Legal recreational and medical cannabis sales hit around $27B in the US in 2021. That represents a market growth of 30%. For context, It’s more revenue than coffee giant Starbucks made in the same period.
Those numbers are seriously impressive for a product that’s only legal in 39 out of 50 states. On top of that, according to a 2021 Gallup poll, about 91% of Americans support legalization. Cannabis’ potential as a business opportunity is obvious.
However, before you jump feet first into the industry, there are some things you need to know. Operating a cannabis business isn’t like running any other company, especially regarding cash flow.
In this article, we’ll look at how cash flow works in the cannabis industry and point out some things you need to be conscious of before you decide to get involved in the business. While money is to be made from the industry, businesses must overcome many challenges.
Prepare for extensive product life cycles.
Cash flow is an issue for most small businesses. Running out of money is commonly cited as the main reason for going out of business.
Long product life cycles are the enemy of cash flow. And the cannabis industry has some very long product life cycles. For example, when the plant was legalized in Canada, demand was high, but producers struggled to meet demands precisely because growers couldn’t produce the product that quickly.
Cannabis can take around 18 weeks to go from seed to harvest. Some strains need about eight months. That’s before even accounting for processing and packaging. While some cannabis can be grown more quickly, it produces lower yields, which creates a different problem for your business.
These long yield times can chew up your starting capital for any business. While you wait, you still pay for premises, electricity, staff, materials, and other operating costs and expenses.
If you’re not prepared or capable of weathering 4+ months without revenue, you’ll find yourself in a sticky situation that could cost your staff and reputation.
Of course, this doesn't just apply to new cannabis businesses. Even established operations need to observe production and perform precise inventory management. Forecasting any delays and cash inflow shortages is essential in this industry.
The importance of demand forecasting.
Forecasting demand isn’t just about ensuring you have adequate cash flow to overcome the peaks and troughs of the calendar year. It can also help you manage your inventory dynamically and responsively to the market's needs.
As the cannabis market boomed over the last few years, some problems emerged. California — a $5B cannabis marketplace — began reporting oversupply. While exact figures were short on the ground, one estimate suggested that suppliers were growing three times as much cannabis as sold at dispensaries.
Similar problems have been reported in Canada and Oregon over the last few years. Problems got so bad that people in the industry have been openly wondering about alternative uses for this excess cannabis, such as converting it to CBD.
Over-production of cannabis is devastating for cash flow. If supply drastically exceeds demand, prices drop.
Cultivators must closely watch supply and demand trends within their state. Being stuck with excess stocks sitting idle in storage should be avoided.
With a better grasp of demand and more accurate forecasting, businesses can deploy their cash on hand to support innovation, including investing in staff, equipment, R&D, etc.
Cannabis businesses need vast amounts of liquidity to survive.
Entrepreneurs look at the cannabis industry and see its billions of dollars. Some of them assume that we’re living through some sort of gold rush. However, for any startup hoping to break into the sector, the need to beware of just how much money is required.
Whether a producer or a retailer, grabbing a slice of the cannabis market takes a lot of work. It also requires a tremendous amount of liquidity. Starting and maintaining a marijuana business is a six or seven-figure project.
Licenses for opening and operating a cannabis business are expensive. Equipment, rent, security, and advertising are significant outflows you need to consider before paying staff or taking profits.
Staying cash positive requires considerable starting capital and vigilant forecasting and cash management. While a lot of money is sloshing around the industry, there are high barriers to entry. Many cannabis businesses have found this out the hard way.
Taxes and property can eat away at cash flow.
It’s not just the excessive startup and maintenance costs that mean businesses need vast amounts of liquidity. There is also the matter of government taxes on profit and informal taxes on property rental. Let’s explore both.
While a lot of the discussion around legalization centered around human liberty, for the states that passed these laws, it was mainly about taxing a new revenue stream. Excise taxes on marijuana vary from state to state. In some places, it’s as low as 10%, while typical ranges are between 15% and 37%.
However, cannabis is still illegal on a federal level. That means cannabis businesses aren’t entitled to tax breaks or deductions designed to encourage commercial activity.
But there are also more informal taxes that cannabis businesses face when renting premises. Many landlords push the prices once they hear a facility is being used for cannabis production. This “green tax” means that even businesses generating lots of revenue are hurt by outflows.
Soaring real estate costs and the inconvenience of relocating operation licenses mean that many businesses are left with little option except to absorb the costs. So, if you’re a startup hoping to enter the cannabis market, remember that landlords see these businesses as higher risk, ask owners to pay a premium, and often add contingencies into the rental agreement.
A recent survey highlighted the most significant issue facing Portland’s cannabis business. Over 70% of companies cited the “lack of access to banking or investment capital.”
Cannabis is a Schedule I drug. Many banks and financial institutions are severely discouraged from doing business with cannabis enterprises. As a result, many big players in the legal marijuana business operate with a bank account and the privileges that come with one, like loans and lines of credit.
The industry has too much cash. And with only about 1% of banks willing to work with cannabis businesses, many problems arise.
