5 Biggest Mistake Cannabis CEOS Make that Can Put Them Out of Business… Quick!
With an influx of new businesses in the cannabis space, it is easy to get caught up in the opportunity that this burgeoning market brings. As marijuana makes it’s transition from a street drug to a medicinal substance used in various treatments, to a state-legal - yet Federally classified Schedule I drug, some investors and CEOs are making the crucial mistake of not treating their investments as businesses.
Here are some common missteps that canna-business startups can avoid, and protect their investments.
- Not paying enough attention to compliance.
Many companies (especially those that have evolved out of the black market) are going from a completely unregulated black market to one of the most regulated industries in the US. Additionally, many cannabis companies include every vertical: farming, chemical processing, food manufacture, and retail. This adds complexity, as well as many layers of regulation: city, county, State licensing, federal, IRS, FDA, OSHA, EPA and more. State license requirements and federal law require compliance with many laws or your license can be revoked, not to mention large penalties and interest. Good practice is to have the position in the corporate org chart of Chief Compliance Officer, who takes complete ownership of this key function.
As Warren Buffet points out in his 2 rules of investing: rule #1 don’t lose money and rule #2, see rule #1.
If your company is shut down, it’s a complete loss to owners, investors, and employees. - Poor Organization
Building a World-Class _______________ (fill in the blank: grow, dispensary, extract, edible, product), but not being focused on building a World Class Company. A world-class product is just the start, yet if don’t have world-class accounting, tax, finance, compliance, risk management, corporate/board/legal, your valuation diminishes for any investment, loan or exit, while you risk of failure greatly increases. - Not Understanding the Need for Robust Accounting.
To further complicate #2, Big Accounting, and even mid-level firms have taken a stand (or their insurance requires them) not to serve cannabis while federally illegal. Since Cannabis is the fastest growing industry in the US, you have a huge vacuum: a lack of quality accountants supervising day-to-day accounting at most cannabis companies. Additionally, the complexity of accounting required by the IRS and State isn’t easy (GAAP/accrual accounting required to implement absorption/cost accounting to comply with 280e/471). Even without cannabis issues, farm accounting, chemical manufacture, food manufacture, and retail are four distinct industries, that differ greatly from each other, and each with their own specific and complex accounting issues. The final piece of this “perfect storm” is the fact that almost all cannabis companies are using untrained, under qualified and unreviewed bookkeepers to enter day-to-day transactions. These bookkeepers are not trained in Accrual, GAAP, or cost accounting, (most don’t have accounting degrees or CPA designation) and simply don’t have the knowledge to account correctly for these entities. This means many entities are out of compliance; see #2 above. (P.S.: your tax CPA barely has enough time to complete your annual tax return and is likely not reviewing your accrual accounting or bookkeeper entries each month). One solution is to hire an experienced part-time CFO or at a minimum make sure your bookkeeper has training in cannabis accounting. - Not paying enough attention to market conditions.
For example, in late 2017 there was a supply glut of flower in Oregon, prices dropped significantly, and purchases by dispensaries significantly decreased, with many doing consignment only. Due to this, many farms were put up for sale at pennies on the dollar or shut down. However, I know of several grow startups that had plans to invest large sums of money starting from scratch without investigating what might be available for sale. With predictions as high as 4 out 5 new cannabis startups going under in California, smart CEOs and investors, might sit back and wait to pick up premier assets on the cheap. - Not planning for worst-case scenarios.
It’s fairly easy to predict your yield or volume, and prices at the top end might stay stable, but it’s harder to predict if you can actually sell large volumes of product at good pricing. The field is loaded with competitors and many have the same plan: increase the yields, grow “clean green/organic indoor”, and move lots of product, but simple math says some will be able to but many won’t. Are you well capitalized to sustain long periods of low cash flow?