Vishal and Ankur Rungta, two brothers who launched C3 Industries Inc. in Ann Arbor with longtime friend Joel Ruggiero, are living proof of how maddeningly complicated the Michigan cannabis business has been.
Last year, months before state voters passed Proposal 1 allowing adult recreational use of marijuana and creating what is projected to be a $1-billion industry — Michigan will start accepting license applications for commercial cannabis on Nov. 1 — the partnership sought a license to grow and sell medical marijuana in the second-largest market of its type in the United States (close to 300,000 registered patients).
They knew it would help them gain an inside track on a new recreational license, given Michigan is expected to fast-track applications for those who hold medical licenses. According to language from Proposal 1, recreational marijuana is open to adults 21 and older, and people can grow up to 12 plants in their home for their personal use. The first commercial cannabis stores could open as soon as Dec. 1.
Still, for all the promise the industry holds, getting a license is no easy task. C3 Industries’ application to the now-dissolved Michigan Marijuana Licensing Board ran to an incredible 100,000 pages. By a conservative estimate, that’s a paper stack nearly 21 feet tall.
Why so much? The application process required documentation of not only the partners’ financial backgrounds, but also those of C3’s shareholders and investors — along with their spouses. Bank statements, investment funds, and brokerage accounts all had to
“In an effort to be completely transparent with the state and ensure we were providing all the information they were seeking, we put together everything under the sun and submitted it,” says Vishal, 33, who has a background in investment banking and private equity.
The brothers — Ankur, 36, is an attorney with a real estate background — are already veterans of the legalized cannabis scene in Oregon, where C3 Industries also operates. The pair says it was so much easier there. “For Oregon’s application process we submitted, I believe, two pages for each investor,” Vishal says.
In July 2018, their medical license in Michigan was granted. Last fall, C3 broke ground on an ultra-sophisticated 35,000-square-foot facility in Webberville, near Lansing, where its director of horticulture, Ruggiero, 33, now oversees the growth of plants and preparation of products under the Cloud Cover brand name.
The multimillion-dollar grow house — which was designed by Daniels and Zermack Architects of Ann Arbor and built “almost exclusively” by Michigan contractors — is a cleanroom environment that’s controlled for internal temperature, humidity, carbon dioxide levels, and numerous other variables.
As the growing facility neared completion in August, after 10 months of construction, C3 Industries opened its first High Profile retail showroom on Groesbeck Highway on Detroit’s far-east side. It’s the first of up to 20 planned stores to be located across the state. “Our goal is to be viewed as an incredible retail experience, one of the best retail players in the state, and have a presence with our stores in most of the major markets,” Ankur says. “We have a good start on that.”
There are now about 150 vendors licensed for some aspect of Michigan’s industry. While vigilance against money-laundering and underworld players is high, the inevitable red tape has led to some absurd situations — as former Detroit Lions star wide receiver Calvin Johnson found out. Johnson applied for a dispensary license, but unpaid traffic tickets in his native Georgia stood in the way. After he traveled there to clear up a warrant, he and his team won pre-qualification approval.
To reform what was initially an arduous licensing process, in April Gov. Gretchen Whitmer created the Marijuana Regulatory Agency under the Department of Licensing and Regulatory Affairs. The new entity replaced the cumbersome five-member MMLB that had existed since 2016. In quick order, the MRA reduced the average processing time for licenses to 68 days from 160 days, according to an agency spokesman.
“As the industry is legalized across states, there are the complexities of new regulations to iron out — as well as, of course, the ongoing tension born of state-legal businesses operating under a federally illegal umbrella,” writes Danielle Davenport in her new book, “Cannabis, Inc.: The Journey from Compassion to Industry Consolidation.”
Indeed, the United States Drug Enforcement Agency continues to list cannabis as a Schedule 1 controlled substance, along with powerful narcotics and psychedelics. The DEA cites marijuana as a drug “with no currently accepted medical use and a high potential for abuse.”
Until it is de-listed, cannabis cannot legally be transported across state lines. That means Michigan must have its own endemic industry to grow, process, test, transport, and sell the products. To maintain control, the MRA has implemented a “seed to sale” tracking system called METRC — Marijuana Enforcement, Tracking, Reporting, and Compliance — to guarantee that everything stays above board.
While an operating framework has been assembled and is in place, federal impediments remain major issues. The primary result of federal restrictions is a lack of access to traditional banks and their services. Being conservative by definition, banks are slow to open accounts for fear of risking their charters through inadvertent money-laundering.
