Starting a Cannabis Testing Lab

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Overview

Canna Lab Lady at Microscope.jpg
In 2019, the cannabis industry finds itself unquestionably maturing from the wild and unregulated initial frontier stage of new, uncharted territory, into a more clearly-defined, valid business ecosystem. Just a few searches on business-related social media like LinkedIn or LIMSforum will attest to the great number of various industry-related services, products and organizations. And although testing has yet to become mandatory in every state with cannabis laws on the books, the trend is definitely moving in that direction, for both medicinal and recreational products.[1] There are more than 200 cannabis testing labs across the US currently[2], offering services that range from extraction only, to full analysis (either production QA/QC or commercial), to research. However, it is clear that more will be required as various valid medicinal properties are documented and general usage proliferates.[3]

So the question many lab professionals, investors and entrepreneurs are beginning to ask is "what's the best way to get started in cannabis testing?".

Creating a Cannabis Testing Startup Lab

Before you do anything, the best approach is to take a close look at the industry, its players and how you see your lab fitting in. Do you want to test only medicinal cannabis? Recreational? Both? Extraction only? Who are your customers? Can they afford to pay for the testing you want to provide? What are the state regulations (or national in Canada or Uruguay)? Are changes to regulations coming soon? How much will a certification like ISO 17025 help? The answers to these sorts of questions will help you to decide whether this is something you really want to do, and begin to visualize it, while providing ideas to include in the "strategic considerations" section of your business plan.

Business Plan

As with any business proposition, it is important to create a business plan that outlines your goals and how you intend to reach them, and what the ongoing business operations are intended to look like. Business plans are commonly viewed as a means to acquire a loan or investment, but even if you have all the capital you need, it can still be useful. Constructing a business plan provides a valuable opportunity to clarify everything in your own mind, and allows you to think through every aspect, visualizing as you go before approaching others for investment or any other kinds of participation. And it can continue to be useful for the life of your business, helping you stay on track. You can also update it as you learn and gain experience, creating an improved guide to your business. Templates to help you begin are available for free from a number of sources, including the U.S. Small Business Association, along with guidance in completing them as well as navigating the entire startup process.

Here are some standard components of a business plan:

  • Executive summary
  • General company description
  • Products and services
  • Strategic considerations
  • Marketing plan
  • Operational plan
  • Management and organizational structure
  • Personal financial statement
  • Startup expenses and capitalization
  • Financial plan

Executive summary

This is where you lay out your whole vision, in simple, clear terms. Some advise you to wait and make this the last section you complete so that you have a clearer understanding of the whole picture. For most of us, though, it's helpful to go ahead and add here the vision as you understand it first. You can read it back and ask yourself if it still sounds like a genuinely good idea. And if it does, then once you have finished all of the other sections, you will in all probability still want to circle back and tweak this one, based on any epiphanies or aspects of the plan that perhaps you hadn't fully thought through initially. If you're looking for funds or other support, then this is the place to describe that effort, as many who you approach may only really read this section, at least initially, to determine whether it's worth reading further.

General company description

What will your lab and overall business look like? This section lets you communicate what you see your lab/business as representing. A mission statement, philosophy, goals, values: these really define the "soul" of the company, and you can set these out here. Additionally, a fuller description of the industry and your place in it, how it all works organically, what you bring to the table and how you see it all progressing over time all combine to give the reader—and you—a more gut-level understanding of just what your proposed lab is all about. You should also include the legal forms it will take, e.g., LLC, corporation, sole proprietorship, etc.

Products and services

Canna Lab Pic Facing Left.png
This section describes the core of your lab. What testing will you provide, in what manner and for whom?

Cannabis analysis has pretty much distilled into some well-defined standard sets of tests and processes (see the chapter on The LabLynx Cannabis Solution), with appropriate instruments and methods. These range from potency testing (with accuracy tolerances mandated in some cases by the state) and terpenoid/balance analysis that validates product types, to pesticide, residuals and mold/fungus testing. In most cases, the entire range will probably need to be tested, since potency and safety are important aspects whether the product is medicinal or recreational. Increasingly, the most successful testing labs are the ones who can effectively guarantee those factors and deliver that certificate of analysis (COA) at the most competitive price and speediest turnaround, all while presenting a friendly and attractive, yet business-like and authoritative customer-facing image.

Customer-facing web portals are becoming the standard, and pickup and delivery of samples is another area that is attractive to customers, especially as most markets are no bigger than statewide, with many based at the municipal level. But as laws change, it would be well to keep an eye on scalability.

