The legalization of marijuana for adult use in Michigan in 2018 caused an explosion of cannabis businesses opening across the state. The industry was on an all-time high (no pun intended) for the first few years, but the honeymoon phase swiftly subsided, leaving many licensees struggling. Unlimited licensing due to legalization resulted in supply heavily exceeding demand, while unregulated black-market sales brought low prices that licensed businesses could not compete with.
Tougher times
Among the industry challenges today: businesses feeling compelled to price their products lower and/or cut corners and skirt state laws so as to stay afloat. Attracting capital is another hurdle for businesses in the industry. The federal prohibition against cannabis prohibits many banks from lending to businesses in the industry. In addition, the U.S. public markets that the SEC regulates are not options for cannabis fundraising. All of this means companies in the industry are almost forced to raise capital from friends and family in the private marketplace – many of whom are now closing their wallets for additional capital infusions until they see better financial results.
As new capital sources dry up and profits erode, many cannabis companies are struggling to keep up with their payrolls. In addition, several cannot, or will not, pay their significant income tax liabilities –based on gross profit for retail operations – with the hope that they can eventually settle with the IRS.
At this stage, one would think that struggling businesses would be targets for the larger, better capitalized companies. However, we have not seen the consolidation one may have expected, even with depressed business valuations. This is due in part to the uncertainty in future cashflows and the high-risk premiums a buyer would apply to forecasted cashflows. Profitable businesses are focusing on their own businesses – making them profitable – versus assuming another companies’ unprofitable business.
Looking on the bright side
It may seem hopeless for these businesses now, but there is a silver lining. Prices should stabilize. In addition, if the Cannabis Regulatory Agency (CRA) continues to step up enforcement, the black-market competition should wane, helping to stabilize pricing as well. On the federal level, despite some recent setbacks, many are still optimistic that the Safe Banking Act will eventually clear the Senate, which would allow interstate banks to lend to the cannabis industry. While the bill has yet to pass the Senate, it has gained traction recently and many believe it will be passed.
As cannabis companies face these challenges, they should strongly consider hiring a third party to help with their back office. One business aspect that many owners overestimate is their business management capabilities. Hiring a third party like Rehmann to help with items like compliance, taxes, assurance, financial statements, HR, IT support, and so much more can ultimately save these businesses time and money – not to mention help prevent sleepless nights.
All in all, while over supply will be a challenge for the industry for the near future, the good news is that it’s unlikely that demand will subside any time soon and will likely continue to increase. The businesses that are poised for success are those that are vertically-integrated, which means they are growers, processors, and retailers, and, thus, they control their entire supply chain. With unlimited licensing and the regulation we have in Michigan, more municipalities will opt in over the years, opening more opportunities for these cannabis businesses. At this point, it is survival of the fittest and, if a business can sustain the challenges right now, it will most likely be in good shape once prices stabilize.
Originally appeared in Grand Rapids Business Journal