Pubdate: Mon, 03 Feb 2014
Source: Wall Street Journal (US)
Copyright: 2014 Dow Jones & Company, Inc.
Author: Iris Dorbian


They Think Marijuana Could Be the Next Big Thing. but It Has Some 
Unique Challenges.

In 2010, Jake George saw a market waiting to be served and staked 
everything on a startup: He and his wife, Lydia, sold most of their 
assets, downsized to a smaller apartment in Issaquah, Wash., and came 
up with $10,000 to fund GreenLink Collective.

The gamble paid off. Sales have doubled each year, Mr. George says, 
and the couple has opened a second branch.

A classic story, except for what Mr. George sells: marijuana.

It's legal in less than half the country and still illegal under 
federal law. It comes with cultural baggage and controversial 
associations. But a growing number of entrepreneurs like Mr. George 
are trying to turn cannabis into big business.

Many are driven by a missionary zeal about the drug's medical 
benefits or a passion for its recreational use. But others see it as 
simply a great business opportunity-betting that demand in the legal 
market will rise and the stigma will shrink.

Industry advocates are making heady predictions. Annual revenue for 
legal cannabis could run between $4.5 billion and $6 billion 
nationwide by 2018, up from $1.3 billion to $1.5 billion in 2013, 
according to projections by MMJ Business Daily, an online trade 
publication that covers the industry.

ArcView Group, a San Francisco-based investor network focused on the 
cannabis industry, estimates that the national legal marijuana market 
will grow 64% to $2.34 billion in 2014 and will reach $10.2 billion 
in five years.

"There is definitely money to be made," says Beau Kilmer, co-director 
of the RAND Drug Policy Research Center, a nonprofit research 
organization that studies drug-related matters and trends. Counting 
both legal and illegal sales, he estimates, "current retail spending 
on marijuana in the U.S. is in the tens of billions of dollars," and 
"a fully legal market would be expected to generate billions of 
dollars in gross revenues."

But he-and some state officials-caution that it's impossible to 
predict such an untested market. A lot of the current spending on 
illegal marijuana compensates growers and dealers for the risk of 
arrest and incarceration, which would disappear under legalization, 
Mr. Kilmer says. And if marijuana could be grown openly like other 
agricultural products, prices would fall further with economies of 
scale. "At this point no one knows for sure," he says.

Moreover, cannabis entrepreneurs face roadblocks other fledgling 
businesses don't. Banks, landlords, community leaders-even 
entrepreneurs' families-often look askance at the companies. It's 
hard for these businesses to find places to operate, get the money 
they need or even feel completely secure doing business.

A Changing Field

Currently, 20 states and the District of Columbia allow marijuana use 
for medical purposes, and there are plans to push for legalization 
elsewhere, including New York. But Colorado and Washington are far 
ahead of the pack in trying to turn cannabis into a mainstream industry.

In November 2012, voters in both states approved ballot measures that 
allow the recreational use of marijuana-the I-502 initiative in 
Washington and Amendment 64 in Colorado. The states have been working 
to establish a framework of laws to monitor the industry from seed to 
sale, treating it legally on par with alcohol or cigarettes.

Both states have some rules in common. Most important: All towns, 
counties and cities have the authority to decide whether to permit a 
cannabis business within their community. But there are differences. 
For example, I-502 stipulates that Washington's Liquor State Control 
Board will regulate the industry, issuing licenses and making sure 
businesses comply with laws, while Colorado has entrusted the task to 
its Department of Revenue's Marijuana Enforcement Division.

In Colorado, dispensary owners must also grow their product. In 
Washington, medical-marijuana businesses can do both, but 
recreational-cannabis ventures must choose to be either a 
producer/processor or a retailer. Washington levies a 25% tax on 
recreational sales, while in Colorado, on top of the existing 2.9% 
state sales tax and any local taxes, there's a 10% state tax on all 
retail marijuana sales and a 15% excise tax on wholesale.

Colorado's retail cannabis establishments opened Jan. 1, and 
Washington's will follow soon. Other states where medical marijuana 
is legal aren't as far along. Some, like New Jersey, have only a 
handful of dispensaries serving medical-marijuana patients. Others, 
like California and Oregon, have a plethora of dispensaries but no 
central or statewide regulatory hub. Anyone in those states can 
currently open a dispensary without a license, and local towns and 
cities that house the dispensaries often set and implement their own 
rules. (Oregon recently passed a law that will regulate 
medical-marijuana dispensaries, which takes effect in March.)

