Speaking at a major cannabis conference in Toronto last month gave me a window into the current Canada-California cannabis connection that will likely prove useful in representing clients from both locations in the months ahead. The bottom line is, at the moment, the Canada and California cannabis industries can help each other in more ways than one.

Most know that in 2018 Canada became just the second nation to legalize commercial cannabis (Uruguay was the first). And, much has been written about Canadian investment funds seeking cannabis opportunities around the world, and especially in California, which is expected to be North America’s largest cannabis market by far.

Given this context, my colleague Karen Balderama and I traveled to Toronto to speak at the O’Cannabiz conference specifically to explain the due diligence steps that Canadian investors should undertake before deciding to put their money into a California cannabis company. We have represented both Canadian and U.S. companies on both sides of financing and M&A transactions. As a result, we have a good sense of the upsides and pitfalls.

We know that California companies need capital and that Canadians have it and are looking for deals. What we didn’t fully appreciate was the great extent to which Canada can use help from California (and other states and countries) to make their industry flourish. That’s mostly because product supply and advertising is so extraordinarily limited in Canada.

The restrictions are central to the origins of Canadian legalization, which Prime Minister Justin Trudeau promoted as a way to keep marijuana away from underage users and curb cannabis-related crime. Those goals were key to getting both houses of Parliament to approve legalization and have directly informed the national approach.

In years to come, Canada may loosen its tight regulations and the U.S. likely will modify or end the federal cannabis prohibition. That might decrease the need for cross-border collaboration. But for now, the Canadian and California cannabis industries can help each other out in big ways.

In light of that background, here are our top three takeaways about the current Canada-California cannabis connection.

1)  Canadian cannabis operators (as opposed to investors) who want to expand need open markets like California because Canada’s industry is so constrained. An example from Toronto makes this point. At 2.9 million, Toronto’s population is the largest in Canada. So far, Toronto has allowed five cannabis dispensaries. Oakland, California’s population is 425,000. Oakland has eight operating dispensaries and nine that are conditionally approved, according to the City’s website. While visiting Toronto, I observed lines at cannabis dispensaries measuring full city blocks. Toronto is not unique. Cannabis retail is constrained nationwide.

2)  Canadians are scouring the world (not just California) for opportunities. One conference session I attended was entitled Cannabis Deploys Stage 3: Global strategy in an Accelerating Market. Speakers at the session emphasized that in the near future cannabis companies will emerge that have an international reach, including in Europe, Central America and Asia. The recent news about the Canada pot giant Canopy Growth agreeing to purchase U.S.-based Acreage Holdings, fed into this narrative. “All of the large Canadian companies will have a presence in the U.S.,” said Hamish Sutherland, the President of White Sheep Corp., which focuses on international cannabinoid production. “It’s not a matter of ‘if,’ it’s ‘when.’” Speakers agreed that global cannabis companies would have a significant presence in California.

3)   California provides an opportunity for Canadian operators to create brand identities not available at home. Canada’s restrictive marketing rules mean that their cannabis packaging looks like the U.S. generic food labels from the 1980s. The labels are mostly black or white, except for a red stop sign sticker that includes a marijuana leaf and the letters “THC” and a bright yellow label warning that cannabis can be addictive. The limited branding is a manifestation of the original mission of limiting underage use, but it makes it very hard for entrepreneurs to differentiate their products from others.

In other words, effective product branding is not currently possible in Canada. In contrast, California’s history of a longstanding semi-legal cannabis industry has built-in cultural cache that is perpetuated by innovators creating some of the most clever and creative cannabis marketing in the world, which is generally allowed under state regulations (other than obvious attempts to attract children).

On October 17, Canada became only the second country in the world, after Uruguay, to legalize cannabis for recreational use. Canada’s brand new recreational market allows consumers to purchase, possess and/or share up to thirty grams of cannabis and grow up to four plants. Notably, edibles can only be made at home, and other manufactured products, such as concentrates are prohibited. However, the Canadian government expects to make edibles, concentrates and other manufactured products available for legal sale by this time in 2019.

