By Rosalind Adams (The City)
Updated April 24, 2024 5:01 am
Link to original article: Click here to view. 

Last June, Gov. Kathy Hochul announced that a much anticipated deal had finally been reached to fund a $200 million public-private fund that would finance cannabis dispensaries run by the people who have been the most impacted by the war on drugs.

“Today’s announcement reinforces New York’s commitment to building partnerships that benefit New Yorkers and setting right the wrongs of the past,” Hochul said at the time.

But an investigation by THE CITY — based on a cache of documents including a near-final, 84-page draft of the agreement, internal agency emails and financial projections — reveals that New York state instead signed off on a lopsided deal that undermines its commitment to social equity goals while guaranteeing substantial returns to its partner, private equity firm Chicago Atlantic Group.

The state’s own Office of Cannabis Management later questioned whether the fund had overstated the potential revenue and profit potential, internal documents from the agency revealed.

State officials reached the agreement after they failed to attract a private equity partner to invest in the fund as planned. Instead, Chicago Atlantic will loan the fund $50 million at a 15% interest rate, all of it guaranteed by the state should retailers default, the terms reviewed by THE CITY reveal. The loan is further secured by the leases of the dispensaries as well as a $10 million pool of cash that the state is responsible for replenishing and which Chicago Atlantic can draw from in the case of late payments.

“The state is taking on all of the risk,” said Rachael Fauss, a senior policy advisor with Reinvent Albany, a government watchdog group. “The private entity here is the one benefiting the most, though the goal of public policy is to benefit the state and to benefit the dispensary owners.”

The governor’s office did not respond to detailed questions about the decision to approve the deal with Chicago Atlantic and the specifics of the agreement that guarantee the investment firm’s return on its loan.

“Governor Hochul is committed to strengthening New York’s legal cannabis market, protecting operators and consumers while supporting new entrepreneurs in this sector. The Office of Cannabis Management and DASNY [Dormitory Authority of the State of New York] will continue their efforts to set up the nation’s most equitable adult-use cannabis market,” said John Lindsey, a spokesperson for Hochul, in a statement.

THE CITY reviewed the terms of the agreement with a dozen lawyers and consultants with expertise in private lending and the cannabis industry, nearly all of them agreed that the terms of the deal were poor for the state and the licensees that some even likened the agreement to the junk bonds of the 1980s or distressed debt lending. The difference, however, is that those loans were not also guaranteed with taxpayer dollars.

“There’s no wiggle room for the borrower,” said Neil Kaufman, a cannabis and securities lawyer based in Long Island. “It’s tightly structured to protect the investor on the downside — which is exactly what you would expect for this type of speculative lending,” he said. “It bears a lot of resemblance to distressed debt lending.”

Both Chicago Atlantic and the New York Social Equity Cannabis Investment Fund disputed this characterization in statements provided to THE CITY.

“The interest rates offered by the Fund are far below the rates typically available to start-ups, let alone start-ups in the cannabis industry,” said a statement from the social equity fund, describing the loans as offering “borrower-friendly terms that are virtually unheard of in the private debt market.”

“The terms are not akin to distressed debt or junk bonds, but standard in commercial lending. These terms compare well to the non-cannabis lending market for start-up businesses and are, to the best of our knowledge, unmatched in the market for cannabis debt financing,” said Alise Edgcomb, the managing director of public relations for Chicago Atlantic in a statement.

The correspondence reviewed by THE CITY reflects concerns over financial projections shown to licensees considering taking a loan from the fund that included extremely optimistic projections about how much their stores would earn. Previously, THE CITY revealed how licensees who accept loans from the social equity fund are burdened with high construction costs that they don’t control and with interest rates that exceed the state’s initial estimates.

“Everyone is worried about defaulting because of the rules and regulations of this loan,” said Roland Conner, a Queens native who runs the legal cannabis dispensary Smacked on Bleecker Street in Greenwich Village who previously has been supportive of the state program.

A papered-over storefront of a one-time women’s health club on Steinway Street in Astoria, Queens, is visible evidence of the troubled rollout. The expansive space was leased by the fund from a landlord, built out by an approved contractor at a price of $1.6 million dollars, and offered to a retail licensee, Keith Dalessio, who owns a pet store down the block. Dalessio ran the numbers, decided the loan didn’t come close to adding up, and, after some agonizing, walked away.