Another point to note is diversification. The lab that is equipped to test cannabis is equipped to test other things as well, so why limit yourself? Even though you may position yourself as a cannabis lab primarily, there is risk reduction in offering your services in other areas as well. For example, many of the tests involved in cannabis testing (pesticides, mold/fungus, microbiology) are also common in food testing. Why not branch out and invite other types of customers as well? Of course there is overlap already, obviously in the area of edibles. But the more diversification you can provide, the more built-in protection you have against market forces—as long as the cost in time, effort and expense of those additional services doesn't outweigh the benefits.

Coupled with the idea of diversification is the choice of data management solution. There are, for instance, some cheap or even free cannabis LIMS available. But now that specific and rigorously-enforced regulations inevitably accompany legalization, labs are unwilling to risk their sizable investment on anything less than a fully-compliant solution. It may also be wise to select something that is flexible and easy to modify as those regulations and standards - and demands of the industry itself - change as the cannabis industry continues to evolve and mature (see LIMS for Cannabis Testing).

Strategic considerations

It's all well and good to decide that you want to deliver analytical lab services to the cannabis industry, but there's more to consider if you want to be truly successful. This section is where you identify and address important elements of your strategy to succeed. Ask yourself questions like:

  • What will my competitive advantages be?
  • What relationships or potential partnerships should I consider? Growers, dispensaries, collection/delivery services, extraction labs, subcontract labs...
  • Where should I locate my lab?
  • What kind of volume am I looking at?
  • Are there existing competitors? How are they doing? Can I learn from them?
  • What is the regulatory landscape and how is it likely to change?

The answers to these and similar questions can prepare you for the realities of the operation you will encounter. Martin Zwilling, experienced entrepreneur and investor, in his advice to those planning startups:

Accept uncertainty as the norm. You will never remove all uncertainties, so accept them, and plan your activities in an incremental fashion. Too often, a business plan is seen as a mechanism for eliminating uncertainty, lulling the founder into complacency. Eliminate major uncertainties before the plan and update any plan as you learn.[4]

Marketing plan

Marketing - girl-iphone-social-media facing right.jpg
Your marketing plan includes two key elements: research and dissemination.

You're already making a good start to your marketing plan research by reading this book. Marketing research falls into two categories: primary and secondary. While this and other resources like industry magazines, groups and communities (like you will find at Limsforum.com/sciCloud.net®) and blogs can provide great insight and information about the industry, you should also do your own primary research. Meet with people in the industry, talk to competitors, potential customers, producers, and industry advocates. Check with those who failed or moved to other markets; what happened? What are the economics of the industry, e.g., size of the market, your predicted share, trends, growth, etc.? Is there a genuine opportunity, a need for what you will provide? Who are your competitors? Will your pricing be competitive?

Next, devise your marketing strategies to get the word out about your products/services, and to keep them in the spotlight. That includes how much of your overall budget you need to apportion, and whether you are willing to accept that. But also, it includes strategic thinking so that your investment yields the most effective results in the most efficient manner. It also includes communicating your particular qualities that comprise your uniqueness and competitive edge.

Today's marketing strategies are heavily internet-based, which can allow huge bang-for-buck results that were unimaginable in yesterday's traditional advertising models. But no matter how technology advances the options in this area, there is never a substitute for the power of positive word-of-mouth. Indeed, successful sites such as Amazon and eBay, and many others, recognize this fact very well, providing customer star ratings and feedback for all of their products. That is the modern-day "tech-ed up" version of word-of-mouth, and the traditional value of it still applies. Building a good reputation is a long, hard process. Tearing it down is easy and quick. That is a place where your core values and principles, as expressed in the "general company description" section, have a real impact, along with your actual performance. But the old-fashioned satisfied customer who speaks well of you to others is still one of your most precious assets.

