The Four Most Common Processing Agreements for Hemp and Cannabis
How Processors and Growers Work Together to Make a Profit.
In 2023 cannabis extracts continue to see massive spikes in adoption among casual consumers across the country through a variety of products, including edibles, topicals, and our favorite, concentrates. Extractors are increasing production in new regions, and trying new products in existing markets. But how do extractors get their biomass? And how do growers process theirs? How do extractors and growers set up the types of inter-organizational collaborations and deal flow necessary to make their products?
There are multiple types of processing agreements that cannabis growers and processors can use to produce cannabis extracts. All come with upsides and downsides. In this article, The SciPhy Systems extraction equipment team lays out each of these processing agreements, so your business can make a smart, informed decision about how to succeed.
1. Toll Processing Agreements
Toll processing agreements are historically one of the most common arrangements in our industry. Here, a grower pays a toll processor to process and extract cannabinoids from their plants. The grower keeps the results but pays a toll based on quantity or other arrangements. Growers then sell this product for higher value to any manner of purchasing organization (dispensaries, other processors, ingredients manufacturers, and more).
Toll processing agreements are a straightforward way for growers to get their cannabis extracts processed without having to invest in their own extraction equipment. They are also a good way for growers to get their products to market quickly. Toll processors enjoy not having to determine a buyer for extracts, as long as they have a steady stream of clients.
But these agreements often require that growers are flush with capital to pay for the processing fee, without having yet realized the profits of selling their extract. Therefore, toll processors thrive in markets that are more mature with a stable consumer base for extracts.
2. Splits Agreements
In splits agreements, the grower and processor split profits from the sale of cannabis extracts. The grower will typically provide the cannabis, while the processor will provide the extraction equipment and labor. Unlike a toll processing agreement, no fees are paid up front for extraction.
Negotiating split agreements between growers and processors can pose challenges, requiring both parties to agree on a fair distribution of profits and establish protocols for handling disputes. Processors often hold the full lot of oil as collateral for their share of the profits, but this can create a reliance on processors for sales and distribution, prompting processors to plan ahead by adjusting splits to account for sales efforts or applying additional sales commissions after the split.
Many companies will choose to dedicate at least a portion of their processing time to in-house processing products, sourcing biomass either by purchasing wholesale on the open market or working with partner cultivators in a Vertically Integrated arrangement (below).
The Purchase-to-Process strategy is what many entrepreneurs picture when they start planning out a business, however because the raw materials in the cannabis industry still command a relatively high price as compared to the refined output oils this strategy demands a large up front investment in biomass inventory.
4. Vertically Integrated
Lastly, vertical integration offers similar benefits while requiring investments in both cultivation and processing facilities, equipment, and expertise. Vertically integrated companies take care of everything themselves. They capture the full value of flower and extracts, eliminating the need to share profits with separate processing entities. They also have direct control over input costs based on their cultivation and processing methods. However, managing the complexity of multiple specialty businesses concurrently poses the greatest risk in this model.
A hybrid approach often proves effective, wherein vertically integrated companies build processing facilities with excess capacity beyond their cultivation capabilities. Capital generated from vertical biomass can then be utilized to purchase additional biomass from the open market, ensuring the processing equipment operates at full capacity, while capturing a greater share of the lucrative extracts market. Once a significant market share is established, further cultivation capacity can be developed through mergers and acquisitions, reducing costs and boosting profitability.
Conclusion: Strategize Wisely
In conclusion, there are various agreement types that cannabis growers and processors can adopt to produce cannabis extracts, each with its own pros and cons. The ideal agreement will depend on the specific needs and circumstances of the grower or processor. It is crucial for both parties to carefully consider their options and plan their business accordingly. In all cases, clearly written terms and enforceable contracts play a vital role in achieving success in this industry.