The new green economy

Legalized marijuana is on the horizon, sending everyone from Loblaw to local growers after the sector’s pot of gold.

Vic Reddy reaches into a glass display case, pulls out a canning jar and pops open the lid. As a customer with a goatee and topknot looks on expectantly, the 28-year-old founder of the Toronto Healing Center (THC) gingerly plucks out a clump of marijuana with a pair of tweezers and places it on a compact electronic scale.

“Funky smell,” the customer says, smiling.

“It’s got that freeness and citrusy flavour to it,” replies Reddy, a broad-shouldered man with a neat beard and a solicitous manner. “It’s one of those that will keep you uplifted. It’s good when you are watching soccer with your buddies.” The customer asks for several grams, which Reddy seals inside a heavy ziplock plastic bag. He brings out a few other jars, each containing a separate strain with its own strength, taste and brand: one is Blue Cheese or CHZ; another is called Girl Scout Cookies.

After about 10 minutes, the customer finishes placing his order, which comes to a total of $239. Reddy reminds him to leave his feedback on the THC website, and invites him to come to a “tasting” event the following week, when a supplier — a “craft grower” — will drop by the store and hand out free T-shirts and other swag.

Reddy is a former special education teacher from Alberta who relied on medical marijuana to ease the chronic pain caused by a 2011 car accident injury. He opened THC (get it?) in the spring, just after a highly publicized police raid on several downtown medical marijuana “dispensaries.” The clampdown, the first of several, led to dozens of arrests, trafficking and proceeds of crime charges and a showy display of confiscated inventory at police headquarters, but many of the operators were back in business within days. Undaunted, the young entrepreneur found a midtown Toronto storefront, tidied it up, invested in security fixtures and a website, and then hung out the proverbial shingle.

GROWING PAINS

While business has been brisk, he’s encountered some of the usual startup growing pains, as well as a few that other entrepreneurs don’t face — for example, dealing only in cash because, he says, there is no regime in place within the tax or banking systems for medical marijuana dispensaries. But with the federal Liberals promising to legalize and regulate the sale of marijuana beyond the medical market, Reddy wants to stake out his place in a sector that, some observers predict, will grow to $5 billion to $10 billion a year, and include some very large corporate players, both on the retail and manufacturing ends.

Smiths Falls, Ont.-based Canopy Growth Corp., for example, one of about 30 Canadian marijuana producers licensed by Health Canada, went public on the TSX Venture Exchange in 2014 and graduated to the full exchange in July; it has a market capitalization of almost $300 million and buy recommendations from analysts. Meanwhile, retail giant Loblaw and its pharmacy chain Shoppers Drug Mart have been quietly preparing to enter the sales arena once new marijuana legislation becomes clear.

But nobody’s weeding out the competition just yet. “I’m a firm believer that the market will dictate where the industry goes,” says Reddy, as he buzzes another customer into his shop.

Reddy may not be far off the mark. By this time next year, marijuana production and distribution could be on its way to becoming a fully legalized, albeit closely regulated, industry — one that attracts investment and entrepreneurs; produces jobs and profits; creates spinoff service industries as well as exports; and garners large windfalls in tax revenue. (Colorado, with a population one-sixth the size of Canada’s, generated US$141 million in sales, retail and excise taxes on marijuana in the first 11 months of fiscal 2016, up 60% from the same period in 2015.)

According to a handful of key judicial rulings, certain individuals have a constitutionally protected right to consume marijuana for therapeutic purposes. Patients with special permits also have the right to grow their own or obtain their supply from designated growers who cultivate particular plants on their behalf, not just licensed producers such as Canopy. But the wider “recreational” market remains in limbo as officials sort through the regulatory tangles. These include handling and packaging rules for the “edibles” segment (still mostly prohibited); regulations governing both large and small producers, including home-growers; and laws laying out which cannabis products can be sold where, by whom, and under what conditions — especially with respect to limiting access to minors.

“Everyone is waiting for legalization to happen, so no one knows what the market will look like,” says Neev Tapiero, who runs the 20-year-old Toronto medical marijuana dispensary CALM (Cannabis as Living Medicine), which provides patients suffering from long-term chronic conditions or terminal diagnoses with safe access to medical marijuana.

GREEN FUTURE

Expectations are running, well, high. The election of Prime Minister Justin Trudeau, who ran on a legalization pledge, coincided with a growing trend, with pop-up dispensaries opening by the dozen in large metropolitan regions. The City of Vancouver, long seen as a haven for medical marijuana clubs (also known as compassion clubs), recently passed tough regulations designed to limit the proliferation of dispensaries, whether or not they’re selling medicinal marijuana to patients with prescriptions. Toronto, for its part, sent in the police after mounting pressure from local councillors and residents uncomfortable with the proliferation of businesses openly selling what some still see as a controlled substance. As in Vancouver, the raids hit fly-by-night dispensaries as well as long established ones.