Operational plan

Now it's nuts and bolts time. This is where the dream meets reality from an operational standpoint. You need to outline exactly how things will work on a daily basis, from receiving to reporting, what software, hardware, processes, staff and other resources are involved and how, with specifications and detailed descriptions. Some points to include:

  • Testing techniques and costs
    • Instruments and equipment
    • Stocks, standards and reagents
    • Submission process
    • Testing processes
    • Reporting processes
  • Quality control
  • Customer service
  • Location
  • Legal requirements
    • Licensing and bonding
    • Permits
    • Health, workplace, or environmental regulations
    • State, local and any applicable federal regulations specifically regarding cannabis
    • Zoning or building code requirements
    • Insurance coverage
    • Trademarks, copyrights, or patents (pending, existing, or purchased; note: until federal laws change, cannabis-related brands cannot be trademarked)
  • Staff
    • Number of employees
    • Type of labor: Skilled/unskilled/professional? Contracted? Full-time?
    • Where and how will you find the right employees?
    • Quality of existing staff
    • Pay structure
    • Training methods and requirements
    • Employee roles
    • Written job descriptions
    • Written standard operating procedures (SOPs)
  • Inventory
    • Operating levels
    • Stocks, standards and reagents suppliers
    • Credit and delivery policies
    • Managing storage conditions and expiration
    • Software application (often available as part of LIMS functionality; see The LabLynx Cannabis Solution)
  • Administrative functions
    • Outsourced? Onsite? Full-time/part-time? DIY?
  • Financial management
    • Credit policy (E.g., if you accept credit, what is the mechanism?)
    • Accounts receivable: Net, aging tracking, collection policies
    • Accounts payable: Recurring, one-time, aging, discounts
    • Billing service or software?
      Canna Potency Test Prep.jpg
  • Data Management: What software applications will you use? Will you need an IT infrastructure or go cloud? You'll want to make sure your LIMS is suited for the cannabis testing you'll do, e.g., The LabLynx Cannabis Solution.
  • Non-testing equipment: What hardware, workstation computers, telephone system, furniture and other fixtures will you use and how?

Another aspect of your operational plan is the design/layout of the premises. This is important, because you will presumably be contending with it for a long time. You'll want to keep some things in mind with your work space. First, make sure you set up zones that make sense so that all of the processes for each type of testing can be done largely within a single zone. Or, if not that, consider keeping all weighing, labeling and other prep in one zone, all gas chromatography testing in another, etc., but arranged so that the process flow is supported. And give workers sufficient access to instruments or workspaces. Keep commonly used large equipment away from heavy traffic areas but easily accessible.

Second, you'll want to focus on cleanliness and safety. Keep any messy or hazardous areas away from main traffic areas, and keep critical areas such as lab surfaces and sinks clean. You'll also want to keep biosafety (if you are doing microbiology, for instance) and good laboratory practice (GLP) in mind.[5] Lab entry should be restricted to authorized personnel to minimize risk. There should be more than one exit from the lab in case of emergencies. Install fire extinguishers, fire blankets, emergency showers (with an easy to reach handle), and keep safety gloves in-stock.

Management and organizational structure

You'll have to decide whether you intend to spend your time managing or performing analyses, or even concentrating more on promotion, marketing and connecting with others in the industry. Or maybe you prefer to do some of all of it, with people already in those designated roles so that you pop in randomly just to ensure things are running as they should. Whatever your intended role and organizational setup, you'll need to specify it all here. If you will have more than about 10 staff, it's a good idea to draw up a hierarchical flowchart-style organizational diagram to make it clear how decision-making and task flows take place.

Example organizational chart

If you plan on having any advisers, consultants or board members, then add those plans to this section, including attorneys, accountants, insurance agent, banker and mentors.

Personal financial statement

What you and any partners, stockholders or investors bring to the table is presented here, shown in balance sheet format that lists both assets and liabilities. This need not be made available to everyone who sees the plan. It can be on an "available upon request" basis for only those parties for whom it is a necessary component (bank, additional investors). A high-level view of this is, however, part of your executive summary.

Startup expenses and required capital

Obviously, starting any laboratory requires capital, in the form of premises, equipment, qualified staff and/or the money to acquire them. Your personal financial statement brings into focus what you are able to invest in the project. This section catalogs every facet of your startup costs, from any licensing, legal fees, etc. to your instruments, property costs, stocks and the like, down to the last sample container. As you may imagine, getting this right is one of the more critical—and expensive—parts of your business plan.

You are the best judge of what equipment and stock you will need, based on your own experience and training. Getting used equipment where possible can save some expense, as long as it's in good condition and is likely to last until you are able to upgrade. You can use the "operational plan" section to help you list the items you'll need to make that happen. You may need to categorize as "essential" vs "nice to have". Even the essentials can be phased in to ease up cost flow, as you can start out doing limited testing and expand as income allows.[6]

Traditionally, it is more costly for a startup lab to lease commercial space with existing lab facilities than it is to establish a lab in an incubator facility.[7]

As for "required capital", include operating expenses for the first year or reasonable period while income is uncertain, with enough reserve to cover any issues arising. These can be derived from the projections in your financial plan.