High Hopes

The $200 million public-private social equity fund was touted by Hochul as the cannabis program kicked off. She allocated $50 million for the fund in her 2022 budget proposal, and signed legislation that specified the fund would finance the construction costs of dispensaries for retail licensees who had been most affected by the war on drugs.

The legislation charged the state’s Dormitory Authority, which finances public construction projects like hospitals and dorms, with finding private fund managers for what was named the New York Social Equity Cannabis Investment Fund. The Dormitory Authority was tasked with working with the fund to identify retail locations and supervise the construction of the dispensaries. A newly-established Office of Cannabis Management, in charge of licensing and regulation, would work with the Dormitory Authority and the social equity fund to support the launch of the dispensaries.

The state aimed to match licensees with ready-to-open dispensaries, built out and designed by state contractors using financing from the social equity investment fund. The fund would in turn offer loans to the licensees that they could pay back over 10 years to cover the related costs.

From its conception, sources told THE CITY they had warned state officials that the premise of the social equity fund was flawed. Cannabis is a risky investment. Since the industry is federally illegal, business owners are barred from deducting their expenses when filing taxes. That drives up costs and eats away at profit margins. Access to capital for any cannabis venture is difficult to obtain, let alone for a class of licensees most impacted by the state’s drug laws launching start-up businesses in a new market.

“The original plan of the social equity fund was just uninvestable. No one was going to give them any money,” said Kaufman, the cannabis and securities lawyer. “I told them from the beginning it was a bad idea.”

The fund forged ahead anyway.

In May 2022, the Dormitory Authority chose a company led by the former New York City comptroller William Thompson; Lavetta Willis, a former sneaker entrepreneur; and the former NBA star Chris Webber to run the cannabis investment fund. It was set up as a private company, with the state Dormitory Authority as a minority partner.

The state estimated that fund managers would be able to attract $150 million in private capital by the end of that summer. The deadline came and went. In September, Reuben McDaniel, the president of the Dormitory Authority, remained optimistic that the fund would open as many as 20 stores by the end of the year, he told the board. That didn’t happen either.

In January 2023, the first fund-supported dispensary, Smacked, opened a temporary pop-up dispensary on Bleecker Street to begin generating sales. Run by Conner, who had been busted for selling weed as a teen, Smacked became a symbol of the hopes attached to the social equity plan.

“I’m grateful for the opportunity to open a business with my son and wife at my side and build generational wealth, working together, right here in New York,” Conner said in a statement at the time.

But a year after Hochul announced the fund, it still had not secured a private partner, despite McDaniel and the fund’s efforts. Through a public records request, THE CITY obtained a copy of five months of McDaniel’s calendar beginning in January 2023 which delineate months of daily meetings with the social equity fund managers.

Beginning last January, McDaniel and Willis met with four possible partners before sitting down with Chicago Atlantic Group. By March, the pace of meetings between McDaniel, Willis and Peter Sack, a fund manager at Chicago Atlantic, began to accelerate.

‘You Guys Are Robbing Me’

In January 2023, the fund held a three day information session with the licensees about what to expect and the Dormitory Authority posted frequently asked questions about the fund. Officials told them at the time that interest rates would likely be 10% and the loans to cover the design, construction and fees would range from $800,000 to $1.1 million, according to a report of the meeting.

Dalessio, from Astoria, was among the first people to be awarded a retail license designated for people impacted by past drug convictions. In January, he was elated when he learned that he had been chosen to operate one of the fund’s first sites on Steinway Street.

But in March, he learned the estimated cost of the build out for the 4,500 square foot retail space was $1.6 million, an invoice shows — much higher than state officials originally projected.

“I told them they were out of their minds,” Dalessio told THE CITY in an interview, recalling his reaction when he saw the invoice. “I know you guys are robbing me.”

Negotiations were still ongoing between the social equity fund and Chicago Atlantic to secure the rest of the financing. Until the deal was complete, the fund didn’t know what terms they could offer Dalessio and other the licensees on their own loans.

The fund chose Grow American Builders to construct Dalessio’s Steinway Street location, one of the 10 firms the Dormitory Authority chose after posting a request for proposals to design and build out the fund-supported dispensaries.

