Cannabis Firm Bakes Up Plan

Aquarius Cannabis Inc. wants to become the first national marijuana brand, and last month it took a step toward that goal by filing paperwork to sell its shares publicly. But the Woodland Hills company, facing challenges stemming from marijuana’s ambiguous legal status, is adopting a business model more similar to the Sunkist citrus cooperative than Big Tobacco. The rules for growing, processing and retailing pot differ from state to state, and even city to city, and the industry is highly regulated in terms of investment, ownership and taxation. What’s more, marijuana is still a federally controlled substance, though the Justice Department has issued guidelines that allow states to regulate its use locally. To work within this regulatory patchwork, Aquarius plans to license growers to use a proprietary system for growing the flowers, including indoor temperature and humidity controls. The system also covers storage, curing and packaging the pot. In return, the company will also license the growers to sell the product under the Aquarius brand name at a premium price. However, unlike Sunkist, Aquarius won’t buy the pot from the growers. The prospectus filed Dec. 17 with the Securities and Exchange Commission states that at no time will Aquarius “produce, distribute or own the actual marijuana products that are distributed under (its) brand names.” Davis Lawyer, the company’s 27-year-old chief executive, said he recently signed a deal with a grower in Washington, but since state law prohibits profit participation deals for marijuana, he had to charge a straight consulting fee. “Every state is different, but our goal is to get so we are winning or losing with our clients,” he said. “That will allow us to become a national force.” Premium price Aquarius plans to grow its brand through licensed dispensaries. The growers who sign up for Aquarius’ system will have to sell the pot themselves to dispensaries – solving what Lawyer said is retailers’ biggest worry: access to consistent, high-quality pot. “There is a lot of product, but the supply of high-quality product that dispensaries know will sell is lacking,” he said. “It sounds rudimentary, but the industry is still coming out of the basement. Just having a consistent product in a package is taking it to the next level.” Marketing for the Aquarius brand will include flyers, posters and video presentations in the waiting rooms at dispensaries. The company also plans to advertise in alternative weekly publications such as LA Weekly, as well as marijuana-focused magazines and websites. Lawyer said that currently, there are no brand products for smokable marijuana flowers, but brands exist for oil concentrates and edible products. For smoked marijuana, it’s still a commodity market. But with an established brand and high quality – including a long cure time and glass packaging to preserve flavor – Aquarius will command a premium price, Lawyer believes. Currently, the typical price is $35 to $45 for one-eighth of an ounce, he said. The plan is to sell Aquarius for about $60 per eighth-ounce, which calculates out to $7,680 paid at retail for a pound of marijuana. Eric Shevin is an attorney in Sherman Oaks who works with Aquarius to ensure the legality of its operations. He believes the money in the industry will inevitably attract large corporate players from the tobacco, alcohol or pharmaceutical industries. He thinks Aquarius is in a race to establish a brand before the market fully opens up. “Having billion-dollar competitors, it’s impossible for a small player like Aquarius to compete,” he said. “But if the runway is long enough so we have a couple years, we can establish a brand identity that those big players would want to acquire.” Shevin anticipates federal recognition of pot, which will allow the Aquarius brand to become national. At the same time, it will put the federal Food and Drug Administration in charge of regulating medical marijuana, which he believes could signal the end for many small pot entrepreneurs. “If history tells us anything, the FDA rules tend to protect large players,” Shevin said. “But it’s inevitable that these huge players will move in because there’s really huge money in this space.” Adam Bierman, managing partner at Culver City marijuana management consultancy MedMen, said that Aquarius isn’t alone in trying to build a national brand. “Everyone you talk to with a modicum of success wants to become a national brand,” he said. “That’s the state of the industry right now, but of course they won’t all become that.” Challenges include accessing capital, attracting talent and structuring deals. In particular, Bierman said licensing arrangements are tricky because the industry doesn’t have a tradition of accurate accounting records, making it hard to track money to the satisfaction of partners, investors or regulators. Also, building the market awareness that brands need has proven even more difficult among marijuana users than typical consumers. “Even if you have the expertise and the money, it’s still a tall task,” Bierman said. “To scale up over multiple states is something that has yet to be done in this country.” Other local public companies have tried to establish marijuana brands. GrowLife Inc., formerly headquartered in Woodland Hills and now in Seattle, sells irrigation and lighting equipment for pot growers. Its website describes the company as “a nationally recognized cultivation brand,” but it has yet to earn a profit. In its third-quarter filings, GrowLife reported a loss of $37.8 million, mostly because of $28.7 million in interest payments. The stock trades over the counter. Also, MedBox Inc., a maker of dispensing machines and equipment for marijuana retailers, trades on the Pink Sheets. The company is based in West Hollywood, but Chairman Vincent Mehdizadeh, the company’s largest shareholder, is based in West Hills. In its third quarter filing, the company reported a loss of $3.2 million, but last month announced it will restate earnings for the last five quarters in response to subpoenas from a federal grand jury and the Securities and Exchange Commission. MedBox is trying to clean up its problems so it can trade its shares on the Nasdaq. Selling shareholders Aquarius plans to begin trading its shares over the counter sometime this year. About 10 million shares will go on the market, but these shares belong to “selling security holders” who are cashing out. The company won’t get any money from the offering. The selling shareholders are 60 individuals, couples and investment firms. After the offering, Lawyer will remain the biggest shareholder with 5.5 million shares representing nearly 18 percent of the company. “All we are doing is clearing shares; however, as a consequence, in the future, shares will be able to be bought and sold on the open market,” Lawyer said. “We are still raising capital, but that would add additional debt or equity shares to our books.” But taking the company public could bring an additional issue of trust for Aquarius, given the history of fraud in marijuana stocks. In May the Securities and Exchange Commission issued a specific warning to investors about marijuana, noting that the agency had suspended trading in five marijuana companies during the previous two months. One of those companies was GrowLife, which was based in the Valley at that time and later resumed trading without any sanctions. “Recent changes in state laws concerning medical and recreational marijuana have created new opportunities for penny stock fraud,” said Elisha Frank, co-chair of the SEC Enforcement Division’s Microcap Fraud Task Force, in the agency’s May warning statement. “Wherever we see incomplete or misleading disclosures, we act quickly to protect investors.” Bierman, the consultant, noted that institutional money hasn’t come to the cannabis sector yet. So despite the scams, going public is still a viable strategy for companies with a solid business plan. “You have fast moving businesses that suddenly access capital and don’t know what to do with it except fail. But if it’s part of a comprehensive plan discussed with a lawyer and financial advisor, it could work,” he said. As for capital expenses, Lawyer plans to buy some land and establish a “flagship” farm, possibly in Desert Hot Springs, a city with pot-friendly regulations. But based on the company’s own business model, he won’t grow the crop himself. Instead, he will lease it to growers who sign up for the Aquarius brand marketing license. “Our goal is to be as close to the process as possible without crossing that line and being an operator,” Lawyer said.