Transparency in the Nevada Cannabis Industry
It’s an exciting and interesting time where states and municipalities are deciding how best to regulate medical marijuana and recreational cannabis for the first time. As more states are moving in uncharted territory, what matters most in designing these programs is flexibility. For states where recreational cannabis has been legalized for some time now, we are seeing changes be made to the programs when something is not working.
In Nevada, running a cannabis business is like running a casino – it’s capital intensive and only a select few have the privilege to participate. Nevada has a uniquely competitive and rigorous scoring process for cannabis license applications and has limited the number of licenses awarded. In this type of merit-based application, there is usually some combination of barriers, all geared towards reducing the number of cannabis businesses granted a license and ensuring that licensees are extremely well-funded.
A few of these barriers to entry include:
A difficult and time-consuming license application process
High application and licensing fees
An unreasonably short application window
High minimum fund requirements
Increasingly favoring big businesses with deep pockets
Bearing all the costs with no guarantee of winning a license
This sort of relative scarcity inherently places a tremendous value on the licenses and to the people who win them. The Nevada market has established that cannabis licenses are worth tens of millions, even hundreds of millions, of dollars. If you are one of 17 people in Nevada that can sell cannabis, that’s a valuable license to hold.
Now, Nevada isn’t known for its sunshine laws but will foster the kind of environment voters wanted to avoid when they approved a legal cannabis market. Namely, to remove the marijuana trade from criminal enterprises, cartels, mobsters, street dealers, and to ensure that they don’t have participation in the legal cannabis industry. This bears the question; what methodology is used in granting these lucrative licenses?
A LOOK INSIDE CANNABIS LICENSING IN NEVADA
According to the Department of Taxation, information about cannabis applications and licenses was strictly confidential as a result of merging two statutory and regulatory structures that deal with highly sensitive information: medical marijuana, which necessarily protects patients and providers, and taxation, which protects the financial and proprietary information of Nevada businesses. Policies aimed at creating a legitimate and well-regulated market are often counter-productive. The lack of information being released prevents the public from holding the state agency accountable to its own laws and maintains the stigma associated with cannabis.
The Nevada Department of Taxation has been under scrutiny since late last year after the latest dispensary license applications were scored and awarded. For the 2018 dispensary application period, current cannabis license holders were competing for 64 dispensary licenses available. A transparency issue arose after the state awarded 61 provisional licenses but didn’t disclose the winners’ names and a lion’s share of the licenses went to a handful of companies.
Nearly a dozen cannabis businesses that applied but failed to receive a license are suing the Department of Taxation, saying the agency’s marijuana regulations are invalid and that a lack of transparency in awarding licenses is opening the state up for corruption. Issues raised by the plaintiffs range from concerns about the breadth of criteria used in scoring, to allegations that some business entities received more licenses than legally allowable in each jurisdiction, to fears that the licenses granted will essentially form a monopoly and starve the smaller businesses that helped the industry get off the ground.
Is an influx of lawsuits by applicants who didn’t win inevitably going to happen with the merit-based application process? And how do municipalities and states go about avoiding that?
In an ongoing effort to improve transparency in cannabis licensing and the industry, Gov. Steve Sisolak announced the passage of Senate Bill 32, permitting the release of details regarding who applied for licenses, who received licenses, their ranking, score and the process of issuing cannabis licenses. Sisolak said the release of the information under Senate Bill 32, which received unanimous support in both chambers of the Nevada legislature, “ushers in a new era of transparency that will benefit the industry and the public.”
“This new policy is an important step in a multi-pronged approach to greater transparency in marijuana licensing under my administration. As our legal marijuana industry has evolved and flourished, it’s more important than ever that the industry and the public enjoy the benefits of a completely open and transparent process from licensing to operation so that our marijuana industry can become the gold standard in the nation.”
- Governor Steve Sisolak.
The Department of Taxation provided roughly 10,400 documents that include the names of winners, losers, a list of current license holder’s owners, officers, and board members, and the methodology used to score the applications available on their site. Within those pages are 8,900 names of applicants for dispensary licenses.
Documents released on the Department of Taxation’s website include:
Information regarding the evaluators of the licensing applications.
The use of state contractors for license application evaluation.
The tools contractors used to evaluate applications.
Methods contractors employed to evaluate applications.
Of the 127 applicants, each submitted on average 3 applications for different jurisdictions totaling to 462 applications. Only 17 of those 127 applicants were awarded licenses.
When the application criteria are scored on a point value system, it’s worth noting how a five-point deficit – say, in the financial resources arena - can make or break your chances of winning a license. Hell, even one-point is the difference between triumph and defeat. In sections were applicants are graded on the adequacy of their business plan and their ability to operate in a compliant manner, by way of a rating scale (10-points for excellent response, 5-points for average, and 0-points for inadequate) is fair.
Evaluating applicant’s financial assets by a rubric with a 10-point grading scale (shown below) of how deep their pockets are, or how much they paid the State of Nevada in taxes seems to favor well-funded cannabis conglomerates versus small businesses, or economically disadvantaged groups.
Total Assets ≤ $250,000 = 1 point
Total Assets = $250,00 - $500,000 = 3 points
Total Assets = $500,001 - $1.5m = 5 points
Total Assets = $1.51m - $2.5m = 7 points
Total Assets = $2.51m - $3.5m = 8 points
Total Assets ≥ $3.51m = 10 points
This isn’t to say that small businesses or economically disadvantaged groups cannot outperform the cannabis conglomerates in other areas, but in such a competitive application process every point counts.
