recreational license approval was granted in December 2019, recreational sales have far surpassed medical marijuana sales, said Bahoura. Both medical and recreational marijuana sales are subject to Michigan’s 6 percent sales tax. Michigan adds a national-low 10 percent excise tax to recreational marijuana products (for comparison, California’s excise tax is more than 30 percent).
Bahoura said the low Michigan excise tax rate has driven recreational sales through the roof and substantially decreased applications for medical marijuana cards. The cost of consulting a physician and annually renewing a medical marijuana card is simply more hassle and not enough cost savings to compete with recreational sales. For an extra 10 percent, consumers 21 and older can simply walk into a store and buy a product.
“In the industry in Michigan, sales have shifted significantly from medical to recreational,” said Bahoura. The moral of the story is if you have medical now that’s great, but if you don’t get recreational to go along with it, you’re going to have trouble sustaining profitability.”
Out Of The Box
Despite the prohibitive costs and regulation endemic to his industry, Savaya has found creative ways to meet his business goals.
His tower growing arrangement allows him to grow 12,000 plants in a physical space that historically has accommodated 1,500 plants, with the attendant savings on water—90 percent of which he said constantly recycles—and electricity.
Savaya also found creative ways to administer payroll and deal with the cash-only nature of the marijuana business.
While many in the industry have turned to credit unions—which are not federally regulated—to do their banking, Savaya formed an employee leasing company and “leases” employees to his multiple dispensaries and grow operations.
He manages the huge amount of cash his businesses generate by paying contractors who build out his facilities in cash.
Savaya, too, is looking for more consistency and efficiency in regulation. He said many municipalities take six months to a year to consider applications submitted by state-approved licensees. He would like to see that timeframe reduced to a few weeks to a month.
Community Concerns
Pharmacist Rony Foumia serves on several state regulatory and pharmacy industry boards. He has been involved in issues regarding opioid issues, Medicaid drug formularies and the evolving practice of pharmacists, who have an increasingly active role in health care delivery. He said consistency and transparency are lacking in current marijuana regulation.
Since legalization, a number of home-based grow operations have emerged. In some cases growers have rented or bought homes strictly to accommodate their operations, said Foumia. He said he has been on conference calls in which residents complain about such activities in their neighborhoods.
He said this is one of the reasons consistency and clarity in marijuana regulation need improvement.
Despite the patchwork of sometimes-conflicting local laws, cultural acceptance seems to have arrived. Bahoura pointed out that dispensaries were considered essential businesses during the most restrictive part of the COVID lockdown. They remained open during the pandemic with curbside service.
Risky Business
Bahoura said the number of people exiting the business has accelerated as new owners discover they underestimated start-up costs. Some of them are selling their businesses at reduced rates, simply to get out.
Underscoring his points about prohibitive entry costs and high risks, Bahoura said he has helped about 100 applicants prequalify for licenses, but only about a dozen have gotten to the point where they open an operating facility.
He said the big question he always asks his clients is: “Do you have enough money to get over the finish line?”
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The team at Future Grow Solutions, a consulting company for the cannabis industry.