Sparking Up: Shining a Light on the Recreational Marijuana Industry

Over the past decade, the United States has experienced the gradual emergence of the recreational marijuana industry. The industry is unique, and perhaps its only comparison could be the alcoholic beverage industries that emerged following the Prohibition era. Regardless, the burgeoning industry represents a possible golden goose for investors and entrepreneurs—a solid market is already in place and demand is high. However, unique opportunities garner similarly unique deterents, not least clashing federal and state laws.

This doesn’t sound new…

Nearly every state has passed some form of legislation that clashes with the federal government’s stance on marijuana. In fact, at the state level, marijuana in all its forms is fully illegal in just four states; however, understanding the difference in state legislation is important. There are the issues regulations bring as well as market size implications. For instance, medical marijuana has been approved by various states since as early as 1996, and while some states have experienced a booming market for medical marijuana, many do not. The market is potentially too narrow, serving just medical patients.

Conversely, recreational marijuana is much more akin to alcohol sales, with the main restriction for consumption being a person’s age. As a result, the potential market is larger. Perhaps more importantly, and a key aspect of the industry’s uniqueness, due to marijuana’s widespread use as an illegal substance, it already contains a robust market. For a potential entrant, this makes the industry highly attractive.

Consider this:
In 2011, when some states had passed medical laws but not recreational laws, revenue for medical dispensaries totaled an estimated $1.5 billion. Ten years later, in 2021, IBISWorld estimates revenue for the Medical and Recreational Marijuana Stores industry will grow to $18.6 billion. The rate of growth is gargantuan, and while some of the growth can be attributed to more states passing medical legislation, an undisputable quantity is from recreational sales. In 2016, Colorado, Washington and Oregon alone generated more than $500.0 million in taxes from the retail sale of recreational marijuana. Not only has the industry proved to be lucrative for potential entrants, the states themselves have significant incentive to pass recreational legislation.

Those fifty nifty not-so-United States

In many ways, Colorado, Oregon and Washington provided a proof of concept for other states’ lawmakers. These states were some of the first to legalize marijuana, buoyed by generally positive, enthusiastic public acceptance. Over the following years, many states followed suit. Below is a review of all states that have legalized marijuana at the time of writing:

The list is growing and, interestingly, states seem to pass legislation in packs, which are also growing. In 2012, just two states passed recreational legislation. By 2016, four more states passed legislation, while in 2020 and 2021, a combined eight states have passed legislation and it is easy to understand why; in 2021, Colorado reported generating $2.2 billion in marijuana sales and more than $380.0 million in related taxes.

Not since the Prohibition era has the United States experienced a previously illegal activity, with an already large market, become legitimate.  For lenders and entrepreneurs in such states, this marks an exciting time, but prospective entrants should also display some skepticism. While many states are passing favorable recreational laws, not all states are as quick to take a shine to the industry.

Sign me up?

Colorado provides a case for when things go right. After passing recreational laws in 2012, Colorado wasted little time in getting its industry running. Currently, IBISWorld estimates the state has more than 570 recreational retail outlets. More impressive, consider California, which benefitted from the oldest established medical market. The state legalized recreational marijuana in 2016; by 2021, the state is estimated to contain nearly 1,000 recreational dispensaries. 

These cases may have proved that recreational marijuana laws could provide opportunities, but for some states, that’s where the inspiration ends. In many states, opening a recreational marijuana store can be difficult. Not only does the industry contend with high levels of regulation, marijuana’s conflicting federal-state status provides a slew of additional headaches for prospective operators. Moreover, most states prohibit retail locations for some time following legislation passing.

Take Virginia: Though the state passed recreational use in 2021, commercial sales are not permitted to take place until January 2024. In Connecticut, laws for recreational use passed in 2021, while retail locations are not expected until late 2022. Even in Maine, where recreational laws were passed in 2016, there are currently fewer than 10 recreational marijuana stores in operation.