Some tips from others who have gone through the lab startup process:

  • Safety glasses can vary wildly in price, from around $2 to around $11 or more.
  • Use less precise balances where tolerances aren't as critical, and save the more accurate one(s) for processes where it matters.
  • It's much better to buy tools and routine equipment (e.g., duct tape) at a hardware store than through science vendors.
  • Buy in bulk and buy early. Delays happen.
  • Some used equipment can be a great bargain. Pharma is hemorrhaging stuff that works. Maybe avoid the used LC/MS, but perfectly good rotary evaporators, vacuum ovens, centrifuges, fraction collectors, etc. Check out the surplus lab supply companies and call them directly with your wishlist. They have warehouses full of stuff that may or may not be on their websites.
  • Ultrasonic cleaners can be found for about a third of the usual price if you buy them from jewelers supply companies.
  • Ask for discounts. They are more available than you think, and can be 30 to 40%.
  • Check surplus outlets.
  • Look out for labs that are closing down.
  • eBay, restaurant supply companies (stainless steel ware, etc.) and other non-lab sources can save you money on the same items you may use in your lab.
  • labx.com, dovebid (www.go-dove.com - not so much for used analytical instruments, they can be difficult to get running again) and the LIMSforum Marketplace (https://www.limsforum.com/marketplace/lab-supplies/) are resources for both new and used items.
  • Watch out for auction houses' fees, and remember you will have to pick up/ship.
  • Always buy service contracts for big items.[8][9]

Financial plan

Creating a realistic financial plan with accurate data (where they are known) and sticking to its budget (or less) is crucial for your project to be successful. Even then, unforeseen economic or business factors may emerge and threaten its fulfillment.

Some elements of a good financial plan include:

  • Important assumptions: Current interest rates and sensible predictions of their likely changes over time, tax rate projections, market and other business factor projections, etc. all need to be considered and factored in as assumptions that impact the projected financial performance of your lab.

Example of a Rates Prediction Table

Business Plan - General Assumptions Table.png


A Break-Even Analysis takes monthly income and expenses into account to calculate the monthly income needed to (a) break even and (b) become profitable.

Break-Even Analysis.png[6]


  • Business ratios: Business ratios are a measure of the company's actual net worth at any given point in time—essentially a snapshot of its financial health. Like your personal financial statement, it shows the ratio between your company's liabilities and assets. However, in this context it plots the predicted ratio over several years, and also compares it to overall industry averages.

Business Ratios Table.png[6]


  • Projected profit and loss: Your monthly projection of profit and loss provides a useful guideline both for initial planning and for maintaining adherence to the plan month by month. If you start to see significant deviation—and not in a good way—then you can make adjustments in real time before things get too far out of control. And include an annual projection for a higher-level view showing the emergence from deficit operations to profitable business operations.


Business Plan - Monthly Profit Chart.png[6]


Business Plan - Profit-Loss Yearly Chart.png[6]


Additionally, weekly projections will help you identify any problems even earlier, and make necessary adjustments well before they are seen in the monthly numbers. Any additional profit/loss projection tools will all add to the risk management of your lab project.

  • Projected cash flow: Having cash on hand, available for emergencies or just unforeseen contingencies is as important as meeting your profit/loss predictions. More than one business has been forced shut because they were operating too close to full cashflow and unanticipated expenses appeared. The ongoing cash flow becomes more important over time as initial capital is expended. Incoming revenue, therefore, must make up the difference in maintaining a healthy buffer. As with all projections and actual records, it is important to make sure you have included everything that applies, including asset depreciation, interest, etc.


Business Plan - Cash Flow.png[6]


  • Opening day balance sheet: Your opening day balance sheet provides the baseline for tracking your profitability and net worth going forward. The reality of it may be a little different than what you had predicted in your startup expenses and required capital balance sheet, but it's important that this one reflects reality.
  • Projected balance sheet: Along with the profit/loss and cashflow projections, a projected balance sheet broken down by year provides another perspective to help gain a comprehensive view of what your financial plan predicts. Like the business ratios, it provides annual snapshots of predicted net worth and shows when that is projected to become positive.

