Cannabis executives can reflect back on 2019 as a year of swift change — and they can expect more of the same in 2020. Regulatory shifts are anticipated, and financing will be in flux across the industry. When planning for the near term, the more data executives can gather, the better.
Executives and investors eyeing growth need to take the opportunity to focus on best practice implementation across governance, operations, finance, and IT, all of which leads to clearer decision making and more predictable outcomes.
The U.S. cannabis industry is benefitting from long-term positives that will shape the future, but surprisingly, those positives will come out of some short-term pain. Here are three primary areas to consider as you plan for 2020:
The Health Crisis
Vaping issues raise the need for continued emphasis on safety, which will create a more credible marketplace in the long run. In fact, if the media emphasizes the Centers for Disease Control and Prevention (CDC) investigations—which indicate most health issues are the result of non-licensed operators and non-cannabis materials (e.g. vitamin E acetate used as an additive)—that should help move more consumers to the legal market.
In the meantime, states have responded differently to the outbreak of vaping-related injuries. Massachusetts, for example, temporarily banned vape products, while New Mexico required additional labelling. We can expect all states will update their regulations to test for vitamin E acetate (hopefully, they will test for oils more broadly in order to expand the safety net).
We expect the effort will eventually be elevated, and the USDA and FDA will issue regulations. Using Massachusetts as an example, you should consider the impact of idle or blocked inventory, and new testing and labelling rules.
Banking Reform (or the lack thereof)
With capital markets down and banking reform unlikely to pass in the near term, we advise operators to have 6 to 18 months of cash (or liquidity) to fund operating expenses (OPEX), capital expenses (CAPEX), and contingencies while continuing to build relationships with capital sources and bankers.
With little control over the banking arena, you should focus more on what you can control: strong balance sheets, disciplined growth, operational execution and efficiency. A financial outlook covering the next 12 to 18 months should be done before the new year, beginning with a look back at 2019 to evaluate forecasted/budgeted-to-actuals. Itemize lessons learned – the good and the bad – and develop a view of near-term financial scenarios.
Risk management and disaster recovery plans should also be factored into your assessment. It is important to consider all types of risks, including: economic, business, operating, financial, asset, product, market, technological, regulatory, and legal.
A Correction In The Capital Markets
Public company stock prices have dropped significantly. This may seem like a troubling trend, but when valuations are reasonable, more investors are willing to engage in conversations. It also reduces the risk of buyers overpaying for acquisitions and engaging in M&A for the sake of M&A. Conversely, the risk of hostile takeovers and take-private deals becomes more prevalent.
For now, though, financing remains difficult. Investors are choosing to protect the downside while benefitting from the upside with convertible debt and debt plus warrants. The problem with debt financing is that interest expense is generally nondeductible. Due to Code Section 280E, the after-tax cost of debt and equity capital is the same. That bears repeating: the after-tax cost of debt and equity capital is the same. One approach to this problem is preferred equity securities, a vehicle that is underutilized. Issuers and investors should also consider other sophisticated financing alternatives that can provide a competitive financial model.
Lastly, the correction in the capital markets should remind companies that partnerships are a powerful tool to meet strategic initiatives and produce results that would otherwise be difficult (maybe even impossible) to achieve.
As you may know, long range planning is particularly difficult in the cannabis industry, given the pace and frequency of ongoing change. Some changes may be identifiable when conducting an in-depth risk analysis.
Every company needs accounting, financial and risk management, and a sound growth strategy in place. We advise clients to take planning seriously at year-end and carry a mindset for growth into 2020.