Lottery for licenses: good or bad for social equity

Although New York has become the 15th US state to legalize recreational cannabis as of March 2021, independent state agencies have just begun to issue the regulations for issuing licenses to produce or sell cannabis.

One of the regulations anticipated by many who want to join the industry is how the state agency will distribute the licenses.

As New York's Marihuana Regulation and Taxation Act (MRTA) aims to issue 50% of licenses to social equity applicants—defined as people that belong to minority groups affected by the War on Drugs, women, disadvantaged farmers, and disabled veterans—many are wondering what procedure will be used to issue licenses.

This is a crucial point of the legislation, as it will help determine the feasibility of the implementation of the MRTA regarding its social equity goals.

Most US states that have legalized cannabis before New York have awarded licenses to cannabis businesses through a competitive licensing process. This method consists of submitting applications that are rated on the basis of several criteria, including proof of capitalization and an inventory control plan, an operations plan, and a security plan. Only applicants with the highest scores are granted licenses using this process.

However, other states such as Illinois, Connecticut, and Washington have adopted a cannabis lottery system for both medical and recreational cannabis licenses.

In the lottery process, cannabis businesses submit applications and are subject to paying fees. All eligible applications are put into a lottery. Winners are picked at random with little to no consideration of their qualifications. Those winners then receive licenses.

Some other states use a qualified lottery, where qualifying applications are chosen randomly and receive licenses. Unlike a regular lottery, the criteria used in the qualified lottery are rigorous. Applicants must meet high standards to make it into the lottery.

As cannabis has shown to be a profitable industry, competition is high. Therefore, many states restrict the number of licenses granted to supply chain operators, including dispensaries, cultivators, processors, and testing labs.

However, the lottery process may not always be the best option for the social equity goals of state legislation on cannabis. Any effect on equity would depend on how the lottery system is designed, how the criteria is adopted, how many lotteries will be held, and how many licenses will be issued in each one.

Illinois was the first state to establish an ad hoc lottery for social equity applicants when the legislation came into force in 2020. However, there has been a lack of social equity dispensaries and multiple lawsuits 2 years after the start of the process.

In the summer of 2020, California replaced the first-come, first-served process with a lottery system in which applicants could secure their property after they’d been selected. This change was beneficial for a number of social equity applicants, as they could then have the reassurance of a guaranteed license before starting to invest.

Arizona, which legalized cannabis in 2021, launched a "social equity ownership" program as a form of reparations to communities that harsh cannabis enforcement laws had disproportionately and excessively harmed. However, according to investigations made by local news outlets, at least 58% of the applications submitted to the state had ties to industry money or major investors. They were backed by established multistate operators who already had Arizona dispensary licenses.

Similar scenarios happened in other legal cannabis states that have opted to use a lottery as a process to distribute licenses. Other states are currently planning to hold new ones.

The lottery system as a social equity program may not work for all the states, as there may be loopholes to taking advantage of it.

As New York's industry is expected to generate over $4 billion by 2026, the competition to obtain a license will be embittered. Amid the spark of competitors who will be vying to get their slice, social equity applicants might be frozen out.

Regarding the type of licensee, social equity applicants seem to apply for microbusiness licenses more often, as that is the most cost-effective option for them, although there are limits on cultivation and sales. Furthermore, according to the MRTA, microbusinesses can only sell the products they make; they cannot sell anyone else's products. This would mean that smaller operators can't create a cooperative network to work with each other. Furthermore, larger operators and investors may not be incentivized to work with microbusinesses in such conditions.