News Column

Colorado's Medical Pot Biz Offers Look into Industry Risks, Rewards

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DENVER -- At Leela European Cafe, a quirky, 24-hour coffee shop and bar in the heart of downtown, a bartender was quick with her thoughts on Colorado's experience with the legal sale of medical marijuana.

"It's really easy to get," said Cara Wanek, 25, who says she uses it to calm her anxiety, boost her appetite and help her sleep. "And it's delicious."

That's exactly what Illinois is trying to avoid.

While Colorado is not quite the Wild West of medical marijuana, it offers a window into the opportunities and consequences that arise when a state allows the legal sale of a long-banned drug.

The state's therapeutic cannabis industry launched in earnest in late 2009, triggering a "green rush" that boosted the state's economy. Big Marijuana added thousands of new jobs, revitalized aging industrial warehouses and shuttered storefronts, and generated millions of tax dollars for the federal, state and local governments.

At the same time, state officials acknowledge they were unprepared to license, inspect and regulate medical marijuana businesses, leaving millions of fees and taxes uncollected and a significant swath of the industry unchecked. And recently released police data show a modest uptick in certain crimes near marijuana businesses in Denver.

But as the nation's first highly regulated, for-profit market, Colorado has served as a model for other states seeking to get in on the action.

In crafting legislation that would allow for the legal sale of the drug to certain patients beginning in 2014, Illinois lawmakers looked to build upon the experience in Colorado, where pretty much anyone with a long-ago injury can get a doctor's approval to purchase up to 2 ounces of pot at a time _ enough to stuff two small sandwich bags.

Illinois' proposed statute is far more restrictive, placing tighter limits on who can legally purchase the drug and where it can be grown and sold.

The bill, which would allow people with 42 defined conditions to purchase the drug legally over a four-year trial period, was approved by the Senate on May 17. It awaits the signature of Gov. Pat Quinn, who has said he is "open-minded" about the prospect.

As the governor contemplates a decision, experienced pot entrepreneurs in and around Denver are watching closely with the hope that the time and money they've spent shaping and supporting the Illinois bill will pay off.

"Everyone is looking at Illinois and New York because that's where the population is," said Kayvan Khalatbari, a 29-year-old Nebraska native who was one of the pioneers in the Denver marijuana scene. "The ball is rolling, and with more and more states coming on all the time, we see opportunities everywhere."

If Quinn signs the bill, Illinois would become the 20th state, plus the District of Columbia, to allow the sale of medical marijuana. Dispensaries could open as soon as next year.

In Colorado, legalization of the drug for medicinal purposes was approved by voters in 2000. But because the drug remained illegal at the federal level, most users remained underground, growing as many as six plants each for their own medical needs.

The industry didn't emerge until 2009, after an Obama administration memo suggested that federal authorities would not aggressively challenge state laws.

Almost overnight, Colorado was swamped with retail dispensaries and large-scale operations to grow the plants. The state, which didn't have an adequate regulatory or tax structure in place, soon had more weed shops than Starbucks.

By the next spring, when lawmakers scrambled to pass regulations, more than 2,000 companies had filed with the state to sell medical marijuana.

"We didn't get off to a great start because we didn't have the time or the staff to tool up," said Ron Kammerzell, the Colorado Department of Revenue's enforcement director. "We're still, in a way, playing catch-up."

At the end of 2010, the first year of regulated medical marijuana in Colorado, the state's industry had more than 1,100 businesses, including dispensaries and manufacturers of marijuana-infused products, according to state statistics.

Today, there are 675.

"A majority of the people who came in in 2009 to make a quick buck are either broke or in jail," said Norton Arbelaez, a tall, loquacious Oklahoma native who practiced medical malpractice law in Louisiana before he and a friend founded River Rock Wellness, a two-store medical marijuana operation in Denver.

"There were a lot of bozos in this business in the beginning," Arbelaez said. "For the most part, those of us still around are the ones who are doing it right."

In the roughly three years since the regulations took effect, sales have ballooned to nearly $200 million, generating $5.4 million in state sales tax in 2012.

In addition, operators have paid the state more than $10 million in application and licensing fees.

The most successful of Colorado's 479 registered retail dispensaries log annual sales greater than $3 million.

Kayvan Khalatbari's venture, Denver Relief, started with $4,000 and a half-pound of marijuana.

Wedged between a salon and an urgent care center on Denver's near south side, the 25-employee operation expects sales of $1 million to $2 million this year. It has made money from day one, Khalatbari said.

But even as the legal sale of the drug emerged from rogue growers' basements, retail owners and growers said they still operate in an environment of fear.

Because state laws run counter to a 43-year-old federal law that classifies cannabis as a Schedule 1 controlled substance, companies say they face hurdles that other businesses typically don't encounter.

Banking is difficult, insurance is hard to come by, and operators fret that their nascent enterprises could be shut down at any time by federal regulators.

Operators say most banks won't lend to enterprises that handle a product that is illegal under federal law. As a result, the vast majority of Colorado's marijuana enterprises are financed solely with their own and private investors' money.

