Jan 142014
 

Making of Colorado’s Marijuana Millionaires

January 14, 2014 

I’ve seen a lot of marijuana over the past two weeks, but nothing like this.

Less than two miles north of Denver’s central business district lies the headquarters of Garden of the Gods, one of the region’s largest commercial cannabis operations. “We grow 280 pounds a month,” its owner tells me as we stand in his office surrounded by a handful of administrative staff. And I believe him.

Unlike many of the smaller facilities I visited in Colorado last month for research on this three-part series, this massive operation situated in the heart of the state capital evidences all of the trappings of a professionally run enterprise. It’s clean, well-organized, buzzing with activity, and bursting at the seams with marijuana plants. Thousands upon thousands of them; situated in more than a dozen 1,000 square-foot rooms dedicated exclusively to the latter stages of a cannabis plant’s lifecycle — there’s a separate building on the property for breeding and cloning.

Walking down its main corridor, I can’t help but think that this business, more than virtually any of its competitors, has truly uncovered the profitable sweet spot that exists in the legal grey zone between federal and state laws governing the marijuana trade. Indeed, one could even go so far as to say that this legal no man’s land is the very reason that a small handful of well-heeled businessmen and women have been able to amass growing pot empires. 

An uncomfortable legal reality

As we make our way through the facility, the telltale signs of this uncomfortable legal reality are everywhere.

Security cameras are above every door, in every room, and along every hallway. The security guard makes himself highly visible and is outfitted for what appears to be an impending SWAT mission. To get past the front desk, you have to sign in and wait to be buzzed through a secured entrance. And in the principally cash-based business, a steel safe in the office is roughly equivalent in size to my law school apartment — that is, very big for a safe, but embarrassingly small for an apartment.

An employee of Denver-based Garden of the Gods cleans and repaints one of 13 rooms for late-stage cannabis plants. Photo by author.

“The government wants our tax revenue, but regulates the industry as if we’re common criminals,” a grower in Colorado Springs emphasized to me earlier in the week.

To be clear, these aren’t discretionary practices unique to the massive Denver-based facility I’m visiting. They’re instead the consequence of a fragile accord between the federal and state governments over how to regulate the production, sale, possession, and consumption of medical (and now recreational) marijuana.

Traditionally, state and local governments enforced small indiscretions, while the federal government — namely, the U.S. Department of Justice and its Drug Enforcement Administration — prosecuted large operations reaching across state lines.

Get busted with a joint in your ashtray? You’re headed to city or county court. Have a large shipment of weed intercepted by the DEA on its way from Texas to Minnesota? Put on your big boy pants, because it’s federal court for you.

While this separation of responsibilities began to fray more than a decade ago with the passage of medical marijuana laws in multiple states, it’s only recently become a focal point after both Colorado and Washington legalized recreational use as well. As we sit here today, smoking a joint in either of these states is legally indistinguishable for all intents and purposes from drinking a beer even though cannabis remains a Schedule 1 controlled substance under federal law.

Consequences of marijuana’s legal grey zone

After speaking with numerous industry participants over the last few weeks, it’s become exceedingly clear that the repercussions of this legal conflict are far from academic.

Most notably, it’s why Colorado adopted such a stringent (and expensive) regulatory regime and why a business like Garden of the Gods is run with the clinical efficiency of a Swiss watch manufacturer. Application and licensing fees add up to tens of thousands of dollars, dispensaries and cultivation facilities must be equipped with sophisticated security and product-tracking systems, employees in the industry are screened by the state before getting cleared to work, and only a fraction (30%) of a cultivation facility’s harvest can be sold to third-party dispensaries.

These measures are in direct response to the Justice Department’s recently announced policy of avoiding marijuana-related prosecutions “based on the expectation that states and local governments that have enacted laws authorizing marijuana-related conduct will implement strong and effective regulatory and enforcement systems.”

A jar of medicinal marijuana at Rocky Road Remedies. Photo by author.

The legal divide also explains why most banks won’t service businesses linked to the production or distribution of marijuana. Under the Bank Secrecy Act, federally insured depository institutions can’t accept deposits from businesses engaged in federally proscribed activity. The same prohibition holds for checks, debit cards, credit cards, and wire transfers.

“In short, federal law says any entity that holds deposits from another person, transfers funds between parties as in checks, debit cards, wire transfers, or otherwise is connected to the payments system — the movement of money from one financial entity to another party — must abide by federal law,” Don Childears, the president and CEO of the Colorado Bankers Association, told the Denver Post.

