CFN Insider Takes a Look at Cannabis Banking & Inventory Management

Ryan Allway

October 30th, 2017

Policy, Top News

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Amanda is a compliance officer at Choice Organics, a dispensary in Fort Collins Colorado. She tells the Coloradoan newspaper that she has a money problem.

I have been denied loans before and that’s always a concern. I bought a house last year and I was concerned that they were going to going to deny [me].

Why? It’s the work she does. While marijuana is a legal business in Colorado, it’s still illegal at the federal level. So, every time Amanda, a formal schoolteacher, intersects with money and federal law, she flinches.

I can’t work for school district, if I wanted to go back and be a teacher, right? I have a really hard time getting government jobs because of the industry have work done. So, it one of the… even though it’s a legal industry, it can be hard… because it’s federally illegal.

It’s the same problem a lot of cannabis businesses face every time they open their doors. They have all this cash, but they can’t find a bank that will take. Sure, 29 states have legalized marijuana for either recreational or medicinal use, but as Mark, a New York University Professor of Public Policy, tells Fortune magazine: That really doesn’t mean much at the federal level. 

My company worked with the Washington State Liquor Control Board on their regulatory process and I had to keep reminding the state officials that we were in the position of issuing state licenses to commit federal felonies. That’s not a good long-term situation.

Three years ago, the House of Representatives considered HR 2652, which would have updated America’s banking laws to create protections for banks and credit unions serving the cannabis industry. One of its sponsors, Washington Congressman Denny.

If you want to keep marijuana out of the hands of children, and if you want to keep cash out of the hands of gangs and cartels, you will support this amendment.

The amendment pass but the bill ultimately failed. So, President Barack Obama’s Administration, through the government’s Financial Crimes and Enforcement Network, FINSEN for short, provided banks and credit unions with a set of guidelines released in February 2014.

The federal government, at this hour, the Justice Department more specifically the Treasury Department Bureau of Financial Crimes Enforcement Network, are releasing guidelines to banks that would allow for banks to actually provide services to marijuana businesses to marijuana customers. This is significant because the federal government still views marijuana as an illegal substance treated that way…

But, as Bloomberg correspondent Peter reported at the time, there were conditions.

First and foremost, they need to do thorough due diligence on their customers. They need to know exactly who it is they’re doing business with and they need to continue filing suspicious activity reports involving any transaction involving marijuana that’s significant. And that means everything they do with those businesses must be reported to the federal government and the banks need to red flag effectively those customers that the banks suspect may be doing above and beyond what’s allowed under the law. So, it puts a responsibility is on the banks but does allow them to go forward.

But three years later, the vast majority of banks and credit unions still refuse to get involved.

There is a significant amount of inherent risk – moreso than any other industry because as marijuana remains a Schedule I narcotic under the classifications of the Drug Enforcement Agency. Banking is generally prohibited.

Cannabis industry insider Matt Karnes, Founder and CEO of Green Wave Advisors, in New York.

What that means is many of these businesses operate in cash only, which obviously poses a lot of public safety concerns.

Affected banks are staying away from the cannabis industry and drugs, meaning growers, packagers, transporters, and retailers must deal in cash. And cash is an almost irresistible attraction for criminals. You probably heard us talk about the Cole Memo written in 2013 by Deputy U.S. Attorney General James Cole. The memo outlined eight conditions under which federal prosecutors would remain hands off when legal cannabis operations are concerned. The Cole Memo requires cannabis businesses create a seed to sale tracking system, prevent marijuana from falling into the hands of children, keep marijuana revenue out of the hands of crooks, gangs and cartels, and stay away from federal property, which brings us back.

It poses a tremendous compliance burden such that its cost prohibitive for a bank to want to engage in banking these type of clients because of the costs associated with ensuring the compliance issue is dealt with accordingly. Their customers in full compliance. There’s just added risk because there are no legal precedents as to whether or not banks could be subject to any type of punishment from the federal government for laundering money basically.

It’s tempting for cannabis operators to try flying under the radar, misrepresenting their business to a financial institution to gain access to traditional banking, but that’s obviously risky more so than operating in cash. Enter a company call Hypur.

Hypur is a technology that’s been built to give financial institutions the ability to enter and scale within, highly regulated cash intensive industries.

That’s Typer, Hypur’s Vice President for Business Development.

