Why Cannabis Businesses Can’t Make Money


“It all stems from federal illegality,” said Anita Famili, who leads the cannabis and CBD industry group at Manatt, a law and consulting firm. “The cost of doing business for cannabis companies is just much higher than for any other business.”

Arguably the biggest obstacle to making money is the exorbitant taxes that cannabis companies pay because they are treated as illegal narcotics dealers under the federal tax code. Goods also cannot cross state borders, and this lack of interstate commerce means businesses must build farms, factories and stores in every state where they do business and navigate in a rapidly changing patchwork state regulations. Finally, raising capital is extremely expensive due to the lack of financing options, a problem that Republicans and Democrats in Congress recognize but have yet to address.

“If you’re able to generate cash flow with all of these headwinds, when those headwinds start to go away, that’s going to be an incredibly, incredibly good business model,” said Jen Drake, co-chief operating officer. of Ayr Wellness, which has retail and culture operations in eight states, including Florida, New Jersey and Pennsylvania.

Another factor aggravating the current financial malaise: companies spent a lot last year to increase capacity due to misguided optimism about the prospects for easing federal restrictions on marijuana after Democrats took control of Congress and the White House. This has led to a glut of products and a drop in prices in many of the larger state markets like California, Colorado, Michigan and Massachusetts. These struggles are aggravated by inflation and an illicit marijuana market that remains robust in many states.

“You have more capacity in a market with less consumer buying power,” said Charlie Bachtell, CEO of Cresco Labs, one of the nation’s largest cannabis companies with more than 800 million cannabis. dollars in revenue last year. “It’s an economics 101 lesson on supply and demand.”

The end result is that cannabis companies are in deep financial crisis. Fundraising is down more than 60% from 2021, according to Viridian Capital Advisors, a financial analyst firm that tracks the cannabis industry. The AdvisorShares Pure US Cannabis ETF – a popular industry gauge – is down around 50% year-to-date, despite rising recently from less than 20% percentage decline for the broader S&P 500.

“If you have too much exposure in a market where wholesale price pressures are a headwind, those companies suffered in the quarter,” said Morgan Paxhia, co-founder of Poseidon Asset Management, which invests in companies. of cannabis since 2014. “There are a lot of companies that will end up being abandoned.

Failed lawsuits and lobbying efforts

The industry has been trying unsuccessfully for years to abandon some of the onerous policies that make it so hard to make money selling weed.

Companies have not found success in the lawsuits they filed to invalidate Section 280E of the federal tax code. This section was enacted by Congress in the early 1980s in response to outrage over a tax court ruling that a cocaine dealer was entitled to deduct his operating expenses. The result is that cannabis companies cannot deduct any business expenses, including salaries and benefits, and end up paying tax rates that can exceed 70%. Cresco Labs, for example, estimates it paid an additional $80 million in taxes last year due to 280E.

“Weed companies are really taking a double whammy when it comes to federal taxes,” Manatt’s Famili said. “One might wonder if there is a deterrent for the federal government to legalize cannabis in this regard.”

Similarly, the cannabis industry and its allies have been pushing Congress for years to pass legislation that would allow cannabis companies easier access to some of the simplest banking tools, like loans, and raise capital. These restrictions mean that companies in the sector generally have to pay much higher interest rates than those in other industries.

The Safe Banks Act originally passed the House in September 2019 with strong bipartisan support, and has since authorized the House six more times as a standalone bill or as part of a larger legislative package.

But he never went anywhere in the Senate. That’s largely because Democrats touted it as a giveaway to big business and insisted it be paired with additional proposals designed to help people who have been disproportionately harmed by the criminal enforcement. marijuana. The latest talk on Capitol Hill has centered on a potential “SAFE-plus” package, which would tie criminal justice provisions to the banking bill in hopes of placating liberals without alienating too many Republicans.

“The idiots in Washington are the root of the problem,” said Matt Hawkins, founder and managing partner of Entourage Effect Capital, which has been investing in cannabis companies since 2014. “They need to understand that for this industry to grow and prosper, it must be past.

The lack of interstate commerce is a thornier problem that few industry watchers expect to go away any time soon, as it would require a significant shift in federal marijuana policy that seems unlikely in the near future.

But even if something akin to federal legalization were to happen, the industry is divided on whether it wants state lines to disappear when it comes to the production and sale of cannabis. A company that has invested millions of dollars to build indoor growing operations in Massachusetts, for example, probably won’t relish the prospect of competing with California growers who can grow outdoors at a much lower cost.

“One of the hardest things about being an illegal business at the federal level is the difficulty of dealing with state-by-state regulations,” said Drake, of Ayr Wellness. “If I could wave my magic wand and make one thing easier and smoother, it would be the state-by-state regulatory process.”

Play the long game

Despite the current financial difficulties plaguing the cannabis industry, most keen market watchers remain overwhelmingly optimistic about the future. Indeed, more states continue to embrace legal sales, with five states potentially holding referendums in November on whether to legalize marijuana use for anyone 21 or older. Furthermore, they see some form of federal legalization as inevitable at some point, given that just over two-thirds of Americans consistently support this position in polls.

“It’s really not so; it’s a matter of when,” Famili said. “The industry is not just going to close up shop and walk away.”

This means that many of the biggest companies are still making large investments in the hope of reaping huge profits when obstacles such as high taxes and lack of access to capital eventually disappear.

“In reality, it’s still a little too early to expect anyone to really make money, because all these guys are still in the investment phase,” said Jon Decourcey, director of research. on stocks at Viridian Capital Advisors. “It is to be expected that this will take time [have] these investments pay off in terms of real benefits.

Bachtell of Cresco Labs argues that anyone expecting to make a quick buck in a heavily regulated and rapidly changing emerging market with unique legal barriers was naïve. Instead, he sees it as a long-term bet on the financial potential of what is likely to be a $100 billion+ market one day.

“We thrive in this environment where you kind of make the plane while flying it,” Bachtell said.


rt

Back to top button