Weed is the New Dotcom

Now that cannabis is a legit business, entrepreneurs and investors are eager to cash in on the green rush. But how big can it get, and who is making money from legal weed? From our perspective, the rapidly growing cannabis industry looks a lot like the dot-com boom. It’s not a perfect analogy, but some key aspects of the tech industry mirror cannabis so well that it's a helpful guide to understanding some of the challenges of the cannabis industry as we all try to forecast the future. These similarities include how companies in both sectors are financed, innovation as an advantage, rapid growth, technical bottlenecks, hubris, and exuberant expectations.

Finance: Both cannabis and tech companies are typically funded through equity rather than debt. Generally, no one lends money to develop software because, unlike real estate, there is no collateral if the business does not perform. Banks and other lenders generally won’t lend to cannabis businesses because financing a federally illegal business jeopardizes FDIC insurance, removes the process of federal bankruptcy, and is generally riskier. Therefore, cannabis entrepreneurs have to fund their businesses through equity, which means selling part of the company to raise cash. If the business succeeds, everyone makes money.  If it fails, the investment often goes to zero, and most investors walk away with only losses. This financial model is classic in the tech startup world. As a technology lawyer now working with cannabis startups, this investment paradigm is hauntingly familiar. 

Innovation: Innovation and potential disruption of legacy industries is a competitive advantage in tech and cannabis. Cannabis companies are developing new genetics, better processes for growing, and innovative products such as topicals, “fast-acting” edibles, and concentrates formulated for specific effects. Similarly, tech startups constantly innovate to create products and services that take advantage of technologies like the “internet of things.” The cannabis industry can potentially disrupt the pharmaceutical and alcohol industries. Over the past few decades, the technology sector has disrupted (or disintermediated) almost every industry it has touched, notably media, retail, and transportation. There is also an emerging “canna-tech” sector that combines the two industries. Novel e-commerce, gig-work services, media, grow-tech, and resource management software platforms are striving to be the Levi Strauss of the green rush. 

Growth: Both cannabis and tech have exploded, at least in terms of the number of companies and interest in investment. The legal cannabis industry has grown due to existing demand along with legalization in many states, while the tech sector has experienced extensive growth due to innovation and the rapid adoption of digital solutions, especially during the pandemic. In addition to e-commerce and web-conferencing, the pandemic also increased cannabis adoption. 

Hubris: In both industries, founders often believe their product is better than everything else. In tech, it manifests as “my app will revolutionize the [insert name of niche industry].”  In cannabis, you may hear things like, “we grow the best weed.” Really? On the one hand, the confidence that you have something new to contribute is part of what inspires people to start a business. On the other hand, while confidence can be a helpful trait, it's also important to recognize the limits of this mindset. Everyone thinks their product is better than others, but subjective quality rarely creates market dominance. Does Domino’s make the best pizza? Comprehensive research suggests otherwise. But it’s the most popular because they sell the best solution to the problem most people have, which is where to get a predictable, filling, and cheap meal for any number of people in less than 30 minutes.  

Dependence on experts: When Apple’s App Store opened, it exacerbated an already intense battle for technical talent to build a new generation of software and mobile applications. Smart and experienced entrepreneurs struggled to find experienced developers to write and maintain code in a rapidly evolving technology market. Many cannabis green rushers find themselves in a similar predicament. The plant is difficult to grow at any commercial scale. In most newly legal (or expanding to recreational) markets, there are not enough growers to manage all the new operations. Furthermore, many “experienced” growers got that experience under a different regulatory environment. Adapting to a new, state-regulated system with investors and employees is not a smooth transition. Hence new cannabis businesses are as beholden to their growers as tech firms were to software developers at the peak of the boom.

Expectations: These industries' final similarity (and perhaps the biggest pitfall) is that everyone thinks they’ll get rich in a few months. We all know the image of some pimple-faced teenager cashing in before zipping into the sunset after some big company buys them out. Sure, that happens occasionally, but the brutal truth is that 90% of startups fail. Of the remaining 10%, not all are home runs. But FOMO keeps the investment dollars and entrepreneurial juices flowing. People may think the cannabis industry is a surefire way to make money fast; it's “new” and in high demand, some even calling it a “license to print money.” Think again. The cannabis industry is not a place you can throw a few seeds in the ground and sell whatever grows for a quick profit. It has the combined complications of farming, manufacturing, retail, and some hybrid of pharma/alcohol, plus an extremely complicated and evolving taxation and regulatory environment. Everything is more difficult (aka “expensive”), including banking, taxes, leasing, and employment, to name a few. It takes creativity, business savvy, and much more time and money than most people seem to expect to be a successful cannabis company. Opening a cannabis business should be approached like any other start-up: with eyes wide open and reasonable expectations. Profitability for successful cannabis startups is often years after the initial investment.  Be wary of opportunities that promise, or investors that expect, a rapid return on investment.  As markets mature, the “wholesale price of cannabis flower” generally trends lower, while the capital costs for lights, irrigation, construction, and labor increase with inflation. In short, the formerly big margins have been harvested.

Differences: There are many differences between cannabis and tech, but some key ones include regulation and scalability. The tech business started out with little to no regulation. As small startups have grown into near monopolies and tech invaded every aspect of our lives, it is drawing more ire and attention from regulators. The cannabis business started heavily regulated, including, for example, laws like Section 280e that have unintended burdens on otherwise legal entrepreneurs. Scalability is another enormous difference. If you build a SaaS software application, the marginal cost of supplying it from 100,000 to 1,000,000 users is relatively small compared to that kind of growth in a cannabis operation. The raw material in cannabis is an agricultural product that must be grown, tested, processed, cured, and finished by manufacturing or packaging. Each state can restrict the number of licenses or plants that can be grown under a license, directly preventing scalability. Furthermore, the security and transportation of the product is a massive undertaking.  

While the legal cannabis business effectively began over ten years ago, this industry is still very new. It will undoubtedly evolve in surprising ways over the next few years. The future is impossible to predict, but studying the tech sector may provide some helpful insights while navigating the growth of cannabis. Tech operates in a funding cycle (sometimes characterized as a bubble) driven by investor sentiment, market conditions, and unforeseeable events like a global pandemic. The cannabis market is driven by some of the same (i.e., the pandemic) and also some different market forces, including oversupply, complex regulation, and a thriving black market. Some in the cannabis market see an opportunity for consolidation of distressed assets in the coming year. Tech may not offer a crystal ball for the future of the cannabis business, but I think it can illustrate some of the pitfalls and opportunities participants are likely to encounter along the way. 

Written with help from Lauren Leland