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Acquiring an Arizona Medical Marijuana Dispensary License Now May Be the Ticket to Obtaining an Adult-Use Dispensary License in 2020

If adult-use legislation is passed, owners of licensed medical marijuana dispensaries will likely have an exclusive or preferential additional opportunity to own and operate an adult-use dispensary.

Recognizing the strong possibility that marijuana legalization will appear on Arizona’s 2020 general election ballot[1], many entrepreneurs are renewing their interest (and investment dollars) in acquiring an Arizona medical marijuana dispensary license.

Although we cannot predict with any certainty the outcome of the ballot, if adult-use legislation is passed, owners of licensed medical marijuana dispensaries will likely have an exclusive or preferential additional opportunity to own and operate an adult-use dispensary. This opportunity suggests that substantial new revenues can be achieved by tapping into the recreational market.

There are a number of avenues for obtaining a medical marijuana dispensary license now, or for otherwise becoming an integral participant in a dispensary business. This article summarizes various entry methodologies, with an emphasis on June 2019 modifications to the Arizona Medical Marijuana Act, or AMMA (A.R.S. §§ 36-2801 et seq.).

A. Become an Investor/Partner in an Affiliate.

By investing your own money, you may be able to join others as partners in the dispensary business. While Arizona requires the dispensary licensee to be operated as a non-profit, meaning that there are no profits to distribute to partners, most dispensary licensees are managed by an LLC, which typically earns substantial management fees paid by the dispensary. This managing entity may provide an opportunity for investors to become partners (members/owners) in a marijuana business.

An investor should exercise considerable due diligence on a subject dispensary, including its financials, operations, licensing status, and assets and liabilities, and seek legal and tax counsel advice before investing. Federal and state securities laws may require registration of the investment raise, and Arizona may require the investor’s submission of fingerprints and an application for a dispensary principal card to the Department of Health Services (DHS).

B. Become a Lender to the Dispensary or Other Marijuana Facility or Operation.

Making a loan to a dispensary can be an effective strategy. The borrowing dispensary gains additional financial resources to buy or update equipment, make tenant improvements, or hire additional employees, and the lender is typically paid a commercial rate of return (often in excess of 20%) far above traditional commercial loan transactions, given the potential for Federal or state criminal law enforcement and property seizure.

Collateral for the loan is typically the dispensary’s personal or real property, but not its medical marijuana in any form. Whether the borrower’s AMMA dispensary license (and related approvals to operate [ATO] the dispensary, kitchen and/or cultivation facility) can be collateralized for loan purposes has not yet been litigated in Arizona, but the AMMA does prohibit the transfer of dispensary licenses. (The creation of a security interest in a license for the benefit of a lender is a form of interest transfer.)

Again, thorough due diligence should be undertaken before a loan is made.

C. Become a Landlord to the Dispensary.

Some dispensaries do not own, nor do their affiliates own, commercial real estate to house their retail and cultivation activities. Entering into a commercial real estate lease with a dispensary or its affiliated businesses can pay above-market rentals and other concessions to the landlord. There are commercial real estate brokers focused on serving the marijuana real estate niche.

In Arizona, the AMMA and local zoning ordinances limit the size of dispensaries to not more than 2,000 to 2,500 square feet. Monthly rents often exceed $10,000 to $20,000, plus real property and rent taxes and operating costs, with the tenant also paying for its own improvements and building repairs and maintenance.

The AMMA prohibits a dispensary from entering into unreasonable business transactions whereby compensation is paid, a contract is consummated, or an asset sold or purchased. Thus, while the AMMA permits a lease to be lucrative to a landlord, its terms cannot unreasonably bind the dispensary.

Landlords have a statutory lien on the tenant’s personal property for unpaid rents. Most municipalities and counties have enacted ordinances limiting the location of marijuana business facilities to industrial and retail areas that are separated from child care facilities, schools, religious buildings, and other dispensaries.

D. “Purchase” an Operating Dispensary.

As mentioned above, a dispensary license cannot be transferred (sold), but the management control of a licensed dispensary can be changed (transferred) on the resignation of some or all of the dispensary’s board of directors and appointment of a new board, coupled with a management change.

Here again, comprehensive due diligence is important to the transaction, and all of the due diligence activities typically undertaken in the purchase of any non-cannabis business should also occur on the change of management control of a dispensary licensee.

Purchase prices typically range from $15 million to $30 million for control of a licensee and may reflect an expectation that Arizona voters will approve a legalization measure in November 2020.

E. Apply for New Licenses Expected to Be Issued in Spring 2020.

Senate Bill 1494 (codified at A.R.S. § 36-2803.01) enacted in June 2019 requires the issuance of new dispensary licenses in April 2020, with a preference for rural geographic areas in Arizona. The AMMA as originally enacted in 2010 permitted the relocation of a dispensary after operating at a site for three years; thus, to maximize revenues, many dispensaries that originally located in rural Arizona have relocated to Maricopa County, which now has approximately 60% of all dispensary licenses. With the recent passage of Senate Bill 1494, DHS is now mandated to issue new licenses, if and when they become available, to rural areas first.

