Imagine you’re an entrepreneur and someone tells you that the future of your business depends on whether or not someone picks a plastic ball with your name on it out of a lottery machine. Sounds crazy, right? Not in the marijuana industry!

Both Arizona and Washington use some kind of lottery system to award marijuana licenses to businesses, and Guam might use a lottery system in the future. In addition, some states allow municipalities to approve or ban some types of marijuana-related businesses from operating within their borders. These municipalities grant their own licenses to marijuana businesses, and some of them, like Long Beach and Santa Ana in California, use lottery systems, too.

I remember when I was in college, and there was a lottery system used to pick dorm rooms for my sophomore year. I didn’t like it at the time. Of course, I might be biased because I was one of the last 10 unlucky people to see their names drawn out of the lottery machine. However, in hindsight, it makes sense. How else do you rank who gets to choose a dorm room first if all other factors are equal? It was the fair way to do it.

Fast forward to today, and I’m watching the lotteries for marijuana licenses that are happening in different parts of the country. In the marijuana industry, all other factors are not equal. As an entrepreneur, I don’t like it.

Let’s take a closer look at what’s happening.

The Licensing Process When the Number of Marijuana Licenses is Restricted

Many states restrict the number of licenses granted to dispensaries, cultivators, processors, and testing labs. Some restrict the number of all of these license types while others only restrict the number of specific types of licenses – most often the number of dispensary licenses. States use one of three different processes to grant those licenses: competitive, lottery, or qualified lottery.

Competitive

With the competitive licensing process, marijuana businesses submit applications (with application fees) that are rated based on quality in a variety of areas such as proof of capitalization, inventory control plan, operations plan, detailed policies and procedures, security plan, criminal record, and local support. Every application is rated using the same criteria, and applicants with the highest scores are granted licenses. Yes, there can be problems with how applications are rated as we recently saw in Pennsylvania and Florida, but this is still the process used by most states that have approved medical and/or recreational marijuana.

Lottery

In the lottery process used in Arizona and likely Guam in the future, marijuana businesses submit applications with their application fees. All applications that meet the minimum requirements (e.g., they don’t violate the required buffer zone between the business and a school) are put into a lottery. Winners are picked at random with little or no consideration of qualifications. Those winners receive licenses.

Qualified Lottery

A qualified lottery works like a regular lottery where qualifying applications are chosen at random and those applicants receive licenses. However, the qualifying criteria is much more specific and strict than in a regular lottery. Typically, applicants have to meet high standards to make it into the lottery. Washington State uses a qualified lottery system, which is a hybrid between the competitive and lottery processes.

The Problem with Marijuana License Processes

Aside from the obvious problem of the most qualified businesses not always getting licenses when lotteries are used, there is also the problem of awarding licenses based on luck rather than merit. With a lottery, you’re getting a business that meets minimum qualifications rather than one that you’re certain did the most planning to build what can become a sustainable business.

Consider this – seven months after 20 marijuana license applicants were granted dispensary licenses by lottery in Santa Ana, California, only two of those dispensaries had opened. Would the story be different if a competitive application process was used?

However, the competitive process isn’t perfect either. Ratings are subjective and sometimes, applicants gather large sums of money and political favors to increase their chances of securing licenses. It’s far from a perfect system, and it’s wrought with lawsuits. Of course, the lottery process isn’t immune to lawsuits either.

In a young, growing industry, being first to market (or early to market) presents a significant advantage. Yes, most states that restrict the number of marijuana licenses will probably add more licenses in the future giving more businesses a chance to enter the industry, but for now, a restricted number of licenses means an oligopoly is forming in many states.

This is in stark contrast to states that do not restrict the number of marijuana licenses. For example, Colorado doesn’t restrict the number of licenses and has granted hundreds of them. Ultimately, the market will decide which businesses will last in Colorado.

Think of it this way. In Connecticut, there are nine dispensary marijuana licenses per 400,000 residents. In Colorado, there are 528 dispensary marijuana licenses per 10,416 residents. Yes, the Colorado market is more mature and residents voted to legalize recreational marijuana last year while only medical marijuana is legal in Connecticut. Naturally, Colorado has more dispensaries at this time. However, the question is this. In which state will the free market decide which businesses make it? If you answered “Colorado,” you’re right.