Many lack business bank accounts and pay all of their bills _ workers' paychecks, utilities, contractor fees and mortgages _ with cash or money orders.

Another issue is taxes. On average, small businesses pay an effective tax rate of about 20 percent on net income, according to the Small Business Administration. Marijuana purveyors, by contrast, say they pay an effective tax rate of 60 to 70 percent.

That's because the federal tax code prohibits the deduction of standard business expenses for those who deal in controlled substances _ marijuana included _ even in states where it is legal.

"It's a very heavy-overhead business that requires a lot of capital," said Rhett Jordan, co-owner of Native Roots Apothecary, an upscale medical marijuana shop on the 16th Street Mall, Denver's answer to Michigan Avenue.

Inside the spalike shop, 30 airtight glass jars filled with buds sit behind a counter. A "bud-tender" helps patients choose the product best suited for their ailment. Chocolates, candies, tinctures and tiny jars filled with concentrated cannabis, called hashish, are arranged much like jewelry inside a glass case. Cameras are everywhere.

Customers range from local business magnates to musicians and construction workers.

Jordan, who said he has relatives in Illinois, has a keen interest in opening a dispensary in Chicago.

If and when Illinois opens the door to medical marijuana, weed retailers like Native Roots will face a much different regulatory environment. The number of dispensaries will be limited to 60 statewide and the number of growers to 22, one for each state police district.

Illinois also will be more restrictive on what diseases can be treated with medical marijuana. Of the roughly 108,000 Coloradans who hold state-issued medical marijuana cards, more than 101,000 reported using cannabis in part to treat "chronic pain," a catchall category that will not be recognized in Illinois.

While the tighter restrictions in Illinois likely mean a smaller pool of potential customers, industry veterans in Colorado are confident the law eventually will loosen.

Colorado law, just like the one proposed in Illinois, requires growers to raise their plants indoors, under tight security. Installing robust security systems, which include high-definition cameras, automatically locking doors and shock sensors, can cost more than $100,000.

The state's marijuana cultivation centers range in sophistication, security, employment and quality of product. Some have a thousand plants; some have more than 30,000. Most are grown indoors in modified warehouses; some use greenhouses surrounded by 10-foot-high electrified fences.

To prevent theft and diversion of the product to the black market, operators are required to invest in sophisticated software that tracks the plant from "seed to sale," a Colorado mandate that Illinois' legislation adopted.

Each crop, on average, takes about four months to grow. Monthly electric bills range from $3,500 to more than $15,000. The retail value of the inventory inside can easily stretch to several million dollars.

The plants are finicky and prone to mold and mildew, so temperature, humidity levels and air circulation are closely regulated.

Some operators grow their plants hydroponically, some prefer dirt, and others such as Gaia Plant-Based Medicine use a dirtlike product made of crumbled coconut husks.

The company's indoor cultivation center, a single-story brick building with barred windows, sits across the street from a Denver Police Department outpost in an industrial area on the northeast side of town between the airport and downtown.

A few years ago, many of the aging buildings here were empty. Today, they're the headquarters for metropolitan Denver's marijuana growers. The fragrant, unmistakable aroma of pot plants wafts down the street.

"If you look all around Denver, we came in and rented undesirable spaces," said Meg Sanders, Gaia's co-owner and chief executive. After Gaia opened a retail dispensary in east Denver, a Starbucks and a grocer moved in, Sanders said. "It becomes a hub."

Anecdotes like this abound in Denver, running contrary to what many feared would happen to their neighborhoods once the marijuana industry moved in. Visions of drug-addled stoners and nefarious pushers flooding the city's streets never materialized.

Two Denver City Council members and the head of the Denver Metro Chamber of Commerce said complaints to their offices about marijuana dispensaries and growing operations are rare.

Colorado's medical marijuana experiment has gone well enough that voters in November were emboldened to push forward another constitutional amendment that will allow anyone 21 or older to buy the drug for recreational or "adult use" purposes as early as 2014.

It represents a major opportunity for Sanders, 47, who left the financial world in late 2010 to ride the marijuana wave.

Inside her discreet cultivation center, a Zen-style front waiting room makes way to an open warehouse, where tattooed workers trim marijuana plants, separate leaves from flowers and weigh product.

One-thousand-watt sodium lights cast a bright glow through ajar doors that lead to separate grow rooms.

Sanders had just returned from Illinois, where she spent time in Chicago meeting with potential growers and retailers and a day in Springfield to "help with the legislative process."

She wants to ensure Illinois doesn't make the same mistakes as Colorado, and that those who participate in the industry can learn from her company's initial struggles. When she and other investors took over Gaia two years ago, it was hemorrhaging money.

The company finally turned the corner and became profitable this quarter, she said. For the full year, the three-store company projects revenue of $5 million to $7 million.

"It's been far more challenging than anyone thought because the rules kept changing," Sanders said. But with more than $3.5 million of their own money financing the venture, she and her investors remain bullish.

"There are few other industries that have insatiable demand," she said. "Every single product we put on the shelves is sold each month. It pays for itself very quickly, and that's what makes it so appealing."

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