In addition, the Bank Secrecy Act of 1970 requires financial institutions to report transactions in excess of $10,000, which makes banking for cannabis clients something of a burden because of the extra staff and training required. “Banking has become, through regulations, a bit of the front-line law enforcement as it relates to financial crime,” says Patricia Herndon, executive vice president for government relations of the Michigan Bankers Association in Lansing. “Banks are very often that front-line red flag.”
The traditional banking moratorium remains far-reaching. After the Michigan Cannabis Industry Association formed in January, a natural step for the trade group was to open a checking account. “It took us weeks to find a bank that would be willing to work with us, even as a nonprofit association that doesn’t handle cannabis plants whatsoever,” says Josh Hovey, an MICIA spokesman. “We’re not involved in the sale. We’re just advocating as a nonprofit, using our free speech rights to advocate for policy issues.”
Finally, Bank of America accepted the group.
Nationally, about 550 banks and credit unions provide services to the cannabis industry. A preponderance of them are located in Colorado, Oregon, and Washington, the states that pioneered legal recreational use. Officials widely agree about the necessity of providing financial services, in part as a way of giving a state the means to track vendor incomes and collect taxes.
But for all the rules and regulations, the lack of mainstream banking services and the limited number of municipalities across the country that allow dispensaries to operate helps to perpetuate black-market sales of cannabis.
California tax revenues, for example, haven’t met expectations since the start of legal cannabis recreational use there in 2018. Estimates for 2019 activity put regulated sales at $3.1 billion while street sales will total $8.7 billion, the Los Angeles Times reports. A forecast shows legal sales exceeding the street market by 11 percent in 2024, but experts say it will take years to fully integrate black-market producers and sellers.
Beyond the difficulties of revenue-tracking and tax-collection, operating in cash sets up an invitation for burglaries, as seen in a series of incidents nationally where thieves rammed vehicles through the walls of dispensaries to steal goods and cash.
The most immediate reform is broadly seen as H.R. 1595, the Secure and Fair Enforcement Act, which in September was passed 321-103. Known as the SAFE Banking Act of 2019, it would “create protections for depository institutions that provide financial services” to legitimate cannabis vendors. The bill now goes to the Senate. The Michigan House and Senate also adopted resolutions in support of the bill.
Estimates for 2019 activity put regulated sales of cannabis in California at $3.1 billion while illegal street sales will total $8.7 billion.
“The reality is, in some ways, credit unions are the only options,” says Ankur Rungta. “It’s important to have proper banking.” Already, a handful of community banks and credit unions have been opening up to cannabis industry clients.
“When it comes to the cannabis business, especially in a state like Michigan that now has authorized legal recreational marijuana use, all financial institutions should want to serve those small businesses with checking accounts, payments processing, and even small business loans as needed,” Dave Adams, president and CEO of the Michigan Credit Union League, wrote in an email. “In the case of most credit unions, it isn’t a moral issue so much as a legal one.”
MCUL Executive Vice President Patty Corkery adds that the organization has hosted educational events and offers members a “toolkit” with sample policies, reporting guidance, information on vendors, and checklists for initiating accounts.
As it gets better established and starts to expand, the cannabis industry is creating widespread disruption — and opportunity. Despite the many obstacles, players are thronging to the industry. One unforeseen consequence is taking place among investors who had backed mining lithium salts for the development of lithium-ion batteries, but are now shifting to cannabis.
Another is expressed in a 2017 study by university researchers, who found falling alcohol sales in states with medical marijuana laws. Such a development would lead to lower overall tax revenue. But an alcohol industry group’s subsequent study disputes the finding, saying sales of beer, wine, and spirits in Colorado, Oregon, and Washington remain steady. Meanwhile, a Nielsen report released in June found snack food consumption in cannabis-friendly states growing faster than in those where the drug remains illegal.
“The increased legalization of cannabis in the U.S. presents big opportunities for the American food and beverage market, particularly for the snack and confectionery category,” the report says, noting the obvious cross-selling opportunities. Furthermore, there are edible hemp-based products. Hemp is the variety of cannabis with less than .03 percent THC, or tetrahydrocannabinol, the crystalline compound that is the psychoactive element of cannabis. Traditionally useful for fiber, hemp is illegal and therefore not cultivated. The 2018 Farm Bill de-scheduled hemp, which, in addition to its agricultural value, is thought to present a $6 billion opportunity for the food and beverage industries.