Meanwhile, nine states where medical marijuana is legal-Alaska, 
Hawaii, Montana, Connecticut, Massachusetts, Illinois, Nevada, 
Delaware and New Hampshire-don't have active retail markets. 
Sometimes state law forbids them; in other cases, there just isn't 
interest. People can grow the drug for their own medical use, as can 
registered caregivers, but there aren't retail storefronts for it. 
Some experts believe that will change this year when new laws take 
effect in several of the states.

For its part, the federal government said in August it won't 
interfere with marijuana sales in states where they're legal, except 
when the operations are fronts for a drug cartel or are selling the 
drug illegally to minors, among other things. Rep. Jared Polis, a 
Colorado Democrat, introduced a bill that would take away the federal 
government's power to regulate marijuana and allow states to handle 
it the way they do alcohol. The bill has been referred to the 
Judiciary Committee, he says.

(Late last year, the federal Drug Enforcement Administration raided 
several Colorado marijuana dispensaries. In a statement, the agency 
said that the investigation was continuing but that there were 
"strong indications that more than one of the eight federal 
prosecution priorities identified in the Justice Department's August 
guidance memo are potentially implicated.")

The New Profile

Cannabis advocates are betting there's a big base of users who will 
respond strongly to the efforts in Colorado and Washington. Already, 
lots of newcomers have entered the cannabis field, say entrepreneurs 
in the industry. "It's really fascinating the kind of investor that 
now wants to get into this industry. A lot of people are looking at 
this as the next great American industry," says Jay Czarkowski, 
co-founder of medical-marijuana dispensary Boulder Kind Care and 
currently managing partner of Canna Advisors, a Boulder, Colo., 
consulting firm that helps would-be cannabis professionals start businesses.

Troy Dayton, co-founder and CEO of ArcView Group, says his company 
hosted an event in November 2011 in which aspiring cannabis 
entrepreneurs could pitch to investors. Not only was there a dearth 
of pitches but the pitches were unsophisticated, he says.

But late in 2013, he says, ArcView hosted a similar event and 
received 100 applications for 12 slots. And, he says, the pitches 
were far more professional and sophisticated. One idea that attracted 
investors: a social network for the medical-cannabis community.

Brendan Kennedy, a co-founder of Privateer Holdings, a Seattle-based 
private-equity firm focusing on cannabis companies, also says the 
pitches he's seeing from prospective investment targets are "much 
more professional than those we saw three years ago."

Currently, Privateer has one portfolio company: the website and 
mobile app Leafly, where users can review strains of cannabis and 
rate dispensaries. "We liked the fact that it was a clean, mainstream 
site that was approachable and smart," explains Mr. Kennedy. "There 
are no pot leaves all over the site. None of the cliches."

When Privateer bought Leafly in 2011, it had about 180,000 visits a 
month and "essentially zero revenue," he says. Now monthly revenue is 
$125,000, and last August it garnered three million visits, he says.

Other experts and officials urge caution when speculating about the 
prospects of the industry. Brian White, spokesman for the Washington 
State Liquor Control Board, says his state hopes that legal cannabis 
could become a significant revenue source. But he says, "No one knows 
for sure how much revenue will be generated by legal marijuana sales. 
In fact, our Legislature has not booked revenue from sales."

Many entrepreneurs are determined that if the market does take off, 
they're going to be there to reap the benefits. Consider Mr. George.

A Washington state native and former electronics sales rep, he was 
inspired to get into the field after a visit to a local dispensary in 
2008 to fill a prescription for medical marijuana. He thought it 
would be a professional setup, but found "multiple people at one time 
talking to a doctor in somebody's garage," he recalls. "I had a woman 
next to me, an elderly woman in a wheelchair, she was crying and 
having an uncomfortable experience."

It moved him to try to offer a better alternative. The business he 
opened-with a garden to grow plants, a retail storefront and a bakery 
to turn the drug into food for patients who don't smoke-does a lot of 
things any small business does. It offers incentives like patient 
loyalty cards and promotes itself online at Leafly.

But he faced hurdles, most notably finding a bank-a problem that 
comes up often among cannabis entrepreneurs and is acknowledged by 
state lawmakers. Mr. George says that his business must operate on 
cash only. No bank will let him open an account because of his 
cannabis connection, he says, and without one, he can't accept 
credit- or debit-card transactions. (He says he works with a bank he 
declines to name, but it isn't a traditional account.)

Mr. Czarkowski and his wife, Diane, didn't have a connection with 
cannabis when they got into the business. They ran a real-estate and 
construction business in Boulder that crashed during the real-estate 
collapse. Then they decided to change course. "When we first came 
across this idea-we weren't marijuana growers or drug dealers or 
potheads-I had a gut feeling that this would be a solid business 
opportunity but we knew nothing about it," Mr. Czarkowski says.