Let’s say that Company A and Company B have scored the same points thus far, but Company B has $2.5 million in assets and Company A has $1.5 million in assets. Both companies have enough money to cover all expenses, startup costs and the first year of operations based on their respective facility size. According to the evaluation rubric, Company A would receive 5 points and Company B would receive 7 points. Both companies scored very high, with 200+ points overall. Then, there is a limited number of licenses awarded in each jurisdiction allocated to the highest-ranking applicants. Those two points could single-handedly be the reason Company A did not make the cutoff, but Company B received a license.
After reviewing the dispensary application scores and rankings, there are several instances where companies missed the marked by less than one point. Because of the federal illegality, there are no bank loans or commercial banking in this area, there’s no small business administration, and so it’s left to venture capitalist and private asset managers, very few of whom are people from socially disadvantaged groups. Federal restrictions and local regulations also make cannabis a relatively complicated industry to navigate, raising barriers to entry for anyone without significant training, college education or legal expertise.
Each state’s vision for the cannabis industry is different. While some states believe fostering small businesses is a priority, others are not concerned with keeping “Big Cannabis” at bay. Other states recognize the injustices of the War on Drugs and have policies for the participation of socially disadvantaged groups in cannabis companies as a form of restitution. Nevada is not one of them.
The dispensary application did ask for the diversity of race, ethnicity, or gender of the owners, officers and board members for the proposed cannabis business, as a result of the passage of Assembly Bill 422. However, in the evaluation rubric for the organizational structure, there was no mention or instruction for an applicant to receive points for having diversity amongst its owners, officers, and board members.
In fact, the only aspects evaluated were:
The organizational chart clearly demonstrates the following: (i)Defines the roles and responsibilities that will make up the company’s functioning and shows how everything fits together as a whole (ii) Demonstrates grouping of functions to ensure they are overseen and performed by a member of the organization (iii)Position job descriptions demonstrate the scope, function, and limits of their roles, and for what tasks outcomes they will be held responsible for (iv)The organizational structure shows efficiency between roles.
Owners, officers, and board members can demonstrate business experience running other businesses or non-profits. Each individual has the knowledge and experience relevant to the roles and responsibilities outlined.
The educational achievements, specifically a college degree or higher, of the owners, officers and board members
The information and documentation required for a dispensary application are quite extensive, but it seems counter-intuitive to ask for information that is not taken into account when assessing and scoring the applications. Another example of this is how the application required two narrative descriptions for each owner, officer and board member:
Highlighting their past experience working with government agencies and highlighting past community involvement, and
Any previous experience at operating other businesses or non-profit organizations, including marijuana industry experience.
In the evaluation rubric for the organizational structure, each team member was evaluated based on their business acumen and educational achievements with no mention of assessing their experience working with government agencies or community involvement. Based on the evaluation rubric, it appears the first narrative description was not taken into account at all – why ask for the information?
It’s worth noting that Nevada is a national leader in oversight systems though, and perhaps there is a method to the madness. The state has successfully and responsibly managed gaming, and the oversight of that industry is now the model across the world. With the creation of the Cannabis Compliance Board, which will review regulatory structure, licensing procedures (including the most recent licensing round), oversee the development of banking solutions and potential cannabis consumption lounges, Gov. Sisolak is aiming for the Nevada cannabis industry to reflect its gaming gold standard. The board will consist of five members appointed by the governor and will be modeled after the Nevada Gaming Control Board, which oversees Nevada’s gaming industry.
Unlike other states which allow for a free market with no limit on licenses, Nevada will not have a flood of cannabis businesses. The tight number of license and rigorous reviews means the industry as a whole will remain stable, delivering predictable tax results for the state.
THE IMPORTANCE OF TRANSPARENCY IN CANNABIS LICENSING
Despite the fact that more than half the United States has legalized some form of medical marijuana, and 11 states have legalized recreational cannabis, there is still a lingering negative perception associated with cannabis. If the cannabis industry operates under a veil of secrecy, particularly when the secrecy relates to information, people will feel a sense of distrust toward it – more than they do already. When the processes governing, and the operations conducted within the industry is open and transparent and the veil is lifted - trust in the regulation of cannabis increases. Information transparency is critical in removing the stigma associated with cannabis, but it’s also essential for the industry to grow accordingly.
Revealing how these lucrative licenses are awarded is an eye opener for current license holders and for entrepreneurs wishing to break into the nascent cannabis industry in Nevada. The extensive licensing application process and high cost of establishing a cannabis facility make entry into the market a time- and capital-intensive process. There are major barriers to entry in the Nevada cannabis market with a lack of capital being the most cumbersome of all.
Small businesses are natural Davids, the underdogs fighting against larger competitors who seemingly have all the advantages of strength, size, and resources. This means that small businesses must think outside the box and deploy “David strategies” to overcome Goliath's by using their own built-in advantages to compete or by being a different kettle of fish.
An example would be to make your application stand out by having a unique idea, creative story or overall theme. Our client was one of the 17 companies to win three dispensary licenses in the recent dispensary application round. What made their application unique was the overall philanthropic theme centered on the local community and their declaration to donate 50-70% of profits to Nevada charitable organizations. Helping Hands Wellness Center pioneered the idea of a Nevada cannabis philanthropic enterprise, helping to coalesce a new movement within the industry by generating a steady source of revenue for the non-profit sectors in the state. Not only will this unique idea reshape the cannabis industry and demonstrate that cannabis can create a positive social impact on the community, but it is the shiny needle in a haystack of applications.
The transparent nature of the licensing processes moving forwards allows the David-esque businesses to know the true odds of winning a license, what they must do to compensate for their lack of capital and develop strategies to outperform the cannabis conglomerates in other areas. The world is full of entrepreneurial upstarts that took down industry giants and overcame every obstacle and barrier in the way.