The movement towards the legalization of recreational cannabis has been greeted by the business world with the raptures reminiscent of the U.S. gold rush of the 19th century and the worldwide dot-com fixation of the 20th century. As governments try to figure out what controls they wish to impose on production, quality, location of retail outlets, advertising and driving-under-the-influence, entrepreneurs and investors everywhere are throwing buckets of money at all kinds of business ideas and hopefully, some opportunities. Most however, are not yet proven and are ripe with unprecedented risk.
Is it Legal?
With sweeping language and definitions, the Ontario retail licensing legislation attempts to limit vertical integration to prevent producers from dominating the retail cannabis distribution sector. While not explicitly specifying franchise systems, the language regarding control could one day be interpreted to include the type of “control” found in most franchise systems. This could prevent franchisors from expanding their franchise systems beyond a mere handful of franchisees, if at all.
Despite this potential interpretation, without much delay, experienced franchise business people spotted an opportunity and have jumped into this new, uncertain, highly regulated and rapidly evolving market segment with vigor. And, why not? It seems certain there will be a high and long-term demand for cannabis products. Retail franchising offers a proven, effective and durable method of distribution for all sorts of products and services. So, what more is there to say? This post outlines the key business and legal considerations that prospective cannabis franchisors and franchisees should plan for as they develop their business in an evolving cannabis industry.
Be Prepared to Manage Change
At the heart of a successful franchising is the concept of a proven business formula over many years of trial and error. The all-important consistency of product, service and brand recognition that successful franchisors and their franchisees have mastered over time should not be underestimated. The franchising of a retail cannabis business or the purchase of a cannabis franchise is not for those who want to avoid risk, at least not until governments have figured out their own needs and plans to meet those needs.
The value proposition offered by a cannabis franchisor cannot be about historical success, at least not for the core of the business. Rather, a cannabis franchisor should be an excellent change agent, as the cannabis sector evolves and changes rapidly over the next several years. In addition to being able to manage change, franchise agreements and franchise disclosure documents should be very carefully crafted to ensure that all contingencies are covered, and all material facts and risks are clearly set out.
Challenges of Retail Cannabis: Product Supply, Locations and Marketing
Supply chain issues have already surfaced with an initial inventory shortage for on-line orders in Ontario (which is currently the only way to purchase cannabis for recreational use in that province). Inventory will continue to be a challenge for cannabis franchise systems as demand, price points, type of products and strength of products fluctuate.
Choosing the right locations will also challenge cannabis franchisors, both because of government regulations and the lack of market research and statistics about cannabis consumption, which has, up to now, been serviced by a black market. Likewise, marketing franchisors retail cannabis products may be limited as Governments appear to be headed in the direction of no or restricted advertising for recreational cannabis, particularly with respect to young consumers. Growing a franchise brand is much more difficult without the freedom to advertise in the most effective way.
Cannabis and Franchisee Earnings Claims
Earnings claims are a tricky part of the franchising process, but many are of the view that, realistically, prospective franchisees need some information about what they can earn from the franchise. For cannabis franchisors, the task is made more challenging by the lack of historical numbers and the uncertainty surrounding the cost of inventory and the acceptable sale price of cannabis at retail.
Cannabis Franchise Agreements and Risk
For those people considering the purchase of a cannabis franchise, they must keep in mind the increased risk associated with a franchise and as a result, the higher degree of research and due diligence that is necessary. This also means the provisions of a franchise agreement for a cannabis franchise, from the franchisee’s perspective, needs to be different in some significant ways.
Not much is predictable for this industry other than, for the near future, there are going to be winners and losers. The challenge for investors and franchisees is going to be in picking the winners in advance, with more than luck as your guiding star.
What legal and business questions come to mind with the prospect of using a retail cannabis franchise business model? I welcome your feedback and questions on this topic. Please post your comments on our LinkedIn page at: Dickinson Wright Canada, on Twitter at @DWrightCanada or on my personal LinkedIn pages at: linkedin.com/in/nedlevitt