Top challenges for prospective recreational marijuana retailers:

1. Regulations
   As previously mentioned, recreational marijuana stores operate in a somewhat grey area: they are legal at the state level but illegal at the federal level. The conflicting nature results in a unique set of regulatory issues. Prospective entrants should be prepared to experience high regulatory costs, including licensing fees, and dedicate ample resources to keeping abreast of the ever-changing landscape.
2. Bank apprehension
   Due to marijuana’s status as a Schedule I illegal substance, prospective operators are likely to experience inability to work with certain lenders. This may change in the future with the passing of proposed acts, but for now, operators’ bank and credit union options are relatively slim. As a result, many operators rely on cash transactions, which may not be sustainable or feasible.
3. Taxes
   As displayed, the industry has proven to be a valuable source of tax dollars for states that permit it, but these taxes are to the detriment of industry operators. Moreover, many operators are unable to deduct common operational expenses, such as advertising and rent costs. Add in the issues doing taxes from a cash-only business, and a situation is created that may deter many onlookers.
4. Supply chain logistics
   Due to the industry’s infancy, combined with state-federal restrictions, supply chain issues can be a significant factor for new and experienced operators. Retailers are subject to stringent regulations pertaining to their products, so ensuring the quality and consistency of a supplier is crucial. However, the industry still lacks a substantial, tenured workforce, especially in states where laws have recently been passed. As a result, many new operators must learn as they go, without much of a roadmap to guide them.
5. Competition
   Finally, there is competition. This may sound like a strange challenge for operators in an emerging industry to experience, but it is growing fast. The industry’s built-in illegal market is just as attractive to large conglomerates as it is to small entrepreneurs. As a result, large alcoholic beverage producers, such as Anheuser-Busch InBev SA/NV and the Molson Coors Beverage Company, have already either invested in relevant marijuana companies or working on products of their own. Moreover, just to the North, Canada’s federally legal cannabis industry has a major leg up on domestic operators, with mega-marijuana companies possible already in the making.

The sky’s the limit

It is difficult to say where this leaves us and what is in store for the recreational marijuana industry. One thing that is all but certain, money will be made and lots of it. By 2026, IBISWorld estimates the combined medical and recreational industry will grow to include more than 60,000 stores, generating a total of $45.7 billion in revenue. But even that estimate may be a kick in the bucket compared with what ends up coming. After all, how many more states will pass recreational legislation by this time next year? And the year after that?

But before we start hailing the industry as a potential haven for small business owners, let’s back up. Remember those challenges?

A tale of two tales

One potential outcome: the gold rush, or green rush, is less of a rush and more of a trickle. This could be beneficial as states can ease into the new laws. This gives everyone an equal chance in entering the industry, but the trickle benefits the already established giants. International corporations with the buying power and financial leverage to navigate the ever-changing regulatory landscape will likely be poised to strike while the iron is hot, and their strike will likely be far stronger than mom and pop shops.

As mentioned prior, large companies are aware of the opportunities, and many are investing early, priming themselves for the rush to come. Further, in 2021, two of the largest cannabis companies, Tilray and Aphria Inc., completed a high-profile merger, becoming the largest cannabis company in the world by revenue. Such monoliths could effectively run the industry, by establishing and controlling supply chains, and setting market prices, before local operators even have legal status to operate in their state.

Conversely, due to the hassle and effort it takes to enter the industry, only the best and most dedicated businesses will likely survive. Or maybe the inherited market will be galvanized and denounce any “Big-Cana” of the future, buttressing their local industry. Or perhaps the industry will grow to mirror the domestic beer industry and its subsegment craft beer.

What’s the word?

Every state that has legalized marijuana has experienced the growing pains that come with it. New business owners experience difficulties becoming operational, stores open at a slow rate, certain communities and towns fight to prohibit the stores. The list of potential issues is long, but it’s difficult to pinpoint what exactly enables certain states to excel, such as Colorado and California, and some to seemingly drag their feet, such as Maine.

Regardless of the final outcome, the potential is undeniable, and at this point, unavoidable.