According to Dori Dempster, executive director of The Medicinal Cannabis Dispensary, which has locations in both East Vancouver and the city’s west end, Vancouver city councillors and by-law enforcement officials have unleashed a costly campaign of legal harassment against dispensaries such as hers, forcing operators to defend themselves in court or before municipal boards of variance. She predicts most of those rulings or closure orders will be overturned on appeal. “They clearly could have handled this in a much different way,” Dempster says, adding that she’s “disgusted” by the misuse of taxpayer funds.

But while such crackdowns made splashy headlines and generated outrage from dispensary operators, the future shape of the formal market is beginning to come into focus. Provincial politicians such as Ontario Premier Kathleen Wynne and BC Premier Christy Clark say they will work with Ottawa to implement the looming legalization legislation, although perhaps with an eye to limiting the distribution of recreational marijuana to government-owned liquor retailers, as Wynne has said. Meanwhile, the Neighbourhood Pharmacy Association of Canada (NPAC) is lobbying Ottawa to pass rules ensuring pharmacists, with their professional credentials, be allowed to dispense medical marijuana as they do with other prescribed drugs.

Chains such as Shoppers Drug Mart, which is not a member of NPAC, are said to be looking for large guaranteed shipments with stringent quality controls. “They have talked to pretty much everybody,” says Tim Saunders, senior vice-president and chief financial officer at Canopy. “They’ve been knocking on doors and pounding the pavement.” Dempster, for her part, believes Vancouver has mounted a campaign to thin the ranks of dispensaries in order to clear the way for the large drugstore chains to move into the retailing of medicinal marijuana.

As was the case with alcohol after Prohibition ended, the transition from a black or gray market to a regulated one will spark demand for all sorts of inventory control and financial reporting services, including those provided by the accounting profession. “Think of it as a multibillion-dollar shift from the unaccounted for to the accounted for,” says George Smitherman, a former Ontario cabinet minister who now sits on the board of THC BioMed International, a licensed medical marijuana producer. “Making money in regulated marijuana will have a paperwork burden that will in turn be a boon for professional services.”

“CPAs will be involved on the front lines of many of these emerging businesses,” says Robert Laurie, a BC lawyer who serves on the advisory board of the Canadian Association of Medical Cannabis Dispensaries and has dispensary clients across the country. “What it boils down to is a control issue.”

“IT DOESN’T TAKE A LOT TO OPEN A DISPENSARY”

Setting aside the cloud of legal murkiness that is likely to dissipate in the near future, there’s nothing all that complex about setting up business in the retail end of the cannabis industry. “It doesn’t take a lot to open a dispensary,” says Laurie.

When Reddy decided to open THC, he began by looking for growers within his network who could supply the more exotic types of weed that his customers seem to prefer over the strains sold by the large licensed producers. “I know the growers, I know where it comes from and I’ve seen the facility,” he says, adding that it was more difficult finding a willing landlord than securing suppliers.

Similarly, Marina, a Toronto dispensary marketing and operations manager (who won’t give her last name due to previous police raids), says her partners “saw a gap in the market and we figured we could fill it.” They opened three outlets within 12 months. The business-school graduate who worked in wealth management and events planning says her daily challenges aren’t much different from what a nightclub or restaurant owner would have to do to track food and liquor sales. “Honestly,” she shrugs, glancing at the dispensary’s CCTV video stream on her phone, “it’s your four Ps: product, place, promotion and price. Just like any other business.”

Pot has been priced on the black market for years, but the emergence of federally licensed producers and other growers inching out of the shadows has created more transparency and greater specificity, with marijuana strains now retailing for $5 to $15 per gram (publicly traded producers even disclose metrics such as operating cost per gram). Compassion clubs tend to keep their prices low, while other dispensaries, such as Marina’s, use a range of techniques that will be familiar to anyone who’s worked in the retail sector: bulk discounts, loss leaders, special promotions and daily specials.

But the pricing may be secondary to the abundant and increasingly heady demand, particularly for affiliated products, such as edibles or cannabis-infused oils. Both product categories have seen explosive growth in places such as Washington, Oregon and Colorado, where recorded sales overall surged after state officials legalized the retailing of marijuana. “A gold rush? Absolutely — that’s exactly what it is,” says Marina.

Tim Saunders, CPA, CA, the aforementioned CFO of Canopy, Canada’s largest licensed producer, arrived at this green gold rush after what can best be called a circuitous journey. It began in 1983 in public practice and took him through industries as diverse as computer hardware, telecom and clean energy. Along the way, he oversaw several large financings and in 2015 joined Canopy, whose founder and CEO, Bruce Linton, he knew through business networks.

GREEN GOLD RUSH

Saunders was keen to hitch his professional wagon to a rapidly transforming, multibillion-dollar sector. He was also drawn to the therapeutic benefits of medicinal marijuana, although he’d not tried it himself. “It was something you could care about. I have seen evidence of how it’s helped people cope.”