When we first launched, we started getting calls from institutions they said, hey, we would really like to explore banking the legal cannabis industry. Can we use your technology for that? And so, through the past three and a half years, we have built out specific feature sets for the state with cannabis industry to address some of the specific issues that financial institutions experience when trying to go into those spaces.

Hypur’s customers are banks and credit unions. It monitors merchant transactions looking for unusual activity, provides currency transaction reports, in some cases, call CTRs, on deposits or withdrawals of more than ten thousand dollars. Hypur generates suspicious activity reports, SARs, tools the government uses to flag possible cases of fraud and money laundering.

We have the ability to monitor all license information in real-time for our financial institutions. We can monitor licenses for the retailers, in some cases, even their employees in real time. So, it puts everybody again in a proactive environment. So, if I’m a bank and a retailer loses a license, the financial institution knows immediately, the licensee knows immediately, that this is a problem and needs to be rectified.

That’s the kind of thing that gives banks and credit unions the confidence they need to enter the complex financial environment surrounding the cannabis industry, where entities are legal at the state level to some degree but not with the federal level. Hypur is getting calls every day from financial institutions looking to enter relationships with cannabis businesses and there’s plenty of incentive for that. As we’ve discussed before, the cannabis industry is expected to balloon into a fifty billion dollar economic powerhouse in the United States by the year 2026. And insider Matt Karnes believes that a lot of that business will come from California.

As we look to next year, as California begins to implement its recreational use program, we’re going to have another three billion dollars or so floating around California – a real problem! How do we address that? And how do we ensure that the public remain safe as a result of this idiotic, if you will, red tape that we have to deal with.

Another solution being explored in California is the creation of a state bank to deal with cannabis transactions. Fiona Ma is a member of the California Board of Equalization.

I think people get a little bit fed up and they want some sort of alternative that is going to be easy transparent and affordable.

This state bank would be publicly controlled and free from federal or regulations, but basically shut cannabis companies out of traditional banks and credit unions. It would be controlled by state government officials and its shareholders would be the people of California. So what are the drawbacks? Well, a state bank like that wouldn’t be insured by the federal government. But, in a state with the cannabis business will be worth an estimated three billion dollars a year to start, it’s an idea that’s of this gaining attraction.

Let’s move from the macroeconomic policies of cannabis finance to the micro level. Medical and retail dispensaries sell a variety of cannabis products, often by weight. Every gram of marijuana has to be accounted for. That’s where Tim comes in. A formal Microsoft executive, Tim now runs a company called 420 Tech, an accountability application that helps retailers keep track of their products. They got started a few years ago with a tantalizing offer from a friend who operated a medical dispensary.

The owners were having a hard time with their inventory. The inventory was short substantially and they went through all the normal “oh my gosh what’s going on, our employees are stealing from us”. She knew I had a deep background in tech, but a background also in the retail industry from work I done at Microsoft. So, she asked me if I would just come hang out at the dispensary and see if I could kind of figure out what was going on because the owners were just going ballistic.

The payoff? Tim says she promised him a dinner! And that was good enough for Tim, so he went to the dispensary and watched what was going on.

What I first observed was that there was a gender bias between bartender and patient.

Gender bias?

If it was a male bartender and a female patient, that’s 3.5g gram weigh out might be 3.7g or even maybe as high as 4g, but they’re only charged for an eighth or 3.5g. And similarly, if it was a female bartender and a male patient, total gender bias. Similar to what you might see in a bar, where you order a cocktail and the bartender may partly over pour, so the recipe calls for one ounce of whiskey they may give you an ounce in a quarter or even a half. As the customer, you’re thinking, hey, I got a bigger drink for the same money, yay! You know, your tips and loyal to the bar etc. there’s a lot of common business practices, but I observe that they were actually doing that, but in this case that was along gender lines. So for male patient if a male bartender intended to be closer to bang on 3.5g for that purchase.

The second thing Tim noticed was shake.

Just in the natural handling and jostling, some of the tiny particulates or in this case some of the tricones and crystals, where the active ingredients would fall off of the bud, or maybe some small leaves could fall off just when handling. And that sediment, if you will, at the bottom, which the industry term is shake, they weren’t accounting for that weight. It wasn’t substantial, but what they would do is over a period of time, they would collect this material again which was now off book and they would roll marijuana cigarettes out of them as house joint.

But the biggest problem we found was in the software dispensaries used to keep track of their product.

