The Distressed State Of Maturing Cannabis And The Prescription For Recovery

Cannabis businesses in survival mode must identify their core competencies and streamline operations to stay solvent and restore trust. 

The legacy cannabis market is in distress. To bring it back from the brink, lenders and operators need transparent evaluations and rapid action to preserve value, overcome obstacles and survive.

High taxes, burdensome regulations, traditional market competition, federal illegality, individual market saturation, price compression and an oversupply of product have all held back cannabis businesses. New financing to triage, stabilize distribution, and/or expand is difficult to secure thanks to these risks.

With the federal government recently signaling it will move forward to reschedule marijuana from a Schedule I controlled substance to Schedule III under the Federal Controlled Substances Act, consumer products companies hope interstate commerce will soon help them grow and expand. Still, if rescheduling happens, it will take time, and other problems, including a lack of available bankruptcy protections, will persist.

Distress In Maturing Cannabis Markets

Especially among the more mature adult-use and medical-only state cannabis markets, distressed assets are piling up as businesses struggle over time and financing dries up.

These commercial, regulated markets primarily exist in the western United States, and this huge industry segment is suffering. Their woes stem from debilitating regulations, over taxation, single purpose retail outlets, a lack of federal policy change, and competition from a thriving illicit market. In addition to these challenges, many operators underestimated the cost of doing business and overestimated the value of their businesses, creating a losing proposition. As many as three-quarters of those companies are now in survival mode, and depending on how they positioned themselves in the market, they will either pivot and adjust or face liquidation.

A Prescription For Recovery

Cannabis businesses in mature markets must act now and preserve as much value as possible. Already, a staggering 75% of cannabis companies are not making a profit. They operate in the red and cannot make payroll or operate within the current environment of the regulated market.

To reset, most lenders and businesses need to be honest with themselves and one another to identify the core competency of the business, and this often requires the guidance of a neutral third party. With any distressed business, the goal is always to find a way to restructure the company and refocus it on what it does best. Those who figure this out and successfully pivot are much more likely to stay in the game until the market is favorable enough to offer better prospects for growth. Through honest transparent reflection and cooperation, businesses and lenders can salvage what value remains and refocus.

Those that fail to effectively streamline operations will go out of business, shutting down or being liquidated in some manner. Others will tap into the illicit market, because the cost of continuing to remain compliant appears just as bad as that of getting caught. This short-term solution ends in failure with companies eventually getting caught and further harming the legal industry, which is designed to protect consumers and foster public safety.

Limited Options Available

With no bankruptcy restructuring available to cannabis businesses, owners and investors must fix problems and realign the business before it’s too late, but both leadership camps first need to acknowledge their painful reality and understand neither will get everything they want while preserving value and saving the business. A neutral third party, usually either a court-appointed receiver or a restructuring specialist, can quickly set ground rules to bridge the transparency gap and build trust on behalf of businesses and lenders. Independent third-party experts that report to both investors and leadership simultaneously can help all parties overcome the pride, conflicts of interest and lack of objectivity that often gets in the way without their involvement.

Without transparency, lenders are reluctant to trust cannabis businesses, which leads to zero investment or offers with only very aggressive loan terms. Rather than protecting lenders, investors and businesses, this only exacerbates industry problems and creates more distressed assets. Transparency allows groups with different interests to work together to solve problems but requires objectivity, freedom from conflicts of interest, and severing ties to prior decisions (and sometimes prior decision makers).

Saving parts of these businesses is preferable to losing them entirely, and with transparency, third parties can focus companies on making measurable quarter-by-quarter advancements every 13 weeks. Lenders should insist on this type of regimented stepping-stone approach.

To get started on the road to recovery, ailing businesses and the lenders and investors who support them should work with an expert, independent intermediary and ask themselves a few questions:

• Is there value to protect?
• Is survival possible?
• How do we get there from here?