Californians know craft. Whether you’re touring micro-breweries in San Diego or local wineries in Sonoma Country, or visiting the countless artisanal bakeries, ice cream shops or distillers in metro areas like Los Angeles and San Francisco, you’ll see (and taste) the unique qualities and extreme care that Californian business owners put into their products. For decades, the tenets of craft production – focus on quality, sustainability, and local variation – have also been at the core of California’s cannabis industry. Small-size cultivators, and their retailers and distributors, have made local strains legendary for quality, potency and variation.

With the emergence of the legal adult-use industry in 2018, many cannabis business owners and advocates worried that a deluge of “corporate cannabis” entities would run amuck, eventually dominating the industry and driving craft operations underground.

In an effort to help smaller operations compete in the legal adult-use cannabis landscape, the passage of the Adult Use Marijuana Act (SB94 or AUMA) included the creation of a new license category: Type 12 – Microbusiness. This innovation has been heralded as a way for small businesses to compete against larger entities and maintain California’s proud craft industry – allowing cottage cannabis operations to enjoy the same acclaim as the state’s many microbreweries and boutique wineries.

Creating a Path to Vertical Integration

In California’s newly regulated market, all cannabis operations must apply for various license-types to operate legally. The application process for each license is extremely detailed, labor intensive, and requires significant up-front investment (for details, see our on-going series about applying for California licenses.) Additionally, when California legislators created a single regulatory framework for both medicinal and adult-use cannabis (Medicinal and Adult-Use Cannabis Regulation and Safety Act or “MAUCRSA”), one of the many significant changes was the removal of restrictions on an operation’s ability to hold several licenses.

With different license types in hand, a business can vertically integrate, expanding operations into more stages of production and benefitting from the ensuring operational and cost advantages. With MAUCRSA in place, a cannabis business owner/operator may hold any combination of cultivator, distributor, manufacturer and retailer licenses.

Now that the vertical integration is possible a major remaining roadblock is the fees required to gain the numerous licenses. For example, a medium-size, vertically integrated business might have the following licenses:

  • Cultivator – Medium Mixed-Light Tier 1: $2,885 + $25,970 (Application fee + Annual license fee)
  • Manufacturer – Tier 3: $1,000 + $15,000
  • Distributor – Tier 3: $1,000 + $36,000
  • Retailer – Tier 3: $1,000 + $36,000

In this instance, the application and license fees alone could cost an operation $118,855. Which ostensibly leaves vertical integration available to only the largest cannabis operations.

How the Microbusiness License Works

The Microbusiness license creates a way for smaller operations to vertically integrate without the same initial investment. As a Microbusiness licensee, an operation can “bundle” several licenses into a single application, assuming each activity meets regulatory requirements.

Microbusiness Activities:

  • Cultivation: Less than 10,000 square feet
  • Manufacturing: Level 1, Type 6: Non-volatile, extraction, infusion, packaging, and/or labeling
  • Distribution: Type 11 Distributor or Type 12 Distributor Transport-only
  • Retail: Type 10 retail sales from a physical location or Type 9 retail non-storefront
  • Note: Cannot also act as a Testing Lab

Microbusiness Requirements:

  • Must engage in at least 3 of the 4 possible activities
  • Must indicate desired activities on the application and supply the appropriate information for those activities
  • Must comply with all requirements for each activity the licensee engages in

Microbusiness Annual License Fees:

The fees for the Microbusiness license represent a significantly discounted rate, compared to applying for each individually. The total cost for the Microbusiness annual licenses are as follows:

  • Estimated revenue up to $0.5 million: $5,000
  • Estimated revenue greater than $0.5 million to $1.5 million: $15,000
  • Estimated revenue greater than $1.5 million to $4.5 million: $42,000
  • Estimated revenue greater than $4.5 million: $120,000

The Benefits and Drawbacks of Vertical Integration

As demonstrated by the fee structure, the Microbusiness license gives “smaller” operations a leg-up when seeking a vertically integrated operation. The potential advantages of vertical integration are almost too many to discuss here, but a brief overview includes:

  • Reduced transportation and transaction costs
  • Reduced overhead and management costs
  • Optimized supply chain performance and diagnostics
  • Opportunity for superior quality control
  • Ability to focus/specialize products and services

Vertical integration can be a double-edged sword. Potential issues and concerns related to vertical integration can also be numerous. General business issues include:

  • Operations limited by economies of scale
  • Requires significant capital investment to establish operations
  • Reduced flexibility
  • Requires complex operational structure

Other concerns specific to the California cannabis industry include:

  • The distinct elements of the cannabis sales cycle – cultivation, manufacturing, distribution and retail – all require specialized skills. Taking on more cannabis activities requires a multi-talented and structured organization. This is especially relevant for a microbusiness that conducts distribution. As the distributor, they are centrally responsible for collecting and paying the cannabis cultivation tax, excise tax and other fees. Failure to comply with these regulations can result in major fines or the revocation of the license. (For complete details on cannabis taxes and fees, see ELLO’s comprehensive guide here.)
  • Having all aspects of the sales cycle in-house can prove disastrous if one element fails. For example, a bad harvest, or declining retail sales, could put the entire business into a hole. The Bureau of Cannabis Control’s regulations specifically state that if one license is revoked, all activities will be suspended, making regulatory compliance a necessity.
  • On-site consumption is integral to the “craft beer and winery” model. Current state regulations allow for a retailer to get a license for on-site consumption, but the same regulation bans the sales of alcohol or tobacco at the same location, which could limit public interest and revenue. An additional hurdle is thrown up by local regulations as many cities and counties in California have been slow to allow on-site cannabis consumption.
  • An operator with a Microbusiness license is necessarily limited in long-term growth. Restrictions on cultivation square footage place a cap on output, which could be exceeded by demand. Expanding operations can require a new license category and reworking the entire organization.

Will Microbusinesses Save Craft Cannabis?

That remains to be seen. We are less than two months into the legal market and progress has been steady, but slow. Rules and regulations are still being shaped at the local and state level, and many cannabis operations are still formulating license applications, or are waiting for approval.

Despite roadblocks, ELLO is happy to report that several of our clients have successfully received Microbusiness licenses and are thriving in the adult-use market. It will take hard work, optimal planning, and educated consumers … but we feel that California is well on its way to being a global destination for craft cannabis.

If you’re hoping to create a vertically integrated Microbusiness, or you’re looking for experienced guidance to shape a dynamic business, please reach out to the advisors at ELLO for a consultation.