Apart from national activity, evidence of the cannabis industry’s new phase in Michigan was in view at High Times magazine’s Cannabis Cup, held in mid-August at the Russell Industrial Center in Detroit. Billed as the world’s leading marijuana trade show, the Cup calls at West Coast locations, Denver, and Amsterdam, and was making its fourth visit to Michigan. Like a county fair, there’s judging on cannabis and various extractive products.
When the Cup kicked off on Aug. 17, thousands of people squashed into the outdoor plaza space at the Russell complex, Albert Kahn’s massive factory where Murray Auto Body Corp. once made auto bodies and parts, and aircraft wings were produced for use in World War II.
Like a mini-Woodstock or a Coachella festival, the Cup offered bands and a bazaar with cannabis soaps, hemp clothing, and other merchandise. Grow-your-own equipment also commanded display space.
Chelsea Rebeck, a tax law partner at Rebeck Law Firm in Southfield, attended the Cup. Like many professionals in law, accounting, and tax preparation, Rebeck finds herself serving clients in a once-outlawed industry. Earlier in the summer she appeared as an expert witness at the appeal of a license denial. “The administrative law judges working on those appeals were taking a more logical stance than the original licensing bureau (in Michigan),” she says.
In her practice, Rebeck, at times, defends cannabis clients against the IRS. “The way they’re taxed is completely unfair,” she says. “They’re spending more on taxes than any other business.”
The problem is the Internal Revenue Code’s Section 280E, which Congress enacted in 1982. “All deductions and credits for amounts paid or incurred in the illegal trafficking in drugs listed in the Controlled Substances Act are disallowed,” explained a Senate report on the provision. In other words, the government only allows the cost of goods sold as a deduction. Payroll, rent, advertising, and any other overhead or normal costs are disallowed to cannabis businesses. “Their effective tax rate ends up being double or triple,” Rebeck says.
On this point, Chris Sing, a principal at Rehmann’s Ann Arbor office, agrees. Asked what would blindside an entrepreneur about tax-code nuances, she says, “How incredibly high the effective tax rate is — it could be north of 80 percent.”
The increased legalization of cannabis in the U.S. presents big opportunities for the American food and beverage market, particularly for the snack and confectionery category.
Rehmann, a financial services and advisory company based in Troy, recently decided to welcome cannabis industry clients. To help get the word out, the company signed on to sponsor MICIA’s CannaCast videos, which offer legislative updates and interviews with leading cannabis industry figures.
“The fact that it’s now a thriving and very viable industry means there’s opportunities for all business providers,” Sing says. “Our firm took a thoughtful view. This is an industry that needs help for those that are committed to doing things the right way.” She says that, before making the move, the company cleared its participation with attorneys, insurance providers, and its own board.
Despite what would seem to be a cap on profitability because of taxes, fees, and the need for specialized services, entrepreneurs glimpse a major opportunity and jostle one another to take advantage in the brave, new world of recreational cannabis sales. “Those clients we see investing in meaningful ways have been business owners themselves and have seen success,” Sing says. “They have large risk appetites.”
With the abundance of capital and talent in an expanding industry, it seems reasonable to expect innovation from product development to retail sales, and from manufacturing to marketing. For example, in August, Short’s Brewing of Bellaire and Green Peak Innovations of Dimondale — which plans to open 30 Skymint stores — announced a partnership to produce cannabis-infused, beer-flavored gummies and vapes (it’s illegal to infuse alcoholic beverages with cannabis). The partnership will also create an infused cold coffee and various tonics, teas, lemonades, and sparkling waters.
With 150,000 square feet of grow space to supply its locations, Gage Cannabis has teamed with California’s life-stylish Cookies brand for what could be a big share of the market in Michigan. Their first fruit is a sugary, festival-in-the-forest promotional video in trippy Hollywood fashion.
Advertising by cannabis companies is restricted, but sharing on social media is a different matter. And another benefit: The video serves well in the all-enveloping showroom experience that’s so important in retailing. Beyond themes of festivity and freedom, expect to see a revival of the “You meet the nicest people on a Honda” theme of the 1960s, when people learned that not all motorcyclists were dirty bikers.
