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Emerging Markets: Arizona

Back in January of 2021, Arizona began accepting applications from cannabis operators, and retail sales have thrived since. The state even has a social equity program with a list 39 pages long of applications that have been submitted, unlike many states that have yet to launch a social equity program. However, despite the booming business and long list of social equity participants, there are concerns arising over smaller operators getting pushed out of the market by bigger companies. Additionally, the aggressive tactics of multistate operators, and the current way that regulations and rules are set up in Arizona, has led to abuses of the Arizona licensing system - harming small operators statewide.

Nevertheless, there are also some interesting features that show a fair amount of forward thinking by Arizona regulators. Packaging and labeling requirements rarely differ in ways that are notable state to state, except by compliance professionals. Yet, in Arizona, there are some features that are more engaging (covered later in this article), and could be useful to know for anyone wanting to start a business in the state.


Also, though it has caused problems, the aggressive tactics of multistate operators trying to enter the Arizona market demonstrate how energetically the Arizona cannabis marketplace will evolve moving forward.


Market Challenges in Arizona


First, let's get into detail about some of the problems arising in the Arizona market. In the cannabis industry, consolidation of businesses is eventually going to happen, just as it does in any evolving industry. The more sophisticated businesses acquire smaller businesses to increase their market power until there are only a few operators left to compete with one another. However, in Arizona, consolidation in the cannabis industry is more pronounced because of the state’s limited-license, vertically integrated structure. Already existing, out-of-state cannabis operators have paid millions of dollars to buy licenses off of others who won the license lottery, even where they are solely buying the paper license without any facilities.


Social equity, recreational-only licenses are so valuable they are currently commanding up to $10 million or more if sold. To qualify for the social equity program, an individual must own at least 51% of the business and meet three of four criteria based on income, past cannabis convictions, and residency in a community deemed as disadvantaged. Owing to these requirements, and the fact that these social equity licenses were the last to be awarded to applicants, businesses were actively recruiting social equity partners. The Phoenix New Times reported that businesses attempting to recruit social equity partners even sent flyers to individuals living in the areas designated as disadvantaged, and offered financial incentives to partner up.


Due to this solicitation of social equity partners, three lawsuits were initiated. The first lawsuit, Acre 41 v. State of Arizona, was filed in November 2021 and claimed that the social equity program was not in compliance with its implementing legislation because the program did not do enough to keep social equity licenses out of the hands of big businesses, but that case was dismissed this year. The second lawsuit, Black Seed Inc. v. State of Arizona, raised arguments similar to the first case and was also dismissed. The final lawsuit, Williams v. Arizona Department of Health Services, argued that licensing should be delayed because background checks had not been conducted on 1,175 applicants, which could lead to licenses being issued to people that would be disqualified. However, Williams v. Arizona was ultimately dismissed as well.


As the rules now stand, the social equity licenses can immediately be resold outright. This may provide a nice payout to a social equity applicants, but it also destroys the intent of social equity licensing - to ensure that people from communities disproportionately harmed by cannabis prohibition and discriminatory law enforcement are included in the new legal cannabis industry.


Besides these problems with businesses attempting to buy social equity licenses, there has also been an increase in merger and acquisition activity for all cannabis operators - regardless of equity status. Operators that have only two, three, or four licenses have been seeking to acquire more licenses to remain competitive against the larger multistate operators. As these businesses start acquiring others and obtaining more licenses, the competition is likely to push any smaller businesses that can't maintain a growth trajectory out of the market.


Arizona Market Regulations and Licensing


Now, if the last section didn’t scare you away, let's talk about what the regulatory landscape and licensing processes entails. Arizona requires licenses for anyone who wants to sell cannabis, whether medically or recreationally. People can apply for a medical license, a recreational license, or as a social equity applicant for a recreational license. Currently, delivery licenses are not available in Arizona, meaning that low cost entry point for cannabis entrepreneurs doesn’t exist within the state.


However, the traditional licenses still exist for anyone who wants to cultivate, process, or sell cannabis in Arizona. In Arizona, any operator that wishes to sell medical or adult-use cannabis products must first hold a license issued by the Arizona Department of Health Services (ADHS). Once the business has been issued a license from ADHS, the business can then apply for a transaction privilege tax license with the Arizona Department of Revenue.


Besides licensing, one interesting feature of the Arizona regulations relates to packaging and labeling requirements. As per Arizona Revised Statutes section 36-2854.01, all cannabis products labeled for sale have to have a code that consumers can scan, like a QR code, which links to a webpage that displays a list of details about that product. This statute is in effect, but the statute also states that businesses will only be required to comply after December 31, 2023. So don’t worry if you have products out there right now not meeting this requirement, there is still time!


Regulations requiring a scannable code are not unique to Arizona. Indiana, Texas, Utah, Florida, New York, and Oregon have all made it mandatory to include a QR Code on hemp product labels. Additionally, New York’s draft regulations for adult-use cannabis require packaging to have a QR code linking to a certificate of analysis. California also made it mandatory for licensed cannabis retailers to display a QR Code provided by the California Department of Cannabis Control in storefront windows, though not on the packaging. So this requirement of a scannable code on cannabis packaging is not completely abnormal, but it is a feature of note.


Arizona’s Green Rush


Finally, let’s move into the numbers and how well the Arizona cannabis market is doing financially. In 2021, Arizona generated 1.9 billion in cannabis sales, far higher than the 1.2 billion previously estimated by the state. By comparison, nearby Nevada surpassed 1 billion in total cannabis sales; the United States’ most lucrative market, California, had 5 billion in total cannabis sales; and the original recreational cannabis market, Colorado, came in at 2.2 billion in total cannabis sales. While Arizona is not yet near the 5 billion mark of California, it is still a regional powerhouse currently exceeding professional estimations.


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