And along these same lines, it’s why many of the ordinary and necessary business expenses incurred by a retail dispensary aren’t deductible from federal income taxes.

Under section 280E of the Internal Revenue Code, businesses are precluded from deducting expenses related to the “trafficking of controlled substances … which is prohibited by federal law.” This has been interpreted by at least one federal tax court to capture all deductions for expenses related to retail establishments that derive the majority of revenue from marijuana sales.

“There’s simply no question that the banking ban and uncertainty around taxes are the two biggest issues facing the industry today,” the owner of the second-largest dispensary in Southern Colorado told me.

How legal ambiguity is shaping the marijuana trade

One of the most interesting, albeit unintended, consequences of the conflict between federal and state marijuana laws is that it’s carved out a protected haven, if you will, around a small subset of businesses in the industry — namely, those with access to private in-state capital.

Under Colorado’s rules governing the sale of both medical and recreational cannabis, current industry participants are heavily insulated from competing against well-financed, out-of-state entities with large shareholder bases — think publicly traded companies like Altria, the domestic distributor of Marlboro cigarettes, or Lorillard, the proprietor of Newport cigarettes, among others.

This follows from the requirement that every application for a medical or recreational license must contain “the names, mailing addresses and owner’s background applications of all persons owning any of the outstanding or issued capital stock” (emphasis added).

On the flipside of this, however, is the fact that capital to finance a marijuana business is uniquely difficult to come by.

As I’ve mentioned, financial regulations preclude banks from loaning to businesses that violate federal law. In addition, all of the capital invested in a retail dispensary or commercial growing facility must come from inside the state, curtailing the involvement of Wall Street and other out-of-state financiers.

This leaves local businessmen and women with no disqualifying criminal history or personal enmity to quasi-illegal drug dealing as the sole source of capital. For his part, the owner of Garden of the Gods financed his operation with cash from the sale of his commercial janitorial company.

Consolidation around two centers of gravity

It’s for this reason that the industry is beginning to consolidate around two distinct centers of gravity. The first consists of early adopters that have built up sufficiently large cash flows to finance increased regulatory burdens and further expansion.

This is the case for Rocky Road Remedies, one of the largest retail dispensaries in Colorado Springs, the state’s second biggest city. Aside from a couple of recently purchased 2014 Porsche Cayenne’s for the company’s co-founders, it’s reinvesting the lion’s share of operating cash flow into a new cultivation facility that will more than double Rocky Road’s current capacity.

The second center of gravity consists of newer but deeper-pocketed local entrepreneurs. “This is the traditional story of the haves versus the have-nots,” said Roberto Lopesino, vice president of Advanced Cannabis Solutions and one of the sharpest minds in the industry.  

One of 13 rooms at Denver-based Garden of the Gods, dedicated to the late stages of a cannabis plant’s lifecycle. Photo by author.

The prototypical example is John Lord, who’s purported to be the state’s biggest pot baron, according to an analysis by the Denver Post.

Before getting into the marijuana trade, Lord was president of Denver-based Basic Comfort, a manufacturer of baby sleep positioners and other products, which sold to a competitor in 2008 for $6.5 million. Today, he has ownership stakes in more than half a dozen retail dispensaries scattered along the Front Range — an offshoot of the Rocky Mountains stretching from Casper, Wyoming, to Pueblo, Colorado.

Another example is Elliott Klug, one of three owners of the Pink House Blooms chain of retail dispensaries. Along with money from friends and family, Klug financed the venture with proceeds from the sale of a small oil company that he founded years earlier.

“One thing those on the list [of Colorado's biggest marijuana moguls] share is a wealth of management experience in fields unrelated to marijuana, showing that making it in the legal pot industry today is as much about business acumen as it is about growing good weed,” wrote the Post‘s John Ingold and Eric Gorski.

The commercialized future of pot

As my tour of Denver’s massive Garden of the Gods facility ends, the owner asks me what I thought. “It’s impressive,” I say. “If you think that now, then you should come back later this year,” he responds. “See that parking lot there? We’re about to fill it with 70,000 square feet of greenhouses, effectively tripling our output.”

This, folks, is the future of the marijuana trade. Big, efficient, commercial operations; run by a handful of wily (and increasingly rich) pot barons that jumped headlong into a still-uncertain legal grey zone. As the old saying goes: the greater the risk, the greater the reward.

…. By John Maxfield

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