And how it could change the industry
Cannabis ETFs have soared in 2024 as a top performing theme, so what is causing the surge?1
Potential regulatory changes appear to be the conduit. News broke on April 30th that the U.S. Drug Enforcement Administration will move to reclassify cannabis as a less dangerous drug and recognize its medical uses.2 This reclassification dramatically alters the business environment for cannabis companies. The current administration appears to be pushing for this regulatory change ahead of election season.
Let’s dive into the potential changes and what they could mean for the industry.
Potential Legislation:
Rescheduling – Cannabis companies would potentially become more profitable.
As a Schedule 1 drug, cannabis companies follow IRS tax code 280E which doesn’t allow companies to deduct business expenses, meaning they have been paying taxes on their revenue rather than their profits. Federally, it prevents cannabis operators from deducting employee compensation, rent, and other necessary business expenses. Rescheduling to a Schedule 3 drug category would allow them to pay taxes just on their profits and would immediately keep more cash in their hands. For example, if their gross revenue is 100k and their business expense equals 70k, they still pay taxes as if their profit was 100k.
Right now, retail investors have direct access to cannabis companies, but the federal classification of cannabis as a Schedule 1 substance imposes significant barriers on institutional investors, stemming from the regulatory and legal risks associated with Schedule I substances. This potential reclassification could cause a huge windfall with large inflows into these companies.
Many banks still avoid cannabis companies because cannabis is still a Schedule 1 drug at the federal level.
It is expected that rescheduling would increase the number of banks and payment providers willing to work with cannabis companies. Many are limited in how they can receive payments from clients and customers. They often use vaults of cash and are forced to transact with clients and customers in cash. Predictably, this limits their access to capital markets when they are trying to grow and plagues their business operational efficiency.
It is realistic to assume that traditional packaged goods companies that excel in distribution, including pharmaceutical, tobacco and various consumer good conglomerates would consider M&A activity. Their current distribution systems could be utilized and give them access to a growing industry.
Developments
Separate from legislative changes, consumer behavior is rapidly changing. 70% of Americans support cannabis legalization and cannabis tax income has actually surpassed that of alcohol in nine U.S. states including California.3 Given this trajectory, cannabis may ultimately become more of a traditional consumer packaged good.
Worldwide, the largest cannabis market is currently the U.S. which is predicted to surpass $39.5 billion in 2024.4 Notably, the buzz isn’t limited to U.S. soil; Germany’s legalization of adult use cannabis, which went into effect on April 1st, 2024, shows momentum in the space and could result in a domino effect throughout Europe and other developed markets.
Any positive legislation change would lead to a runway where cannabis businesses have an increased opportunity to grow. It may take time to reap the benefits of these growth effects, but the potential implications are far-reaching and include increased profitability, access to capital markets, institutional investors gaining access, and M&A activity gaining steam.
Additionally, these changes would grant more opportunities for medicinal cannabis research, which has been limited to this point because of its status as a Schedule 1 drug. Cannabis contains over a hundred cannabinoids, however only two have been widely studied, THC and CBD.5 Therapeutic uses cases and sales are expected to continue to rise as research into cannabis compounds expands.
The outcome of these or other legislative developments remains to be seen, but one thing is clear, the industry is on edge of its seat waiting for something to pop that could redefine the cannabis landscape going forward and usher in a new era of growth and opportunity.
1ETF Action and Amplify data as of 03/19/2024
2 https://apnews.com/article/marijuana-biden-dea-criminal-justice-pot-f833a8dae6ceb31a8658a5d65832a3b8 The DEA (Drug Enforcement Agency) is endorsing this reclassification.
3https://flowhub.com/cannabis-industry-statistics
4 Cannabis - United States | Statista Market Forecast
5 Understanding the Medical Chemistry of the Cannabis Plant is Critical to Guiding Real World Clinical Evidence - PMC (nih.gov)