San Francisco Sounds Alarm Bell: Social Equity Applicants Beware

Social equity plays a key role in San Francisco’s adult-use market. Currently, only social equity applicants can obtain a permit. A lot of people did. San Francisco is now concerned that the market is saturated, and that social equity applicants will lose money. San Francisco’s experience could be the beginning of similar stories across the United States.

San Francisco issued a report on the status of the adult-use market following legalization. To date, San Francisco issued temporary permits to the 37 medical dispensaries that operated in the city prior to adult-use legalization. The 35 operating retail stores generated over $220 million in sales in 2018. The retail stores are clustered in three primary areas in San Francisco due to zoning limitations.

Social equity applicants started submitting applications in May 2018. As of August 15, 2019, the city was processing 183 social equity applications. The report indicates that 73% of the applicants are seeking a permit to operate a retail storefront. The new stores would all be clustered in the three primary cannabis zoning areas. The report also states that “[a]t 133 proposed storefront retailers, there is such a high number of applicants intending to establish storefront retail that this activity may not be viable for many of these equity applicants.”

So what is the problem?

An applicant must spend money – a lot of money – during the time that it takes to receive regulatory approval. Almost two years later, San Francisco has yet to issue a permit to a social equity applicant, which means no revenue. The report warns retail applicants that the process takes 18 – 24 months due to the sheer number of applications, the building of the cannabis program infrastructure, and the number of city approvals required.

The city admits that social equity participants are impacted financially. Many applicants spend hundreds of thousands of dollars in rent and licensing costs. The city found that, unlike applicants that raised capital through an equity sale, sole proprietors without outside investors are not likely to survive this process.

The city is also concerned about the ability of social equity participants to build a viable business after making it through the process. A retail store owner will face tremendous competition from the first movers and the clustering of the new 133 stores due to zoning regulations. The city concludes that “due to long permitting timelines the city is in danger of further disadvantaging equity applicants that were specifically targeted due to their disadvantaged status.”

How is the city going to solve this problem?

San Francisco has a tough road ahead with limited choices. What it does next could determine how bad it gets for social equity applicants.

First, the city has an obligation to disclose the financial risks that applicants face. A permit does not guarantee a profitable business or a transfer of wealth. This should be done in community meetings with a broad outreach.

Next, the city needs to address the current market conditions. The market will right size if left to its own devices, but this will mean that folks will lose money. The report recommends that the city consider limiting the number of stores by imposing a moratorium on new applications, providing an incentive to larger commercial entities to provide money to social equity applicants, use a community investment fund to help equity applicants, speed up the approval process and provide access to interest-free loans.

Most of these options are not viable given that federal regulations prevent access to traditional financing and prevent the city from providing capital assistance. There is no current small business loan for cannabis businesses. The only viable choice at the moment is big capital cannabis.

Government versus Big Capital Decision

The problem that we see is that no one addressed the money question. Social equity applicants are at risk. Money is not free- even government money.

Money used to fund a government capital solution comes from taxes. The government can obtain the capital from local residents through higher real estate taxes or consumer taxes on cannabis. Both options are unlikely as no one wants to pay higher taxes. Higher taxes also help the black market.

Market forces are working as big capital companies are finding social equity partners in San Francisco. The city admits that these businesses have a better chance to succeed. Advocates and government regulators want big capital companies to serve as incubators rather than owners – so that social equity applicants control their own businesses. This approach will be very difficult to execute. As we see in every industry, market forces find their way around government regulations – even those that are intended to achieve an equitable social result.

Big capital may be the necessary evil that the industry needs at the moment. Business owners in any new industry take a huge risk, and the cannabis industry is no different. We should not expect these business owners to bear the risk alone. The benefit of accepting money from big capital is that this lowers the financial exposure for social equity applicants. The benefits of risk diversification may outweigh the loss of control to outside persons.

The goal is to help social equity applicants establish a sustainable business. Right now all that is being offered is a dream. A dream that will ultimately result in many folks losing money, time and feeling even further disenfranchised by the process.

The current social equity programs all well-intended but we believe the end result will do more harm than good. It may be too late to press control, alt, delete – but the capital question should be addressed before any other city starts the social equity permitting process.