Every March or April, DHS determines whether the number of registered pharmacies in Arizona has increased (on a ratio of 10 pharmacies to one dispensary license) and whether any new licenses will be issued. Based upon projections made by DHS six to eight new licenses may become available in 2020, with applications being available in the summer and licenses awarded in October.

Senate Bill 1494 requires DHS to give preference to an applicant who intends to locate a dispensary at the former (now vacated) rural location. If there are multiple applications, the applicant’s location serving the most patients within five miles will win, provided that the new location is at least 25 miles from other dispensaries.

Also, the Department will give preference to an applicant intending to locate a dispensary in a town, city or county that is at least 25 miles from its nearest dispensary neighbor.

Third, if there are no applications for the first or second preferences, or there are multiple applications for the second preference, the licenses will be awarded by lottery. Applicants awarded a license of the first or second preference must open within 18 months of approval. The relocation of licenses awarded under the first and second preferences is limited.

Where are these new license opportunities (which may, in turn, give the licensee immediate access to operating in the adult-use marijuana industry)?

  • There are no dispensaries in three Arizona counties: Apache (population 72,000), Santa Cruz (46,000) and La Paz (21,000).

  • Two Arizona counties have only one dispensary each: Graham (population 38,000) and Greenlee (10,000).

  • There are no dispensaries in these Arizona cities and towns: Eloy (population 18,000), Douglas (17,000), Page (8,000), Holbrook (5,100) and Fredonia (1,400).

  • Two Arizona cities have only one dispensary each: Yuma (population 95,000) and Sierra Vista (44,000).

How should opportunists prepare to apply for new 2020 licenses? Prior to the DHS announcement that licenses are available for application, potential investors or lenders should consider the following steps for locating a site appropriate for a medical marijuana dispensary in the rural areas:

  1. Consider hiring a licensed real estate broker specializing in cannabis properties. We can refer you to a few.

  2. Conduct an analysis of commercial real estate locations in the above underserved counties, towns and cities that (a) meet your site selection criteria (traffic and population counts, lot and building sizes, parking availability, surrounding uses, etc.) and (b) qualify under local zoning ordinances for use as a medical marijuana dispensary. Also consider the transportation patterns of nearby communities and whether prospective patients and customers would likely travel to the dispensary location for their cannabis needs.

  3. Overlay the locations of the current dispensaries against the underserved towns, cities and counties, and determine the distance between the prospective location(s) and its dispensary neighbors within 25 miles. Confirm that the location is more than 25 miles away and that the location meets other zoning requirements.

  4. Create a budget for the acquisition or lease of the location including, without limitation, for tenant improvements buildout, fixturization, inventory acquisition, staffing, etc. and for the license application process. Each application you file with DHS must be accompanied by the application fee of $5,000, of which $1,000 is refundable in the event a license is not awarded the applicant.

  5. Consider your available funds: Do you have sufficient assets to embark on this endeavor, or will you need investors? If you will need investors, consider preparing a private offering memorandum for disclosure to potential investors. We can assist you with this paperwork and consult with you on (a) the applicability of the securities laws to your endeavor, (b) how you can comply with those laws, and (c) how you can be personally protected from investor disputes and claims.

  6. Consider contacting the owner of a possible location even if the property is not listed for sale or lease, but be prepared to make an offer to purchase or lease. The offer should include a contingency that it will not become effective unless and until the license is awarded for the location. Agree to pay a monthly stipend to keep the location off the market and under an exclusive contract with you until DHS announces license winners.

  7. Form your applicant company and affiliates. Open a bank account. Execute entity formation documents. Prepare your application packet including, without limitation, various documents DHS will require (entity documents, background check and fingerprints, site plans and specifications, policies and procedures, evidence of zoning conformity, etc.). Obtain a federal taxpayer ID number. We can assist you with all of this paperwork.

  8. Contract with a medical director that becomes effective if you win a license. Engage counsel and a CPA with cannabis business experience. Contingently appoint the dispensary’s board of directors and officers. Identify employees needed to run the business and vendors to assist you (cultivators, marketing agents, managers, etc.).

  9. Be prepared to submit applications for several locations to increase your odds in the event of a lottery. We can suggest application strategies that increase your chances of winning one or more of the sought-after licenses.

Contact Us. If you have questions concerning the developments described above, please contact marijuana business attorney Janet Jackim at (480) 425-2616 or by email.

More about Sacks Tierney's Marijuana Business practice.

[1] The author is a member of the Board of Directors of the Arizona Cannabis Chamber of Commerce, which has proposed to the Arizona legislature a referendum that would legalize marijuana for adult use (also referred to as “recreational use”). This effort is in addition to a planned initiative by the Arizona Dispensaries Association for the same purpose.