There was a math error in conversion between grams, ounces and pounds. There was a simple rounding error, but it was compounded because the fairly high volume dispensary with lots of product coming in and out, and that added to it.

Taking all that into account, Tim picked up the phone.

I thought to be a nice time to report a bug and needless to say that bug report didn’t go well I got accused of all kinds of people thing and I thought, “you know what this is crazy.” So, it inspired me to go create a really simple inventory management system that would keep track of these kind of things. It wasn’t a full on point of sale. And I went and found other dispensaries that were using the same software packages that I had found the bug in, and I gave it to them for free. The only thing I asked for was some feedback and the feedback is literally what caused me to get in the business. That’s how I got here.

Tim says, 420 Tech revolves around two key principles.

The first one was obviously was an accurate inventory system was really simple to use, and that would interface with whatever the regulations were, and whatever state that our product was to be shipped in and we consider that table stakes. Have a price of any value it’s just got to put math right, got to keep track of the inventory correctly, and got to do all those kinds of things.

But we kind of took it a step further. We recognize that, if we’re talking about a dispensary, that they are retailers just like every one else, and if you ask any retailer what keeps them up at night they all have the same answer: I want one more customer every day and I want each customer put one more thing in their basket. So, we added features that help the retailers commit to those goals.

Perfect example is that just in doing simple basket analysis of what their customers are buying and understanding what their inventory turns are and understanding not just what hive but in the family of products that they carry to then give them indications as to what products they need to replenish or perhaps even what new products they should consider selling because of the profile of the customers that actually shop there.

There are a lot of dispensaries that are similar, very very similar, to traditional pharma, and any brick and morter establishment, any one, they typically serve a geographic area that is convenient to where their population is. For food, typically we’re going to shop a grocery stores conveniently located to where we physically are. If you’re a medical marijuana patient, you’re going to get your medicine in a dispensary that is conveniently located where you are or at minimum of what your typical travels would be. You wouldn’t drive across state for medicine nor would you drive across state for food.

If you’re a recreational user, in face of offer of like that, same way it’s going to be more of a geographic convenience. What that implies is that now you’re able to on a geo basis kind of anticipate what that population based on what you’re doing and what the items are turning in inventory you able to now actually anticipate that and move forward and plan your inventory allocation accordingly. That’s really how we approach the business, give them more tools to actually run their company as your supposed to… you know just the table stakes of you have to do math right we know exactly how many grams are running out and we do the rounding the appropriate way.

The idea, says Tim, is to bring big company thinking to companies the size of cannabis dispensaries when it comes to things like merchandizing and analysis what does and doesn’t sell.

If the type of the analytics available to the very small retailers, the same kind of thinking that some of the world’s largest retailers use to plan their assortment and plan their inventory and the seasonality all of those kinds of processes that a large global retailers, but same algorithms that they use to determine that, we bring those to small businesses. They still have the same need to understand their business, who their customers are, and how to find a new customer, how do I locate a new customer. And even that is somewhat being faced because of regulations around advertising and how you accomplish that and then once I get that, like core customers are having the door how do I up sell them to having that… just one more thing in their basket.

Finally, when we talk about issues related to point of sale, Tim says one of them is cash, as we mentioned at the top of this podcast, but that way Tim sees a huge job opportunity.

The biggest key point is to see that the entities that they’re typically investing in is going to be handling a fair amount of cash. And as risky as that sounds in nature, the thing that they should be looking for is what the business policies are beyond just a business plan what their policies are around that cash management and what the accountability is there. That would be the thing, as an investor, that I would want to look to before investing in any business that is a predominant cash business.

The other thing I would look for as an investor is recognizing that many skills are transferable. For example, someone that came out of the consumer packaged food industry, those skill sets that they have might transfer very well to somebody who’s a processor who is actually converting infused products into edible products and therefore that whole consumer packaged good thing that all transfers really really well. In this example, cannabis is just another ingredient in whatever the end product is that they’re making. I would look to depth and the qualifications about the leadership, as well as even down the line management, of those types of businesses. We kind of do skill assessment.

You’ll find us on Apple iTunes, on Google Play and Please subscribe to CFN Insider and don’t forget to write us. I’m Alexandra Lawson from all of us here thanks for listening. Will be back soon with another edition of CFN Insider.

Ryan Allway

About Ryan Allway

Mr. Allway has over a decade of experience in the financial markets as both a private investor and financial journalist. He has been actively involved in the cannabis industry since its inception, covering public and private companies.

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