The authority’s request differed from a typical state project bidding process where contractors are awarded a contract for government work based on a proposal and estimated costs. Instead, the state did not seek specifics from the firms of how much a dispensary build out might cost — they only had to show the financial viability of their companies. The fund decided how to allocate the firms to each dispensary site based on their locations.

After the build out of the Steinway Street site was done, Dalessio learned that Grow America Builders had subcontracted the work to a local company. He was shocked to learn of the cost difference between the two jobs. The subcontractor shared a project proposal with him which THE CITY reviewed showing the costs of the work came to about $250,000 — less than a sixth of what Grow America Builders planned to charge Dalessio.

The build out itself is not the only cost that makes up the loan. According to a breakdown of a loan dated March 2024 and obtained by THE CITY of another dispensary site, the construction and design costs came to about $1.7 million but with additional fees and other expenses, the total loan came to $2.1 million — about double the high end of the range that the Dormitory Authority and the fund had told licensees to expect back in January 2023.

When reached by phone, the local subcontractor of the Astoria dispensary confirmed he completed work at the location but said he could not discuss specifics.

David Fettner, one of the owners of Grow America Builders, told THE CITY that he had signed a nondisclosure agreement and could not discuss the costs of the build out.

‘Fantasy Projections’

As the Dormitory Authority and the social equity fund continued their meetings in 2023 with Chicago Atlantic to hammer out an agreement, the fund also started to share with the licensees revenue projections that had been developed by Sean Kennedy of Palomino Consulting.

THE CITY reviewed copies of the financial projections for multiple Manhattan dispensary sites that were shown to licensees, including Smacked on Bleecker Street. Each of them showed identical sales revenue, predicting about $13 million for the first year, rising steadily to nearly $30 million in year four. When the cost of the monthly loan, rent and other expenses were considered against those sales projections, the models showed that the stores would post huge profits from year one.

The Palomino figures were beyond ambitious. A dispensary making nearly $30 million in a year would place it among the country’s top performing cannabis stores. The projections showed revenues climbing every year without factoring in how the market might develop over time, amid developments like increased competition that could depress prices.

The city’s Independent Budget Office, by comparison, predicted the average legal dispensary in New York City will make about $8 million in sales annually, according to a report last August.

In an interview, Kennedy, who runs Palomino Consulting, told THE CITY that the figures were based on data from his own cannabis business in Nevada. When asked if his stores made $30 million, Kennedy said that he was party to a non-disclosure agreement and couldn’t discuss it. And when pressed on how the numbers were generated for New York dispensaries, Kennedy said that it represented the top end of the range of what a store could make and some would fall below that.

“It’s a general model. It’s more of a way to analyze risks so that you can make money,” said Kennedy, who denied that the estimates of sales revenues on the documents offered any sort of projections.

“The reality is, we don’t know what numbers the stores will do,” Kennedy said, noting that there are a lot of different variables that impact revenues. “You can try and model them but I think what we’re trying to do is create something that’s easily understood.”

In a statement to THE CITY, the New York Social Equity Cannabis Investment Fund echoed this, describing the document Kennedy produced as a “general framework and a teaching tool, not meant to predict any individual store’s actual performance.”

The statement added “it assumed a scalable retail revenue range based on experience in other limited license markets.”

Mentors advising hopeful licensees grew concerned when licensees shared the projections with them and alerted the Office of Cannabis Management, emails obtained by THE CITY show. The projections set off alarm bells inside the agency, according to records and interviews with current and former agency employees.

“The Fund is materially overstating the potential revenue and profitability potential of the Fund’s flagship locations,” an internal OCM assessment of the social equity fund’s projections asserts.

The internal document pointed out that only 20 to 30 stores nationally pull in $30 million in annual sales. Smacked, the first fund-supported dispensary, was on track to make $5 million in 2023, and two other fund-supported dispensaries, Dazed, in Manhattan, and William Jane, in Ithaca, were on track for less than $5 million in sales.

The Office of Cannabis Management was concerned that by using the Palomino figures store owners would take on the expensive build outs and high monthly rents and be unwittingly headed to defaults, the document said.