The medicinal benefits of those volatile hydrocarbons, the terpenes, and THC’s activation of a whole different neural network have remained a little-understood phenomena because of federal research restrictions. As these become easier to bypass, more doors open to innovation.
For example, beyond his role in Michigan’s grow industry, Johnson and former Lions teammate Rob Sims have grabbed the marquee for their work with Harvard University on cannabis and chronic traumatic encephalopathy, or CTE. They’ll investigate whether cannabidiol, or CBD, another compound in cannabis, has a positive effect on cognitive disease and if treatments can be developed.
Manufacturing is another potential avenue of growth. Centurion Pro, of Maple Ridge, British Columbia, has developed a line of buckers and trimmers to de-stem marijuana plants and harvest the flowers. With its long history of metal-bending and mechanization, would it be unreasonable to expect distinctive offerings from Detroit?
Perhaps the most surprising part of the emerging industry is the rapid innovation and national academic leadership from universities in the Upper Peninsula. This fall, Lake Superior State University kicked off its cannabis chemistry program based on safety and regulatory compliance. “We’re looking for heavy metals, residual pesticides, and solvents,” says Steven Johnson, dean of the College of Science and Environment at Lake Superior State. “It’s very much a chemistry degree.” A cannabis business degree is also offered to train future managers to operate within regulatory constraints.
In Marquette, Northern Michigan University welcomed its first senior class of homegrown medicinal plant chemists who can also choose an entrepreneurial track. These analytical chemists are the terpene hunters, and what they learn about extracting and processing cannabis oils and the THC and CBD compounds extends to other herbs and plants.
“Extracts are very popular,” says Brandon Canfield, associate professor of chemistry at NMU. “They don’t require the same method of consumption.” In other words, vaping meets the objective of getting the THC without the tars from combustion. “You extract it, but you want to remove the solvents when people put these into an edible or a vape cartridge,” Canfield says.
Since the program started in 2017, NMU’s chemistry department has tripled in size to about 250 students from 48 states. They resumed their studies this fall in a brand-new, 3,800-square-foot laboratory that was developed in partnership with Shimadzu Scientific Instruments Inc., which donated gas- and liquid-chromatography equipment valued at $850,000. NMU plans to acquire mass spectrometers, as well. “It’s a really exciting time,” Canfield says, admitting that his initial question about the program was: “Are parents going to be into this?” The answer: “They’re very excited.”
With so much entrepreneurship and innovation happening all around the state, refinement of the regulatory framework for the legal cannabis market looms as ever more important. Gov. Whitmer’s dissolution of the old licensing authority showed great foresight, says Michael Tierney, president and CEO of the Community Bankers of Michigan in East Lansing, who calls the MRA’s executive director, Andrew Brisbo, “a very talented individual and great ambassador.”
Brisbo brought 15 years of regulatory experience to the position. Among the MRA’s biggest challenges are helping to ensure the adequate supply of products, guaranteeing social equity in licensing, and tamping down the black market that has persisted in other states. “Safe, consistent access to products in the regulated market will be key to reducing the black market,” he wrote in an email. “We also work closely with our law enforcement partners to support their efforts in combating illegal, unsafe operations.”
Still, there are challenges. At the retail level, purveyors of medical cannabis say Michigan regulators this year have been slow to approve the product for use. But that wasn’t a problem in 2018.
“Last year, caregivers could grow cannabis and the excess could be sold to medical marijuana stores, but that’s not the case this year,” says Rush Hasan, operations director of The Reef in Detroit. “It’s created a huge supply problem, and we and others are losing customers. If patients can’t get it in approved stores, they’re likely getting it on the black market.”
The supply issues make it difficult to predict future sales, but it’s clear some ventures will surely fail because of insufficient funding or unoriginal concepts. They’re also seen as vulnerable to the predations of large brewers and distillers, tobacco companies, and agricultural conglomerates. But it would be easy to underestimate the special knowledge and dogged determination of the entrepreneurial class.
“Like wine, and what we’ve seen with craft beers and other movements in the alcohol space, there’s room for high-quality producers like us, even in a more mature market,” Ankur Rungta says.
His brother allows that partnerships may eventually happen. “A large brewer or a tobacco company can’t enter (the market) and just wave their money and big balance sheet around, and all of a sudden they’re sitting next door to you,” Vishal says. “They would need to get all of their approvals before anything could happen, and from a regulatory standpoint, it’s not possible right now.”
What About Hemp?
