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Will Mom-and-Pop weed shops survive in Canada’s biggest market?

The Ontario government has not shut the door on Mom-and-Pop cannabis stores, but industry observers expect the rules will initially favour larger, well-capitalized businesses and early entrants to coveted urban markets.

The Alcohol and Gaming Commission of Ontario (AGCO) released rules for its Expression of Interest Lottery to pick the province’s first 25 private cannabis retailers on Wednesday.

Online applications will be accepted between 12:01 a.m. ET on Monday and 12:00 p.m. next Wednesday. The AGCO said it will choose the winners next Friday in a lottery overseen by KPMG, and announce the results within 24 hours. The winners will then have five days to submit a $6,000 non-refundable fee and provide a $50,000 letter of credit.

Licensees that fail to start selling cannabis on April 1 will be hit with a $12,500 draw down from the letter of credit. If sales have not commenced in two weeks, the AGCO will draw down a further $12,500, followed by the final $25,000 at the end of April.

The commission said the rules are aimed at discouraging applicants unprepared to meet the province’s April 1 deadline for brick-and-mortar retail stores to open. Recreational cannabis can currently only be purchased legally through a government-run website.

Cannabis industry expert Deepak Anand sees the stiff penalties as a sign Premier Doug Ford’s Progressive Conservative government wants to avoid a repeat of the harsh criticism that followed the bumpy debut of online sales in October.

“The province is very desperate to ensure the people that are going to be awarded in these lotteries can actually get into business and provide product to customers on day one,” he told Yahoo Finance Canada.

Ontario’s introduction of legal recreational cannabis has been hampered by hasty shifts in strategy. The previous Liberal government chose provincially-run online sales and physical retail. Ford’s Progressive Conservatives opted for government-run online-only sales, and delayed the launch of private physical retail stores. Lack of supply then prompted a 25-store cap on the number of locations.

“Now, they’ve drawn a line in the sand and said, ‘We’ve made plans. We are now going to execute on exactly what we said most recently, which is 25 stores open in April and no further delays,’” Nick Pateras, vice president of strategy at the cannabis data firm Lift & Co., told Yahoo Finance Canada.

The lottery for the first 25 licenses, set to be conducted without the capitalization threshold that some had predicted, leaves the playing field open to small businesses.

Pateras said the initial crop of licenses, especially the five to be issued in Toronto, and the six slated for the outlying Greater Toronto Area, are like golden tickets for tapping “very attractive market conditions” until the temporary cap on retail store authorizations expires on Dec. 13.

“The return is just massive,” he said. “(For) the operators who secure licenses in those big metropolitan markets, that’s a bit of a goldmine.”

Anand warns small business will face the same pressure to meet the government deadline as larger peers with more resources to prepare for opening day, and greater ability to absorb penalty costs.

“Larger businesses are much better suited from a financial perspective to be able to execute on what comes out through this lottery thing, but I am not eliminating small business entirely,” he said. “I suspect that small business will remain out, at least at the onset.”

Unlucky aspiring pot sellers forced to wait until the 25-store cap is lifted in December will have to ready their business without revenue to offset startup costs.

That’s another factor working against small businesses, especially those leasing storefronts in pricy urban markets while they wait for a chance to open, Pateras said.

“People are burning rent every single month that they cannot open. For the bigger players who are well-capitalized, they can afford to sit there and wait the market out, and wait other players out,” he said. “It looks very different to those who are desperate to set up shop, start selling, and make money on what is a very capital intensive set up.”

The province said the initial 25 stores will be opened in municipalities with a population over 50,000 as identified by the 2016 Canadian Census, that permit the retail sale of cannabis.

The locations will be divided across five regions as follows:

East Region: Five stores (Stormont, Dundas and Glengarry, Prescott and Russell, Ottawa, Leeds and Grenville, Lanark, Frontenac, Lennox and Addington, Hastings, Prince Edward, Northumberland, Peterborough, Kawartha Lakes, Simcoe, Muskoka, Haliburton, Renfrew)

GTA Region: Six stores (Durham, York, Peel and Halton)

North Region: Two stores (Nipissing, Parry Sound, Sudbury, Greater Sudbury, Timiskaming, Cochrane, Algoma, Thunder Bay, Rainy River, Kenora)

Toronto Region: Five stores

West Region: Seven stores (Dufferin-Wellington, Hamilton, Niagara, Haldimand-Norfolk, Brant, Waterloo, Perth, Oxford, Elgin, Chatham-Kent, Essex, Lambton, Middlesex, Huron, Bruce, Grey, Manitoulin)

Both Anand and Pateras see the supply constraints that motivated Ontario’s cap on brick-and-mortar stores beginning to ease.

For Pateras, the promise of larger harvests from licensed producers in this quarter and the next is reason for the province to consider a second block of licences soon rather than later, which would help small business looking to enter the market.

“What I would love to see from the government is agility in recognizing that there is more supply, and they can start to issue more licences so we can actually displace the black market,” he said. “By the end of year one in Colorado, they had 147 stores. That’s a state with three times fewer people than Ontario.”

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