And that, the document stated, could leave the state in a position where it had “to backstop potential losses on the loan, bail out licensees in locations that are extremely difficult to run profitably, or assume payments for vacant properties from which licensees have been removed.”

“What it looks like is that the fund baited people into believing a fantasy,” said David Feder, a cannabis lawyer in New York.

Looking Under the Hood

A year and a half after Hochul first announced the social equity fund, licensees began to lose patience. In May 2023, some of them sent a grievance letter to state officials expressing their frustration with the lack of information available about the loan terms, the high quotes for the build out costs and the pricey rents at the only options for locations.

At the end of that month, officials of the Dormitory Authority and the social equity fund reached a tentative deal that would allow Chicago Atlantic to come in through a loan agreement rather than as an equity partner.

“The state was desperate, they took the deal that they could get,” said Jeffrey Hoffman, a cannabis lawyer who represents licensees with fund-supported sites. He added that a deal was still better than no deal, especially for licensees with so few or even no other financing options.

The details of the agreement remained secret until now, with the state, the Dormitory Authority, and the Office of Cannabis Management declining Freedom of Information Law requests from THE CITY. The state even denied to THE CITY that it had a copy of the agreement. It also said the information law did not apply because the fund — which was founded by the state and counts the Dormitory Authority as a minority partner — is not a public entity.

The state comptroller’s office, which oversees contracts and state spending and has the authority to review the fund’s books, said it had never reviewed any documents related to the deal. Sen. Jeremy Cooney (D-Rochester), the chair of the Senate cannabis subcommittee, also said that he had never reviewed the documents and was not made aware of the terms.

“As with every step in our state’s cannabis rollout, our applicants deserve transparency,” Cooney said in a statement to THE CITY.

According to the draft document obtained by THE CITY, the agreement outlined a strict repayment schedule — payments more than five days late could trigger a default. Notably, the agreement requires that the fund create a $10-million reserve fund that Chicago Atlantic may draw from to cover any late payments.

A two-page draft addendum to the loan agreement titled “Re: Funding of Payment Reserve” signed by McDaniel and Thompson outlines that the payment reserve will be replenished by the Dormitory Authority and or other sources such as the Division of the Budget.

Then, along with the state guarantee on Chicago Atlantic’s $50 million, and its 15% interest rate, came the provision further securing its loans through the dispensary leases themselves. Since it’s difficult to find locations that meet the state regulations for cannabis dispensary locations, industry experts said, there is a particular bonus to Chicago Atlantic in having the right to foreclose on those sites.

Finally, the firm committed $100 million to develop properties and lease them to the fund, Peter Sack, a partner of Chicago Atlantic, said in an interview with THE CITY. Just like the current leases the fund is signing, a license holder will be a tenant and then reimburse the fund for the cost of the improvements over time. He added the firm has not yet begun this part of the financing deal.

All together, the terms of the agreement add up to a particularly good deal for Chicago Atlantic, according to people who reviewed the documents for THE CITY.

“It’s a handout to private equity,” said Eli Northrup, a lawyer for the Bronx Defenders and Director of The Bronx Cannabis Hub, which advises people applying for licenses. He is running for office for a State Assembly district in Manhattan.

“The state essentially wrote a blank check to a firm that will profit off of people who were previously exploited and who were already struggling.”

Although the leases are part of the collateral for the loan, Chicago Atlantic denied that it had any intention of entering the New York market and said it’s invested in the success of the licensees.

When officials from the Office of Cannabis Management reviewed a draft of the loan agreement in early June, they raised concerns about how heavily the deal favored Chicago Atlantic, according to internal emails. The terms of the loan along with the inflated financial projections only increased their concerns of licensees defaulting.

So far, the social equity fund has signed 24 leases — far short of the 150 that the state anticipated when the fund was announced. So far, eleven have opened.

The financial pressures of the loans are already starting to mount, according to interviews with the dispensary owners of the fund-supported stores. Multiple operators, including Conner, told THE CITY that they were concerned about defaulting on their loans with the fund.

In February, Dalessio finally decided not to accept the Steinway Street location within hailing distance of his pet shop. After a year of back and forth with the fund, he backed away from the deal, the terms of the loan and high building costs looming large.

“It just left such a bad taste in my mouth,” he said, referring to the fund’s loan program. “I warned everyone I could to stay away from this deal.”