High Hopes and Blunt Truths for the $2.3 Billion Legal Marijuana Market

High Hopes and Blunt Truths for the $2.3 Billion Legal Marijuana Market
The interior of one of Patients Choice of Colorado's dispensaries in Denver.
Image credit: Patients Choice of Colorado

The second barrier is agricultural knowledge. All marijuana retailers in Colorado are required to grow at least 70 percent of the product they sell. Similarly, all growers are required to run a dispensary. This so-called "vertical integration" requires entrepreneurs to "marry a large-scale agricultural business to a small retail location," says Gehring, who owns Patients Choice of Colorado, a company which operates four dispensaries in the state. "We have thousands of plants that are living organisms that we have to maintain."

This looks set to change in October, when Colorado will allow standalone cultivation and retail operations for the first time, but until then it's the only way to run a legal pot business. More onerous still, every single plant needs an RFID tag so that it can be tracked "from seed to sale." Every weed shop in the state is required to enter this data into the Marijuana Inventory Tracking System, or MITS, which is overseen by the Marijuana Enforcement Division. This is one of the most expensive compliance requirements, Gehring says. In order to open her store for adult-use sales on the first of January, she had to spend $22,000 on tags alone.

Startup capital is the third barrier. What might at first appear to be a small business in fact requires a multi-million-dollar investment, Gehring says. Between her four dispensaries and her 35,000 square feet of production space, Gehring pays $115,000 in annual licensing fees. She paid an additional $27,500 in application fees so that three of her medical dispensaries could start selling recreational pot. And then there are all the other costs associated with running a business that grows a crop, harvests it, packages it, transports it, stocks it and sells it to customers at retail locations.

"This is not just like opening up a flower shop or a sandwich shop," says Gehring. "The overhead just to operate, before you've even built anything..." She falls silent, tallying the costs.

'A rounding error'
Proponents of legalization have long claimed that taking marijuana out of the black market and putting it on store shelves would lower prices and at the same time provide tax opportunities for state and local governments. But Jeffrey Miron, a senior lecturer in economics at Harvard University and a senior fellow at the Cato Institute, is unimpressed with the projections. The $67 million Colorado hopes to make in additional taxes is "a rounding error" compared to the total state budget, he says. (For fiscal year 2013, Colorado's budget was $20 billion.) "It's chump change. It's nothing!"

"Of course it's not nothing," he corrects himself. "Yes, you can fund a reasonable number of teachers, or firemen, or whatever cutesy thing you want to use to make it seem important, but spread out across the whole system it will not have a significant impact."

Related: 5 Year-End Tax Tips to Get You Ready for 2014

High Hopes and Blunt Truths for the $2.3 Billion Legal Marijuana Market
The line outside of Patients Choice of Colorado's Edgewater location on Jan. 1, 2014, the first day of legal recreational marijuana sales. Some customers waited in line for about three hours to purchase cannabis legally at $64.90 for an eighth of an ounce.
Image credit: Patients Choice of Colorado

What's more, the costs of setting up and running a new regulatory compliance and enforcement division "will certainly cut into tax revenues from marijuana sales," says McGrath of Potomac Law Group. But he thinks the burgeoning industry will boost the state economy in other ways. "Even if the revenue benefits to the state aren't as much as expected, the industry will create new jobs and bring money into the state as 'pot tourism' grows."

Meanwhile, however, consumer hopes for cheap weed, if they ever existed, are being quietly dashed. Gehring's shop in Edgewater is selling an eighth of an ounce for $55, which comes out to $64.90 with taxes. She has heard of retail prices as high as $75 pre-tax for the same amount. In return, however, pot users get ostensibly higher quality bud and more trustworthy, consistent suppliers.

Investment potential
Most banks remain wary of the weed business. Others would like to lend a helping hand but find themselves stymied by federal law. Jenifer Waller, senior vice president of the Colorado Bankers Association, told Reuters last November that several of her group members "would be very anxious to bank the marijuana industry, but have been told they cannot."

But in the absence of traditional finance, others are stepping up. This week, High Times, the long-running magazine for weed enthusiasts, announced that it was launching a private-equity fund to invest in marijuana businesses. The HT Growth Fund wants to raise $100 million over the next two years for that purpose. It will invest primarily in businesses that, while related to cannabis, are not directly involved in its production or distribution, with investments ranging from $2 million to $5 million per company.

Individuals are also investing. Jeffrey Friedland is one of these pioneers. He runs the financial services firm Friedland Global Capital as well as a strategic advisory, Global Corporate Strategies, that helps entrepreneurs gain access to foreign capital. He considers legal marijuana an emerging market. He has been making the rounds in Colorado, driving from one small mountain town to the next, meeting with county and local government officials and visiting the facilities in which he hopes to take an ownership stake -- so far, two dispensaries and their growing facilities. His involvement as an equity owner is pending state regulatory approval.

To Friedland's experienced eye, the potential for profit is hard to miss. At 9 p.m. on Jan. 8, he saw a line out the door of an adult-use dispensary in the town of Breckenridge. "Stores running out of supply short term is a real issue," he says. Prices are high, but weed is still flying off the shelves.

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Brian Patrick Eha is a freelance journalist and former assistant editor at Entrepreneur.com. He is writing a book about the global phenomenon of Bitcoin for Portfolio, an imprint of Penguin Random House. It will be published in 2015.

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