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Red Flags For Entrepreneurs Considering A Legal Cannabis Franchise
Carol Tice ~ Forbes ~
Legal Cannabis franchises are emerging -- here's why would-be entrepreneurs looking to buy a turnkey opportunity in this space should be cautious.
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It was only a matter of time before the emerging legal cannabis industry began using one of America’s most popular business methods for rapid growth — franchising. This startup sector is wide-open spaces right now, and full of interesting players looking to grow fast and establish a national brand name.
The quest to franchise a legal cannabis business is even the subject of an upcoming CNN reality-TV series, High Profits, about Breckenridge Cannabis Club in Colorado.
It makes sense that some cannabis businesses will try to grow via the franchise model, which allows them to expand using the franchise owners’ money, rather than corporate capital. This approach has been the fast-growth enabler for so many iconic American brands.
Franchising could seem like a natural step to take. Many entrepreneurs are anxious to get in on the ‘Green Rush‘ — and there’s obvious appeal to a done-for-you, turnkey system that would get you into legal weed, without learning to be a grower.
But with cannabis still not federally legal, and a patchwork of rapidly changing state regulations, this isn’t your typical franchise scenario. Would-be franchise owners should proceed with extreme caution.
Here are some of the potential stumbling blocks on the road to legal cannabis franchise success:
Sudden death risk.
There’s an onerous warning in the federally required Franchise Disclosure Document of legal cannabis franchises. It cautions that while cannabis may be legal in the state where you operate, it is still federally illegal — and if they get in the mood, the Feds could pop in and shut you down. Operating a legal cannabis franchise is basically a dice-roll, notes New York franchise attorney Harold Kestenbaum. The business could suddenly go bust at any moment, your investment could be lost, and the franchisor won’t be able to protect you from that. “This is an area where nobody really knows the answer,” he says. “It’s clearly an issue.”
Evolving legal landscape.
While marijuana advocates believe legalization will continue to spread and become federally legal as well, things could swing the other way. In 2016, it’s possible we’ll have a Republican president, or Congress’s makeup could change. Suddenly, we could see a more aggressive federal attitude toward busting legal-pot businesses in decriminalizing states, increasing the sudden-death risk. The states that have legalized medical and recreational pot could also vote to re-criminalize it, vaporizing the legal-cannabis market in their state overnight.
Newbie franchisors.
Most cannabis businesses are startups themselves, and have no past franchise experience. For instance, pot-smoking cafe concept Cafe Serendipity has no corporate stores. Their first shop, opened last August, is operated by a licensee, and just three units are open so far. It’s highly preferable to have a franchisor that’s extensively road-tested their model, worked the bugs out, and built a support team to help their franchise owners — after all, that’s what you pay the franchise fee for. Here, you get a ground-floor opportunity, but with an unproven team. It could pay off big, but you could also find yourself floundering without a proven system or adequate support.
Skimpy profits.
Cannabis may sound like a cash cow, but it’s often highly taxed. In Washington State, for instance, retailers face a 25-percent use tax that some retailers say is killing their businesses.
Fluctuating prices.
This is an emerging legal industry, and it’s unclear where product prices will stabilize. More growers may pile in, causing a product glut and price crash that could hurt margins for a wide variety of cannabis business types.
Not really franchises.
Some startup cannabis businesses are using the ‘business opportunity’ or licensing route, rather than franchising. They do this because it’s less regulated than franchising, or because it’s simply easier and faster to set up this structure. The licensing or business opportunity format may be less expensive in terms of up-front costs, but be even more wary. The ‘biz-opp’ space is full of dubious offers — you’ll want to do extensive due diligence.
For instance, Cafe Serendipity in Henderson, Nev., is currently offering a licensing arrangement to interested entrepreneurs, while the company completes its financials audit and goes through the franchise approval process, says senior national sales vice president Jimmy Moore. It costs $50,000 to license their products and format — plus a 6% royalty for existing dispensaries that want to convert to the Serendipity format, or and 10% royalty for ground-up new stores. In all, Moore says, the financial commitment to open a store runs $300,000-$400,000, depending on licensing costs in your locale.
Despite the startup nature of the model, Moore says interest is robust. “I’m on the phone from 6 a.m. to 10 p.m. at night,” he says. “We have a lot of traction.”
The hybrid solution
One franchise idea has emerged that may offer the flexibility needed to survive the uncertain times ahead. Buy a franchise that has another business, where the legal-cannabis offering is a bolt-on feature. If you’re busted or laws change, you could potentially continue with the rest of the business and simply stop selling pot.
That’s the model offered by Palm Beach Vapors, a quit-smoking ‘vaping’ concept that recently added a medical marijuana package to its franchise offering, with attorney Kestenbaum’s help. If a franchisee got busted by the Feds, they could theoretically remove the cannabis aspect and continue with the tobacco side of the business.
Thus far, two Palm Beach franchisees have added the chain’s “M-System,” in California and Indiana, company spokeswoman Emily Cheng says. The system allows cannabis consumers to easily adjust the strength of their dose.
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