Covid-19's Impact on the Cannabis Industry

• Publication year: 2020
• Author: Chrystal James

COVID-19's Impact on the Cannabis Industry

Chrystal James

Chrystal James is a California licensed attorney who has been practicing business and civil litigation for over seventeen years. Chrystal is a recognized expert in the cannabis industry through her legal work with local businesses and jurisdictions on cannabis law. Chrystal has advised public and private clients on how to navigate local, state, and federal marijuana laws since 2006. She practices in Los Angeles and Riverside Counties.*

I. INTRODUCTION

2020 has been a uniquely challenging year for the entire world. No industry was untouched by the unanticipated arrival of the Coronavirus disease (COVID-19). COVID-19 officially hit the United States on January 21, 2020, when the first case was confirmed by the Centers for Disease Control and Prevention (CDC).¹ Borders were closed, cities shutdown, families sheltered in place, and "business as usual" became a distant memory. While many of us were focused on securing new supply avenues for basic necessities (i.e., the big "TP Panic"), businesses were quickly pivoting their operations in response to state-ordered shutdowns, remote workflow changes, social distancing requirements, and consumer behavior changes. The cannabis industry was no exception.

Prior to COVID-19, the U.S. cannabis sales' revenue expectations were projected to be $19.3 billion for 2020, significantly increased from the prior year of only $12.4 billion.² In California, projected cannabis excise tax revenue alone was $479 million for the 2019-2020 fiscal year and $550 million for the 2020-2021 fiscal year. The expected annual growth was 15 percent.³

Given the high expectations for the cannabis industry, cannabis business owners and investors faced significant uncertainty when COVID-19 surfaced. Would COVID-19 change these projections dramatically? Would the cannabis industry react similarly to the alcohol industry and prove itself to be "recession-proof"? The cannabis industry has been called the next "green boom" or "green rush" industry because it is a new and emerging market where small investors and small operators still have the opportunity to start and grow large businesses that could create generational wealth. Not many industries today provide this type of opportunity. Thus, the cannabis industry had a lot at stake at the onset of COVID-19.

This article provides an overview of how the cannabis industry reacted to the COVID-19 pandemic. It explores how cannabis businesses adjusted to the statewide shutdowns, the designation of "essential" business status, workforce changes, exclusion from federal stimulus relief, and reopening strategies.⁴ Specifically, it examines 2020 cannabis sales revenues, consumer preference shifts, employee displacement impact, legislative and regulatory delays, and the impact on the efforts of other states and the federal government toward cannabis legalization. In conclusion, it will consider what some of the enduring changes might be to the cannabis industry post-COVID-19.

A. The Pre-Covid-19 State of the Cannabis Industry Faced Market Growth and Contraction

The cannabis industry was experiencing a growth in consumer demand just prior to COVID-19. Demand for cannabis products created more opportunity for new cannabis businesses to enter the market through the end of 2019 and the beginning of 2020.⁵ However, the cannabis industry was simultaneously experiencing an unanticipated contraction in corporate market expansion due to a decrease in access to investment capital. In fact, the cannabis industry was in the midst of a revaluation (or more accurately devaluation) crisis. Much of the initial investment excitement surrounding the cannabis industry had waned as evidenced by the announcements of repeated merger collapses. Raising investment capital became difficult and unpredictable as investors acquired more accurate valuations of their potential investments. The cannabis industry found itself faced with a surplus of grossly overvalued companies that were now coming to terms with their actual worth. After an initial onslaught of premature rushes to public offerings fueled by huge profits gained through state legalization, a severe contraction of the merger and acquisition activity occurred.⁶ Many companies that experienced the initial surge of growth after legalization failed to adopt solid business plans to sustain such growth and to effectively expand their businesses to the next level to meet their investors' expectations. Major acquisition deals collapsed, fringe cannabis operations succumbed to bankruptcy, and a shift in focus to reorganization of internal business operations overshadowed the desire of public offerings.