The 2018 Farm Bill liberalized provisions for widespread production of hemp, or cannabis sativa L., the variant of cannabis sativa with THC below 0.3 percent. For more than 10,000 years, hemp has been useful for its fiber. Over time, it was added to enhance numerous commercial applications, including food products, paper, biofuels, textiles, paint, clothing, and biodegradable plastics.
Although George Washington grew hemp at Mount Vernon and Ben Franklin owned a paper mill that processed hemp into parchment more than 200 years ago — the Declaration of Independence and the United States Constitution were written on hemp paper — production was banned in more recent decades as part of the federal proscription of cannabis.
More recently, the 2014 Farm Bill’s Section 7606 authorized growing hemp for research and pilot production, but left it subject to many restrictions. “The good news with that is the (2018) bill finally opened up hemp research to universities,” says Brandon Canfield, associate professor of chemistry at Northern Michigan University in Marquette. “We’re going to start seeing some better research very soon.”
This summer, Michigan issued emergency rules that laid out testing standards for hemp and stipulations on the extraction of chemical compounds. CBD oils, for instance, are only to come from the more potent form of Cannabis sativa that’s commonly called marijuana.
Farmers see potential for a good return on investment, although estimates vary on whether hemp is a niche or a commodity crop. A test, the Industrial Hemp Ag Pilot Program, was implemented in Michigan last spring.
Still, the USDA cautions against moving ahead with hemp production or research until the final rule is implemented. In other words, no one should try to implement the 2018 Farm Bill production provisions before the final USDA rule is established.
The Essential Handbook
As the daughter of hippie parents, Danielle Davenport grew up learning how to care for cannabis plants, but she didn’t quite follow her parents’ footsteps.
“I’ve never been a user, and you know how you always want to be the exact opposite of your parents,” she said in a podcast. After studying economics and computer science, she found herself doing agricultural consulting, which led back to the cannabis of her youth. Her new book, “Cannabis Inc.: The Journey from Compassion to Industry Consolidation,” guides entrepreneurs on maintaining their competitive advantages. Here are a few pointers:
1. Understand the regulatory framework and anticipate changes, especially in case of federal legalization. Davenport suggests every producer should aim for medical-grade cannabis in order to satisfy the toughest regulatory standards.
2. Raise more capital than forecasted. She cites these estimates by Jonathan Barlow of Southfield’s Cannabis Practice Group: $750,000 to retrofit a retail store, $12.5 million to build a cultivation facility.
3. Develop and support a strong brand. After the inevitable M&A and consolidations, the artisanal brands will remain. Knowing customers and meeting their unmet needs will pay off in a big way.
4. Small, craft-based producers have a three- to five-year advantage over big players. Rather than ruthless infighting, forming strategic partnerships and collaborating on matters like bulk purchasing helps everybody.
5. “Today’s cannabis consumers are looking for refinement and sophistication; so drop the old-school stoner slang and speak to the higher conversation your market is already engaged in,” Davenport writes.
Michael Kus, managing member of Kus Ryan & Associates in Auburn Hills, has been representing financial institutions in his law practice for 30 years. With the market for recreational marijuana in Michigan set to open on Nov. 1,, he weighs in on how to navigate the fledgling industry.
DB: Have you added specialized staff since the approval of recreational cannabis last November?
MK: What we’ve done is try to switch responsibilities to assist in helping financial institutions set up systems within their organizations to properly handle transactions coming from licensed (cannabis) vendors.
DB: What are the complexities?
MK: A few financial institutions have slowly and methodically invested time, effort, and staff to create a department in the bank or processes within the bank to make sure they’re fully complying with federal law.
DB: What’s it like for a bank?
MK: (For regulators), they’re going to make sure that the next time examiners come in, they can support the accounts they’ve opened, how they’ve opened them, and how they’re monitoring them, and make sure they maintain sufficient record information about the vendor, the transactions they’re incurring, and the cash they’re handling.
DB: Can farmers list the coming crop as collateral?
MK: Right now, banks won’t touch any type of lending transaction. They’re not sure if you can use these facilities for other purposes. These licenses are issued on an annual basis. They can be withdrawn for violations of law — for instance, bringing in marijuana from another source that’s not grown in Michigan.
DB: How do you advise clients?
MK: Invite the regulators to sit down with you before you even open up for business, so they get some input and have a good understanding of what it is you’re doing, and how you’re doing it.