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Cannabis, Illinois and Social Equity—The Third Pillar of Legalization or Political Expedience?

Traditionally cannabis licensing depended primarily on the applicant’s ability to demonstrate capital and trustworthiness. By having capital, the applicant demonstrated business acumen and financial wherewithal to withstand the high costs of opening the cannabis venture without the use of traditional financing that other industries enjoy. The economic and political realities of medical cannabis producers in Illinois meted out burn rates that ate into the capital of the select few awarded licenses to peddle the flower to a very restricted list of patients before being granted a temporary monopoly by the Illinois Cannabis Regulation & Tax Act, 401 ILCS 705/1-1 et seq, passed on May 31, 2019.

Background

Cash outflows soared as an anti-cannabis administration took the helm of the state in 2015 after the effective date of its medical law. It then dragged its feet in opening the businesses, and made patients wait for months to get access to their licenses to purchase medicine. Next year, those cannabis businesses still operating will occupy the entire adult use market in the Illinois for at least a year before new entrants can compete with them. Each and every of those newcomers need social equity to get their license, including the existing players that want to acquire the maximum number of new licenses. A total of ten dispensary licenses can be held by any entity, which includes any medical dispensary licenses, and also its second location granted to existing medical license holders.

Of course, the newcomers also need the second pillar of the industry, trustworthiness. You have to ensure that no diversion of supply or cash (until the SAFE Banking Act passes) proceeds will be lost to the untaxed black or grey markets. The security and record keeping requirements of Illinois are as strict as can be found in any other state. The new entrants have to compile a litany of standard operating procedures (SOPs) and company policies on security, operations, community outreach and diversity in order to rack up as many points as they can in their quest to get the highest scoring application in a very competitive field. This competition includes new application requirements in social equity.

A full 20 percent of the points come from a new “social equity applicant” status that is not found anywhere else. Look for this to be replicated in other states, or municipalities, that must legalize legislatively, which has to be done regardless of “marihuana” (the federal legal term of art) being de-scheduled from the Controlled Substances Act because the majority of states still prohibit the regulated sale of the plant’s flower.

Illinois Rehabilitation and Rectification for Past and Present Offenses

Illinois adopted rehabilitation and rectification methods to repair the damage caused by the war on cannabis that enabled millions of arrests and even greater burdens on the poorest neighborhoods. To fix those issues, Illinois evidently will make millionaires from a select few people that are either residing in a very impoverished part of town, or have been arrested for cannabis offenses.

The ‘Social Equity Applicant’

These two things comprise two-thirds of the new legal term of art in Illinois—the “Social Equity Applicant.” 401 ILCS 705/1-10.

“Social Equity Applicant” means an applicant that is an Illinois resident that meets one of the following criteria:

  • (1) an applicant with at least 51 percent ownership and control by one or more individuals who have resided for at least five of the preceding ten years in a Disproportionately Impacted Area;

  • (2) an applicant with at least 51percent ownership and control by one or more individuals who:

(i) have been arrested for, convicted of, or adjudicated delinquent for any offense that is eligible for expungement under this Act; or

(ii) is a member of an impacted family;

  • (3) for applicants with a minimum of ten full-time employees, an applicant with at least 51 percent of current employees who:

(i) currently reside in a Disproportionately Impacted Area [DIA]; or

(ii) have been arrested for, convicted of, or adjudicated delinquent for any offense that is eligible for expungement under this Act or member of an impacted family.

Logistics

The definition section of the new law provides for the terms, DIA, Ownership and control, and Member of impacted family, but not for an offense eligible for expungement. Such offenses can be found in the lengthy amendments section to the new law at §900-12. 401 ILCS 705/900-12. The final social equity bucket that an applicant can fall into calls for a business with at least ten full-time employees, 51 percent of which are from either of the first two categories. This third option represents a validation of the necessity for capital in the industry. A well-capitalized business can hire itself into social equity status, while those first two prongs of the social equity applicant prove hard to achieve.

If you live in a DIA or have been arrested for an expungable offense, then you qualify as a social equity applicant only if you maintain 51 percent ownership and control of the new cannabis business. Ownership and control is defined under the act as control of the day-to-day operations and majority of the capital and profits in the business. A dispensary or craft grow in Illinois will be more than expensive enough to price practically all people that have resided in a DIA for at least five out of the last ten years out of such an opportunity. If instead you got arrested for an offense eligible for expungement under the new Cannabis Regulation and Tax Act, the same 51 percent of ownership and control applies.

Moreover, the two elements appear to have no overlap in that 51 percent number. For example, a company of three people: a capital contributor, someone living in a DIA, and someone with an offense eligible for expungement whose governing documents calls for a two-thirds majority vote in is decisions is not a social equity applicant. The only time that the DIA resident or the offense eligible for expungement coincides in the disjunctive is when they must cede control and merely be an employee.

Licenses Will Be Limited

The limited number of licenses and the lucrative nature of Illinois’ highly regulated supply of legal cannabis will create numbers that may rival Pasadena, California’s uber-competitive ratio of 200 applications for only six licenses. People from multiple states, countries, and neighborhoods all want the Illinois license because they know they can recapture their initial investment and make substantially more than that over time. And publicly traded companies have fiduciary duties to employ tactics to acquire social equity talent in a good faith effort to obtain more licenses and maximize profits.

Empowerment

That being said, the noble idea of rectifying the war on drugs by empowering employment and ownership in the population most severely injured by the past 82 years of federal cannabis prohibition need not completely be swept into the capital pillar of the cannabis industry. Enough money to start a craft grow or dispensary can easily be raised by a handful of people that put trust in a social equity applicant, and may condition that trust with a buyout option in five years—as that is as long as the very limited restrictions on the sale of social equity applicant cannabis licenses place. That buyout need not go to a Multi-State Operator. It could be an employee stock ownership plan (ESOP). It could also be a growth strategy to become a social equity cannabis business because you have grown into one, which is substantially easier for craft grows than for retail.

Conclusion and Implications

How will the State of Illinois score its applications? Will it provide the full 20 percent of the points on social equity for companies with the person lucky enough to now become a millionaire because they got arrested for cannabis, or for living in a bad part of town?  Or will it provide the maximum amount of points for companies that put together a business plan that takes into account an exit strategy that creates jobs and ownership in the new licensee to maximize the benefit to the largest amount of people most injured by the previous law?  We will find out next summer. Barring delays, dispensary licenses should be announced in May, and craft grows in July of 2020.

(Thomas Howard)