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B. The Illicit Cannabis Market Contributed to the Cannabis Industry Contraction Problem

Along with capital market contraction, the cannabis industry was also dealing with an ever-growing illicit cannabis market (illicit market). The illicit market is comprised of unlicensed cannabis growers (farmers), manufacturers, distributors, and retailers. Illicit cannabis businesses range from what is commonly referred to as neighborhood "dealers" on up to large illegal cannabis farms hidden in desolate areas of the state. Of particular concern are the unlicensed retail shops selling directly to consumers and the unlicensed farms growing untested cannabis. Many cannabis advocates believed that state legalization of cannabis would eliminate the illicit market. However, the onerous and expensive licensing process that now exists keeps many cannabis business operators from entering the legal cannabis industry and fuels the growth of the illicit market. Indeed, the continued growth of the illicit cannabis market, despite state legalization of cannabis, has forced many legal cannabis operators out of business. ⁷

Since cannabis is still listed as a Schedule I drug under the Controlled Substance Act, rendering it federally illegal, cannabis businesses are forced to operate differently than businesses in other industries.⁸ Cannabis businesses lack access to essential business tools due to federal illegality, which means the cannabis industry, as a whole, operates at a much higher cost-of-doing business.⁹ For instance, cannabis businesses are required to operate without many normal business protections such as insurance, banking, trademark, and copyright protections. Cannabis businesses are prohibited from engaging in interstate commerce, interstate advertising, and are excluded from most federal programs. Moreover, these businesses have limited federal tax breaks. Another significant difference is that cannabis businesses may be subject to federal, state, or local law enforcement raids at any given time due to the federal illegality of cannabis. These are all business conditions not faced by other industries.

Cannabis industry operators argue that these factors make it difficult to compete with illicit businesses who are not dependent on the normal business tools to make a profit, and therefore the factors contribute to the growth of the illicit cannabis market.¹⁰ Further, the lack of access to these business tools makes it more difficult for cannabis businesses to meet the requirements of becoming legal (or remaining legal) under the current state guidelines.¹¹

C. The Impact of California's Illicit Market on the Cannabis Industry Was Heightened During COVID-19

The California cannabis industry is more severely impacted by the illicit cannabis market than in other states due to the lack of licensing opportunities here.¹² In California, cannabis industry operators cite to all of the issues set forth above as factors that make conducting business legally very difficult. However, they also point to unique obstacles in California that make it even more difficult to become legal than in other states. These obstacles include the high cost of market entry due to the expensive licensing process and limited jurisdictions allowing cannabis businesses; the high cannabis tax rates; and the lack of state banking alternatives.¹³ Legal cannabis operators expend large amounts of operating budget to acquire licenses, to provide security required for large cash handling transactions, to implement track and trace cannabis systems, to continuously meet regulatory compliance, and to pay cannabis taxes. None of these requirements exist in the illicit market, making it difficult for legal cannabis industry operators to compete with the lower cannabis prices offered in the illicit market.¹⁴

While there is not an easy solution to eliminating the illicit market problem all at once, recognition of its devastating impact on the legal cannabis industry was becoming more widespread. State officials such as those in the Bureau of Cannabis Control, state legislators, and even Governor Newsom were initiating steps to enact legislation aimed at combating growth of the illicit market by adopting stronger agency enforcement provisions and imposing additional civil penalties. However, these actions, discussed more fully in Sections V and VI, were postponed by the onset of COVID-19.

In spite of all the foregoing challenges, the year 2020 began with many cannabis companies optimistically projecting growth of operations, increased hiring, and greater profitability by year-end.¹⁵ This optimism was fueled by the increased demand for cannabis products by a growing consumer base. As more consumers began to have access to recreational adult-use cannabis, cannabis businesses were positioning to meet this increased demand for new and diverse cannabis products. Moreover, the new focus on improving fundamental business practices prevailing across the cannabis industry added to increased profitability expectations for year-end.

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That was all pre-COVID-19. When the COVID-19 pandemic hit, many cannabis operators were immediately challenged to adapt to unanticipated changes in their operations and adjust their projected year-end revenue expectations as...