Since 2001, Canada had limited legal cannabis use to medical purposes only. The 330,000 Canadians estimated to use medical cannabis will still be able to access their medicine through the parallel medical cannabis market under the control of Health Canada, the Canadian governmental department responsible for national public health.

Individual provinces and territories will have regulatory control over enforcement including minimum age requirements, personal possession limits, additional restrictions related to residential growing, where and how to purchase cannabis products and legal consumption locations. Currently, Ontario and Nunavut provinces are only permitting online sales via their government-operated online stores, while other provinces allow for private licensed stores, government operated stores, or both. Quebec and Alberta have opted to make the legal age of consumption eighteen to be in-line with their alcohol rules, while nineteen is the prevailing legal age in the rest of the country.

A big question Californians are asking is how will Canada’s legalized recreational cannabis industry impact the U.S. cannabis market? Most would agree that Canada’s nationwide legalization is a huge step forward for global acceptance of cannabis and will hopefully provide a workable model for legalization in more countries. But the competition it may represent is discouraging to some U.S. operators continuing to struggle with inconsistent federal policies, including banking limitations on the one hand, and large tax burdens on the other.

Many California cannabis companies, grappling with the high additional cost of state and local compliance are feeling vulnerable to competition and buyouts by well-capitalized Canadian enterprises. These fears are not entirely unfounded. The twelve largest Canadian cannabis companies, which are collectively valued at about $42 billion, are able to take on more traditional investors. An example is Constellation Brands’ massive investment in Canopy earlier in 2018. In contrast, many investors are still wary of pumping money into California companies facing the federal ban, high taxes and a slow, convoluted path to state and local licensing.

Canada, like California, foresees an on-going battle with a powerful and entrenched black market. Despite that, Canada is shaping up to be the global leader in cannabis capital and investments with an estimated 4.9 million Canadian cannabis users and a market expected to be about $5.6 billion.

There may be a significant tax break on the horizon for California’s growing legal cannabis market. A bi-partisan group of Assemblymembers introduced a bill (AB 3157) that will temporarily cut the state excise tax from 15% to 11% and eliminate the cultivation tax, which is currently $9.25 per ounce ($2.75 per ounce of cannabis leaf and $1.29 per ounce of fresh cannabis plant) until June 1, 2021. The bill is intended give the legal cannabis industry a chance for a strong start, encourage black and gray market cannabis operators to make the transition to the legal marketplace and prevent the black market from successfully competing with legally compliant tax-paying businesses.

AB 3157 will be welcome news to California’s cannabis entrepreneurs, many of whom are concerned about the ability of their businesses to survive under the heavy tax burden imposed by state and local governments, while simultaneously having to compete with a sophisticated and experienced black market. Assemblymember Rob Bonta (D-Oakland), a supporter of the bill, noted “California cannabis businesses are making significant investments as they embrace the regulated marketplace while, at the same time, being undercut by unregulated competitors.” Currently, California imposes an excise tax, cultivation tax, and sales tax, not to mention the license application fees, the general cost of complying with various state and local rules and regulations, and the usual corporate taxes. Local governments are also joining in and imposing significant cannabis taxes on local cannabis businesses, including sales taxes, cultivation taxes and other operation-specific taxes. On top of these state and local taxes, cannabis businesses are unable to deduct business expenses other than cost of goods sold (COGS) from their federal taxes due to 280E.

The Adult Use of Marijuana Act (AUMA) called for the regulation of cannabis to “reduce barriers to entry into the legal, regulated market,” and “tax the growth and sale of marijuana in a way that drives out the illicit market for marijuana and discourages use by minors and abuse.” The disproportionately high tax rate imposed on cannabis companies presents an incredibly high barrier to entry for a new or transitioning cannabis business. Additionally, the high prices that compliant cannabis businesses need to charge consumers in order to afford California rents and California taxes only encourage diversion, abuse and the growth of the black market. By temporarily relieving a portion of the heavy tax burden on cannabis companies while the industry gets its bearings, AB 3157’s supporters hope to reduce the disparity in price between the black market and the legal market for consumers and other operators along the supply chain.