BIG CANNABIZ : Tim Saunders, CPA, CA, is senior vice-president and CFO of Canopy Growth Corp., a TSX-listed, licensed marijuana producer with a market cap of nearly $300 millionCanopy has surged to the front of the pack of licensed producers. Its revenues for fiscal 2016 hit $12.7 million, up from $2.4 million in the 15 months ending March 31, 2015, thanks to customer growth, three strategic acquisitions and a co-marketing deal with rapper Snoop Dogg. “We’re now building a business where it could scale up beyond where it is today,” says Saunders.

The question on everyone’s lips, of course, is how that much anticipated growth will take shape. Under Harper-era legislation, licensed producers could only sell directly (via e-commerce or call centres) to medical marijuana users. However, many people with prescriptions, either from doctors or naturopaths, prefer to buy from dispensaries that source from unlicensed growers — likely out of habit and long-established relationships with dealers. (Saunders concedes that dispensaries are currently his competitors, but they could become customers.)

Ottawa had until August 24 to respond to a landmark February 2016 Federal Court ruling that medicinal users aren’t required to buy their marijuana exclusively from licensed growers such as Canopy and can grow their own or have it grown for them. The decision, and the Liberals’ response to it, will likely open the door to pharmacy and supermarket chains, and will almost certainly ease the police pressure on dispensaries if they adapt their operations to the new regulations. What’s more, looming policy decisions about the legalization of recreational marijuana will send further ripples through the medicinal marijuana industry.

In fact, the opening of the recreational market will provide the fastest growth, if the US experience serves as a guide. Canopy, Saunders says, won’t limit sales to medicinal marijuana once recreational marijuana is legalized. The company’s Bedrocan division targets patients, but he describes its Tweed division as a “high-end consumer brand” gearing up for legalization. It’s promoted through marketing campaigns such as Snoop Dogg’s and through a small chain of storefront locations that don’t sell the drug, but sell branded goods such as T-shirts and vaporizers and help customers locate physicians who prescribe medical marijuana.

At the moment, those storefronts can’t legally sell the product, but clearly that situation could change after the Liberals lay out the legalization plan. “The thing for us is how to adapt to these changes,” muses Saunders. “We have to make some bets. A year from now, this could be quite different if the last year is any indication.”

Indeed, dispensary advocates in Toronto and Vancouver are pushing for explicit municipal regulations that would allow them to operate in a stable way until more permanent rules are put in place. David Soberman, a marketing professor at the University of Toronto’s Rotman School of Management, expects to see a shakeout coupled with the emergence of tightly supervised supplier-retail arrangements, such as the deployment of marijuana kiosks at Ontario liquor board outlets. “Over time, you can see consolidation,” he observes. “There will probably be a few bigger companies and several smaller ones.”

Marina expects precisely that outcome as she ponders the future of her three-outlet Toronto dispensary. “Realistically,” she says, “we’ll get bought out by a big conglomerate. They’ll buy our book of business.”

Back at THC, Reddy foresees the market evolving more along the lines of the craft-beer industry, with a handful of very large suppliers co-existing with a thriving indie sector serving consumers who don’t like mass-produced marijuana. “We want the government to embrace what we’ve done and allow us to stay in charge and dictate where our industry is going to go,” he says.

Whether Reddy’s goal is a savvy niche marketing strategy or merely a pipe dream remains to be seen.

A NEW SIN TAX?

For years, Gerry Hedges grew and sold marijuana to the British Columbia Compassion Club Society, a business that yielded more than $300,000 in revenues between 2007 and 2009. He began growing to manage his own hip pain and then branched out. But unlike more conventional firms, Hedges didn’t charge GST; his business operated in all sorts of gray zones, not least of which involved taxation.

Eventually, the Canada Revenue Agency came calling, hitting Hedges with a bill for $15,000 in tax arrears. He appealed the order, arguing that as a drug, medical marijuana ought to be zero-rated under the GST rules.

“Evidence in the trial focused on the issue of whether Mr. Hedges’ [marijuana], which he labelled Po-Chi (after his dog) was a drug,” the judge noted wryly in his 2014 ruling. “This requires some clarification, as no doubt the person on the street would be perplexed to hear that [marijuana] is not a drug.”

The case questions whether medicinal or therapeutic marijuana meets the conditions laid out in the various laws governing controlled substances and narcotics; the financial stakes, obviously, are enormous for the marijuana sector.

While the judge identified many inconsistencies in the legislation and praised Hedges’ lawyer for raising interesting legal questions, he nonetheless rejected the appeal and urged that the law be clarified: “If the Government intends that all sales of dried [marijuana] are to be subject to GST, say so clearly.”

A federal tax court earlier this year upheld the lower court ruling.

About the Author

John Lorinc


John Lorinc is a freelance writer based in Toronto.

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