With $50,000 as seed capital, they started Boulder Kind Care, 
converting one of their real-estate properties into a dispensary and 
another into a grow operation. Ms. Czarkowski says that even though 
the couple had taken out multimillion-dollar construction loans for 
their real-estate business and paid them off, and though they held 
many personal and business accounts with their bank, the lender 
eventually shut down all of their accounts "after they found out that 
Boulder Kind Care was a medical-marijuana business."

They tried bank after bank until finding a local lender that would 
take them on, she says. After that, the business took off. By 2012, 
she says, Boulder Kind Care was on track to bring in revenue of $2.4 
million before she and her husband sold their majority shares-for an 
amount they won't disclose-and started Canna Advisors.

Setting Up Shop

There are political efforts under way that may ease the banking 
concerns. For instance, Attorney General Eric Holder recently said 
the federal government will establish guidelines to let legal 
cannabis enterprises gain access to banks.

The official rules of Visa Inc. V +0.41% and MasterCard Inc. MA 
- -0.90% prohibit the use of their debit and credit cards for marijuana 
purchases, but some Colorado merchants let customers use them 
regardless because the card giants have quietly decided not to 
enforce their rules, according to people familiar with their 
strategies. Instead, the people said, the companies are following the 
lead of the federal government, which has said it won't challenge 
state laws that decriminalize the drug.

A MasterCard spokesperson adds, "When it comes to this issue we're 
facing a situation where there's an inconsistency between federal and 
state laws. As such, we're now seeking guidance from the federal government."

Yet plenty of roadblocks remain. Simply getting office space can be a 
big issue: Many in the industry say towns are wary of having 
dispensaries nearby.

"Finding a place to open a dispensary was and is very difficult," 
says Ms. Czarkowski, adding, "Many landlords will not rent to this 
industry. They are limited even further by zoning restrictions and 
the 1,000 feet from any school/day-care restriction."

Genifer Murray saw those problems firsthand. A former 
business-development manager for an online-payments company, Ms. 
Murray was inspired to get into the cannabis field in 2010, after a 
chance conversation with an acquaintance. "I just started talking to 
this guy and he found out I was a scientist," says Ms. Murray, who 
has a degree in microbiology. "He felt me out to see if I was 
pro-cannabis, and then he told me about testing the potency of 
cannabis," to make sure the strains are effective but don't harm people.

After doing due diligence, she started her own testing operation, 
CannLabs. But she says her searches for office space in Denver were 
long and frustrating. Three landlords, she believes, took advantage 
of her-one didn't tell her the building was in foreclosure, for 
instance. They knew cannabis was frowned on and she wouldn't complain 
to authorities, she says.

In fact, "I was scared to death the first six months of being 
arrested," says Ms. Murray. Even though the business was legal in the 
state, it was still illegal at the federal level-and right before she 
opened, another testing lab that applied for certification got closed 
down by federal agents, she says.

Today, she's more optimistic. Even though she's leaning on her 401(k) 
to keep her five-person business afloat, she says she's close to 
landing investors and thinks business may take off. Currently, she 
estimates, "only about 7% of the industry" tests their cannabis 
products, for a variety of reasons, such as lack of funds. But 
testing will become mandatory this year-which she thinks will bring a 
surge in business.

Middle of the Road

For all the problems many cannabis entrepreneurs face, some say their 
businesses are treated as basically mainstream. Dan Williams, 
president of Denver-based Canna Security America, which offers 
security services to cannabis operations, says he hasn't had troubles 
with federal agents or banks. "We have a very strong relationship 
with our bank," he says. "I think it's because we're an ancillary 
service provider and we don't actually handle any cannabis."

After running a security company in Connecticut, Mr. Williams moved 
to Colorado, where he worked for another firm before striking out on 
his own. His first client was a cannabis dispensary. "He referred me 
to three of his friends, and they referred me again, and before I 
knew it we were specializing just in the cannabis industry," he says.

Along with his business, he says he helped draft Colorado's cannabis 
security-regulation standards and is helping develop standards in 
Washington and other states.

To be sure, at the start his business raised some eyebrows. "I'm from 
Connecticut," he says. "When I started this and it was getting 
momentum, people would say [to me when I went home], 'Are you dealing 
with a lot of criminals? Where are you guys installing this stuff? In 
the basements of clubs?' "

But the only real snags, he says, have been "keeping up with the 
exponential growth of the industry."
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MAP posted-by: Jay Bergstrom