United States: High Risk, High Reward: When Is It Time To Establish Or Grow A Cannabis Franchise System?

Last Updated: February 14 2019
Article by Daniel A. Blumenthal

Cannabis and CBD-driven business format franchising is coming.

Franchising in the United States has deep historical roots in a nearly endless array of industries, from Benjamin Franklin's Franchise-esque Printing Business to the Singer Sewing Machine's profit-share model (1851) to Martha Matilda Harper's Creation of the Modern Franchise with the Harper Method – all sixty-plus years before Ray Kroc created the World's best-known franchise.

Where business innovation has happened in the U.S., franchising has soon followed: the early automobile industry was promptly followed by the first franchised car dealerships (General Motors, 1898), with the first drive-in restaurant franchises right on their back bumper. Innovative franchise giants like Coca-Cola (1899), A&W Root Beer Stands (1925), Kentucky Fried Chicken (1930), and Howard Johnson Restaurants (1932) paved the way for new industries to grow through franchising, like retail automotive parts (Western Auto, 1909), car rentals (Hertz, 1925), dance studios (Arthur Murray, 1938), carpet cleaning (Duraclean, 1940s), and tax preparation (H&R Block, 1956). The most popular industries for franchising today include childcare, senior care, business opportunities (think ATMs and vending machines), cleaning, recruiting, and tutoring services.

And so naturally, with the dawn of a new $150 billion global industry, more than a few cannabis entrepreneurs are likely to test out franchising as a business growth model. At least one Cannabis company is already trying it out in the U.S., and franchise opportunities are available in Canada as well. Cannabis dispensaries are where it will start, but we expect to see cannabis roll out in a number of other franchised businesses as well, whether in retail (accessories, core products, ancillary products such as cosmetics and body rubs), or in restaurants, home health care, and pet care, for starters. Given the landscape where these franchisors will plant their seeds, success will depend not only on the quality of the system, branding and thought leadership, quality and integrity of products, but just as much upon franchise experience and savvy, and a creative and knowledgeable legal team.

The cannabis industry is fertile ground for franchising. It's a fresh open market, and so the competition for growing brand recognition and market share is wide open. New emerging brands with pipe dreams of being "the Starbucks of weed" will compete to accelerate growth, and there's no faster way to grow your own (brand) than a nationwide business format franchising program. Proprietary products (think custom strains of plant, proprietary edible products, and the like) will provide valuable intellectual property ripe for national distribution. And entrepreneurs who are jonesing to get into the field will be lining up for turnkey systems and consumer-loyal brands to get them started, without the time investment, equipment and property overhead, or expertise necessary for a full farm-to-pipe grow operation.

But the legal landscape is very complex for the would-be cannabis franchisor or franchisee.

First and foremost, cannabis, including for medical use, is still categorized as a Schedule I drug under the federal Controlled Substances Act (21 U.S.C. § 811). And while the Department of Justice has not prioritized prosecuting cases involving use that is legal under conflicting state laws, that could change virtually overnight, leaving the franchisor and franchisee not only in danger of losing their business, but their freedom as well. A budding franchisor may be willing to take that chance in hopes that the federal government will legalize, but it's a big gamble for franchisor and franchisee alike, and perhaps not worth it to a prospective franchisee with safer options.

Even where the franchisor is willing to take a chance within its own state, federal law enforcement would not likely be willing to look past the (rather public) transportation of cannabis and many related products across state lines, even between two contiguous legalized states. Thus a franchisor who sought to franchise outside of its home state would face a dilemma: maintain consistency of product through interstate distribution but at tremendous legal peril, or risk brand inconsistency by not distributing from a central grow facility.

Perhaps the biggest challenge to any cannabis business is the reluctance of most banks to serve the cannabis industry. Because of the federal prohibition, banks that accept cannabis industry money risk violation of federal money laundering and other laws. While individual businesses may be able to work around this challenge by using local banks, running cash-only businesses, and perhaps the eventual institution of state-backed banks or the establishment of private cannabis banking, interstate transactions (such as payment of a franchise royalty) would necessarily risk implicating federal law, opening the franchisor and franchisee to potential criminal liability and even seizure of funds.

Additional questions and challenges await the franchisor, such as the application of federal franchise disclosure laws to the federally prohibited business, and how to properly disclose business and legal risks under state and federal disclosure laws. Under these laws, franchisors are required to provide prospective franchisees with a prescribed franchise disclosure document ("FDD"), in which the franchisor must provide information about a variety of aspects of the business, including risks and laws that will apply to the franchised business. The franchisor will need to rely upon experienced and creative franchise attorneys to artfully craft the document in a manner that satisfies the legal requirements, adequately informs the prospective franchisee, and mitigates against potential legal risks.

And there are dozens of other industry-unique questions that will arise: franchisors and their attorneys will have to start from scratch in designing the franchise system, training and operations manuals, advertising materials, and supply channels. Risk will be shared between franchisors and franchisees, and only a carefully crafted franchise agreement will prevent the parties from throwing each other under the bus if the law comes knocking. And with legalization will come regulation, perhaps including strain-specific and branding intellectual property battles (who "owns" the trademarks to names of strains? are new hybrid strains patentable?), product safety regulations, and labeling restrictions.

Given the expected growth of the cannabis industry and the entrepreneurial hunger surrounding the "Green Rush", it's just a matter of time before pioneering brands emerge as the franchise leaders in the industry. We're probably just a few years from knowing who had the right combination of risk acceptance, creativity, system quality, creative legal support, and luck to become the household names in the industry.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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