California is approaching its fourth year of legal recreational marijuana, yet the underground market is as strong as ever and is making it harder for licensed companies to eke out a profit.
Saddled by steep regulatory and compliance costs, legal marijuana companies in California can’t compete with illicit operators on product prices.
Administrative bottlenecks, substantial capital requirements and dysfunctional social equity programs have kept many legacy players out of the legal marijuana market.
At the same time, cheaper operating costs and limited legal risk continue to fuel the underground trade.
That picture emerges after MJBizDaily spoke with three longtime unlicensed operators who agreed to discuss their lucrative cultivation, sales and consulting businesses as well as the challenges of becoming a licensed company.
The three operators, who agreed to speak on the condition of anonymity to protect their businesses, are a fair representation of California’s legacy market – and they serve as a warning for marijuana entrepreneurs and regulators in new markets.
How so?
The three operators’ comments underscore why illicit businesses are choosing to remain under the radar versus becoming licensed growers or retailers.
“You’re facing the largest uphill battle to break something up that has been ingrained in this area for almost two or three decades,” said an unlicensed cultivator from Palmdale, in northern Los Angeles County.
“You can’t beat that monster.”
That operator is among thousands of illicit business owners who’ve grown and sold cannabis for decades as well as built networks of distributors and loyal customers – long before skirting the 20%-30% tax markups faced by licensed businesses in California.
Most of their bulk flower never leaves Southern California, reflecting the strong demand for illicit cannabis in that region.
Illicit sales outpace legal transactions
Global Go Analytics estimates California’s illicit cannabis market generates $8 billion in annual sales, nearly double that of the legal market, which the MJBizFactbook pegs at $4.4 billion last year.
“California managed to become the only state that actually grew the illicit market by legalizing adult use,” said Tom Adams, chief executive and principal analyst of the Los Angeles research firm.
When state regulators launched California’s legal marketplace in January 2018, medical marijuana dispensaries had to gain both local and state recreational permits.
The vast majority – as many as 1,000 by industry estimates – simply closed, moved or chose to remain unlicensed, diminishing access for consumers and suppliers.
At the same time, dozens of cities and municipalities declined to license retailers and other cannabis businesses.
Adams estimates the policy overhaul shifted at least $500 million in cannabis sales from the legal market to the illicit sector.
Legacy operators and social equity
The transition to the legal recreational market, meanwhile, cut off a steady supply chain for cultivators statewide.
“We all lost our way of life overnight when shops couldn’t buy from us anymore,” said a longtime cultivator from Orange County who is unlicensed.
He has trimmed flower, was a budtender and even managed two pre-Interim Control Ordinance dispensaries – the medicinal cannabis retailers established in Los Angeles before Sept. 14, 2007. He also has a felony for cannabis possession.
On paper, this person is an ideal candidate for a social equity marijuana business license in a city such as Los Angeles, which is why he was courted by several well-known cannabis brands before the application phase in 2019 for L.A. social equity retail licenses.
During the yearlong application process, the Orange County cultivator said he went straight, taking dead-end jobs that included folding boxes at a vape company and side-hustling gigs such as driving for Uber.
The efforts failed to pay off as his family struggled financially.
His application wasn’t among the first 100 filed to qualify for L.A.’s social equity retail licenses in 2019, nor was he among the 200 eventually identified as eligible in December 2020. More than 800 applications were filed with the city.
Frustrated, he returned to the illegal marijuana market, setting up 10-light grow warehouses in Orange County. He has since been managing them on behalf of the owners of those facilities.
“We should be given the opportunity to create a business like we were promised,” he said. “It just seems like it’s not possible.”
That’s a common complaint among social equity applicants and unlicensed legacy operators.
“Every time it seems like we get close, they got something to trip you up,” said another social equity applicant in the unlicensed cannabis market who also serves as a consultant to underground businesses.
He started selling nickel bags as a teenager on skid row in downtown L.A., a child of foster homes and crack-addicted parents.
The South L.A. resident spent two years in the social equity application process, including an internship at a licensed Hollywood dispensary. He understands compliance, excise taxes and inventory.
“I stopped growing weed for a year – trying to make sure I kept all my energy on the right foot, doing the right thing – and it didn’t come through, so I went right back to the trap.”
He has no plans to quit growing or consulting.
“It’s so hard for me to get in trouble now,” he says, underscoring the limited legal risk a number of illicit operators face.
A wide gulf
Economics and barriers to entry in the legal and illicit markets couldn’t be wider.
An illegal 1,000- to 2,000-square-foot grow can be set up in only a few weeks.
The Orange County grower said it costs him about $1,500 to $2,000 in rent, electricity, equipment, nutrients and labor to operate one grow in the coastal county.
By contrast, a similar setup in the legal market would take more than two years in the licensing process and cost about $1 million, according to the Orange County grower and other industry sources.
High capital, licensing and operational costs, coupled with higher prices for legal cannabis, have been devastating for licensed businesses.
“Regulations and tax rates need to change drastically for the legal market to surpass the illegal one,” industry consultant Joey Espinoza said. “It truly comes down to economics.”
Consultants for hire
As part-time consultants, the underground cultivators charge unlicensed customers to help set up illicit grow operations.
Their services include strain recipes, lighting setups, nutrient mixes and other things.
Clients typically pay a third to half the value of the crop for the service.
For clients with cash on hand, the Palmdale cultivator – who’s built illegal indoor grows since 1992 – charges a flat fee of $75,000 to set up a 10-light or fewer automated grow, with strain recipes and other basics included.
A typical indoor harvest yields 6-12 pounds of marijuana every few months, with market rates anywhere between $1,800 and $6,000 per pound on the street, depending on quality, consistency, branding, hype and other factors.
Despite his lucrative underground business, the Palmdale cultivator desires an opportunity in the legal market.
“Nobody wants to look over their shoulder on top of having all this cash we’re not able to deposit at any banks,” he said. “That sends you deeper underground.”
But he also offered up a warning – and a solution – for legal marijuana businesses and regulators.
“The only way the legal market will ever compete with the black market is to give the people in the black market legal licenses,” he added.
“Until we have those licenses and assurance we can get those licenses, the black market will continue to thrive, and it’s only going to get larger.”