Summary

Cannabis testing labs don't enjoy the huge profit margins (around 40%) that growers, sellers and extraction labs do (200% to 400%), but it's still significant. And while federal Schedule I classification remains in place, those high-profit industry players have to do business in cash for the most part, unable to utilize FDIC-insured banks, while independent labs can add cannabis testing to their services with no such restrictions.[10] However, the Treasury Department's Financial Crimes Enforcement Network (FinCEN) released a guidance document in February 2014 that "does not grant immunity from prosecution or civil penalties to banks that serve legal marijuana businesses" but rather "directs prosecutors and regulators to give priority to cases only where financial institutions have failed to adhere to the guidance."[11][12] Furthermore, according to an Associated Press report in April 2016, the guidance has had some sort of impact, with banks and credit unions willing to handle any money associated with marijuana increasing from 51 in March 2014 to 301 in March 2016[13], and up again to 411 in March 2018.[14] And as the trend continues in both medicinal and recreational production and usage, states are quickly seeing that requirements to test cannabis products are essential in order to guarantee effectiveness, health and safety. So the market is there and rapidly growing. Good luck!

References

  1. Tulsi, B.B. (03 October 2016). "A Bright Future for Cannabis Testing Services". Lab Manager Magazine. http://www.labmanager.com/research-specific-labs/2016/10/today-s-cannabis-research-market. 
  2. "Cannabis Testing Market". MarketsandMarkets Research Private Ltd. March 2017. https://www.marketsandmarkets.com/Market-Reports/cannabis-testing-market-46932450.html. 
  3. Schroyer, J. (January 2016). "Industry Snapshot: Testing Labs - Data, Trends and Challenges". Marijuana Business Magazine. https://mjbizmagazine.com/industry-snapshot-testing-labs. 
  4. Zwilling, M. (06 November 2013). "10 Reasons Not to Write a Business Plan". Entrepreneur, Inc. https://www.entrepreneur.com/article/229804. 
  5. Hades, Z. (26 September 2016). "Starting Up a New Lab: What you Need to Know". Science Squared/BitesizeBio. http://bitesizebio.com/30527/starting-new-lab. 
  6. 6.0 6.1 6.2 6.3 6.4 6.5 Fargo Medical Laboratories. "Laboratory Business Plan". bplans.com. http://www.bplans.com/laboratory_business_plan/executive_summary_fc.php. 
  7. Genovesi, L.. "Secrets of a Successful Start-up Lab". Lab Manager. http://www.labmanager.com/business-management/2015/04/secrets-of-a-successful-start-up-lab. 
  8. Paul Bracher (09 April 2013). "Starting Up a Chemistry Lab: Advice & Bargains". ChemBark (blog). http://blog.chembark.com/2013/04/09/starting-up-a-chemistry-lab-advice-bargains. 
  9. freesky99z (27 February 2013). "Tips for the frugal chemist?". Reddit chemistry. https://www.reddit.com/r/chemistry/comments/19aui0/tips_for_the_frugal_chemist/?st=izraqg9a&sh=5bee4861. 
  10. deCesare, K. (02 March 2017). "LinkedIn conversation". "Growers can average a 300%-400% profit, extraction companies 200%-300%, dispensaries at least double their profit. Most labs are lucky to make 40%." 
  11. Kovaleski, S.F. (14 February 2014). "U.S. Issues Marijuana Guidelines for Banks". The New York Times. The New York Times Corporation. https://www.nytimes.com/2014/02/15/us/us-issues-marijuana-guidelines-for-banks.html. Retrieved 25 January 2017. 
  12. Financial Crimes Enforcement Network (14 February 2014). "BSA Expectations Regarding Marijuana-Related Businesses". U.S. Department of the Treasury. https://www.fincen.gov/resources/statutes-regulations/guidance/bsa-expectations-regarding-marijuana-related-businesses. Retrieved 25 January 2017. 
  13. Hansen, K.; Johnson, G. (20 April 2016). "Banking woes easing for some legal pot businesses". Associated Press: The Big Story. Associated Press. http://bigstory.ap.org/article/804ae396daab4ba98f814b186f872ef6/banking-woes-easing-some-legal-pot-businesses. Retrieved 25 January 2017. 
  14. Angell, T. (14 June 2018). "More Banks Working With Marijuana Businesses, Despite Federal Moves". Forbes. Forbes Media, LLC. https://www.forbes.com/sites/tomangell/2018/06/14/more-banks-working-with-marijuana-businesses-despite-federal-moves/#4d828ed21b1b. Retrieved 13 November 2018.