Home Accounting and Auditing Getting into the dagga business – what accountants should know

Getting into the dagga business – what accountants should know

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In September the Constitutional Court made it legal for an adult to grow and consume dagga for personal use.

Dealing in dagga is still illegal, though it remains for Parliament to decide what quantity found in your possession is for personal use. Above that limit you will be deemed a dealer. So it’s still pretty vague, though time will no doubt sort this out. It will be up to the police, “considering all the circumstances including the quantity of cannabis found” in a person’s possession to determine whether a crime has been committed or not, said the court. One can imagine the kind of chaos this is going to engender in the ranks of the police.

It is clear this is the start of a much broader liberalisation of dagga. It is simply impractical for tens of thousands of dagga users to grow their own. Worldwide trends show this is more efficiently done as a commercial farming enterprise. Many other countries have taken the step of legalising marijuana for recreational purposes, including Canada, Georgia, Uruguay, Lesotho and Zimbabwe, as well as nearly 30 states in the US.

The Cannabis Industry 2017 Annual Report shows that US sales of marijuana, both recreational and medical, are likely to top $10 billion in 2018 and $20 billion by 2023. Figures like this will not escape the attention of SA lawmakers.

Growth market for accountants

It is time for accountants to start to pay attention to what will inevitably become a growth market. It makes no sense for government to allow personal cultivation and use, but to prohibit entrepreneurs growing dagga in bulk for mass consumption as is happening elsewhere in the world. Sooner rather than later government will recognise the business potential of dagga for export and domestic use. Another couple of billion in tax revenue would be welcome right now. Dagga for medicinal use will require dispensaries and substance control regulations. There’s plenty here for accountants to get their teeth into.

SA may decide to follow the US and Canadian route by issuing cultivation licenses, which in themselves will become valuable. Accountants will be needed to convert what up to now has been an underground avocation into a legitimate and thriving enterprise. Businesses will have to be registered, feasibility studies prepared for investors, cash flows estimated, loans secured and repaid, management accounts prepared – in other words, all the typical services supplied by accountants to other types of business. This would include preparing yearend financial statements, complying with tax regulations and updates, and applying accounting conventions to the business of growing marijuana.

How to value a dagga business

For example, how should a marijuana-producing enterprise be valued? What are the projections for marijuana prices? Should goodwill be treated any differently than for any other type of business? Getting an understanding of the marijuana business could be a game changer for the early adopters in the accounting profession.

To get a sense of where this is leading, consider the experience of marijuana growers in the US. At present, marijuana may not be transported across state lines, so the product must be sold within state. But this prohibition will eventually disappear, allowing marijuana grown in California to be sold in New York – and vice versa. The end of prohibition will also eventually allow for the legal import of marijuana from low-cost producing countries such as Mexico and South America.

Durban poison

This is where South Africa could score big time. “Durban Poison” is revered by tokers the world over, and thousands of tons are reckoned to be exported to Europe each year. Perhaps government sees the opportunity and amends the law to accommodate trade in this new export crop.

Kris Kane, co-founder of 4Front, an investment and management firm involved in growing medical marijuana, points out in Forbes magazine that the current “green rush” has brought with it an intense focus on large-scale marijuana production. Cultivation licenses are limited, and have a high resale value. Some of these licenses have been re-sold for US$40 million, without a single leaf being grown. In Arizona, California and Oregon, some of the larger greenhouse farms extend to 23,000 square metres, the size of a decent shopping mall, capable of producing 22,000kgs of “flower”.

Marijuana is attracting big-time investors who see this as the next big thing. Kane cautions that they may be in for a fall. For one thing, the marijuana farms are getting bigger and more capital intensive, and that is driving down the price of flower.  By way of example, the wholesale cost per pound of cannabis in Colorado has fallen from US$3,500 when legalisation started in 2013 to the current price of US$1,012.

Prices will fall as supply ramps up

That’s not to say there are not huge opportunities in South Africa. Yes, as more dagga is grown, prices will fall. This will be offset to some extent by a steadily weakening rand (assuming the trends of a last 10 years continue). Skilled, professional growers can capitalise on SA’s worldwide reputation for excellent quality dagga, just as our wines are now revered around the world. Twenty years ago they were a novelty item. Just look at how the quality of SA wines have improved over that period. The same is likely to happen to our dagga crop.

Accountants very often specialise in certain sectors of the economy. Here is one begging for the kind of professionalism and insight that accountants are capable of bringing to an economy.

There’s no doubt many accountants may have a moral problem servicing a dagga business, just as some steer clear of clients involved in retailing alcohol, sex shops and gambling.

The risks

That said, what are some of the risks of having dagga growers and dispensers as your clients?

Exposure to potential criminality, for one. Secondly, making sure the client understands the scope of services. According to the American Institute of Certified Public Accountants (Aicpa), accountants should adhere to the standard client selection process. They should have an engagement letter that details what services are to be provided, what services will not be provided and how much those services will cost. The accountant should obtain a management representation letter in which the principals of the marijuana-related business clearly say that they understand state law requirements and that they intend to fully comply with those requirements at all times. The accountant should also document all work and communication with the client, even if the communication takes place in an informal setting.

“We also recommend that the CPA inquire as to whether the marijuana business has conducted criminal background checks of its employees, and, if so, review those checks to ensure there are no past drug or fraud convictions,” says Aicpa.

In time, South Africa – like many US states – could issue dagga growing licences which would open the door to large scale commercial growing operations. These licence conditions would have to be understood and adhered to. In time, the law may make a distinction between medical and recreational marijuana, and different licensing conditions could apply to each.

Provided accountants understand and apply the law, this could be one of the growth industries of the next decade.

Accountants specialising in cannabis

Watch this interview by NBC News with cannabis accountant Jim Marty. He started an accounting firm in 2013 solely to service companies that work in the legalised marijuana industry.

Training school for dagga entrepreneurs

The following video profiles another aspect of the cannabis industry: training entrepreneurs, growers and dispensers.