If you’re a cash business, tracking money is hard. So too, is making payments. Finally, holding large sums of cash makes for a security risk. Scores of cannabis dispensaries have been targeted by criminals who know they hold considerable cash reserves.
To make matters worse, “the green tax” is at play again with the few banks that do service the cannabis industry. Increased regulatory oversight and paperwork mean that cannabis banking service charges are as much as 20 times higher than standard banking
The situation will seem anachronistic as contactless and digital payments become more prevalent in the United States. With the Senate slow to even discuss the issue, it’s something startups in the area — and established players — will need to deal with.
More money, more problems
With so many cannabis businesses unable to access traditional banking, they need to operate in cash. As we touched on in the last post, that causes issues with security and causes problems making payments. Some business owners are even driving around with bags of cash to pay suppliers.
Keeping track of cash is difficult. The accounting industry has digitized over the last 20 or so years. That has led to better tracking and analytics. Cannabis is being left behind.
Businesses need to employ dedicated staff or teams to deal with this issue. These employees' role is to make drops and get cashiers' checks and money orders. The significant administrative burden isn’t the only problem.
One solution to this industry issue can be found in corporate structuring. Businesses can form two entities: one that deals with cannabis licensing, the other with admin, leases, banking, etc. It’s a split betweenOperations and Administration.
Other businesses use cash security vans to make deposits. That’s an option for bigger players, but it’s not an expense everyone can accept.Other answers businesses have tried are prepaid cards, bank transfers, and crypto currency. However, none of these solutions deliver the balance of customer-focused service with proper cash management.
How rejected deliveries hurt cash flow
There is a lot of money in the cannabis industry. Gross margins are around 15% to 21%. But taxes, high real estate, and operating costs are high, which can chip away at profits.
Rejected deliveries are another area that can cause problems for business owners. Even when cannabis products pass rigorous safety checks, they can still be rejected by retailers. Some estimates suggest that dispensary owners reject around 50% of wholesale deliveries. That’s a massive amount of orders which makes maintaining positive cash flow — or even just running a business — incredibly difficult.
So what causes failed or rejected deliveries?
The most significant cause of these issues is a lack of compliance.Because retail delivery is so heavily regulated, retailers are very cautious.Inaccurate documentation or packaging that falls outside regulatory requirements makes up about 50% of rejected deliveries.
The only solution to the issue is for cannabis businesses to ensure their paperwork and documentation are pristine. That means taking the time to understand and stay current on regulations. Additionally, you need to ensure your vehicles and drivers are compliant too.
One attractive solution for businesses is to send small test runs or samples. You can adopt the same process for larger orders if these work out. Additionally, you’ll have records of accepted
orders. Finally, it will help highlight possible regulatory infringements so you can remedy them immediately.
Reduce your rejected orders, and you’ll boost your cash flow significantly.
Payment term problems
Payment terms are another problem for healthy cash flow. Research suggests that 40% of regional deliveries are net payments rather than cash on delivery (COD).
There are a few contributing factors here. As we mentioned, banking regulations make it difficult for cannabis businesses to open accounts.The consequence is that taking any kind of payment becomes more complex. But that’s not all.
Other problems arise if a significant amount of your deliveries are net payments. Many businesses have 30+ day payback terms, meaning suppliers often wait for payment for more than a month.
We already discussed that going from seed to harvest can be an 18-week process. If you add another month, you get five months of paying staff, utilities, rent, etc., without income.
It’s not uncommon for cannabis businesses to have huge accounts receivables but struggle to find money to pay staff. When you add in the issues with getting a bank account or lines of credit, you can see how cash flow can be a significant problem for a startup trying to break into the industry.
Expecting a business to have around five months of liquidity on hand. So, while there is a lot of money in the cannabis industry, it’s not always available when businesses need it.
How to value your cannabis business using cash flow
Market exuberance has resulted in many cannabis businesses' wild valuations. While part of that may have been due to a broader pattern of low interest rates and an investment market with a monstrous appetite for risk, it was still rather extreme.
If a cannabis startup looking to sell or secure funding, you need to know how to get an accurate valuation. As always, cash flow will play an important role. In particular, discounted cash flow (DCF).
Discounted cash flow is a popular way to value a startup or other businesses. This method suggests that the value of a company can be measured by accounting for its projected cash flows. Or, to put it another way, how much money will the investment bring in the future?
However, there is a DCF challenge regarding the cannabis industry.Cannabis businesses, as we’ve made clear throughout this series of posts, have high operating costs. Rents, taxes, licenses, and production costs are elevated; margins can be reasonably slim in a competitive environment.
As a result, valuations with DCF can seem pretty low. In an era of hyper-inflated valuations, founders might not be convinced this measure is accurate. However, it’s one of the better ways to calculate a fair valuation.
Alternative funding sources to help cash flow
Cannabis businesses are very capital intensive. This statement is true if you’re a startup or an established company. A positive cash flow is essential for expanding or growing your business, especially in an industry that doesn’t have as much access to loans or lines of credit.
So what are the options for a cannabis business that needs an injection of cash or funding?
Well, first things first, you need to decide if you want to do debt or equity. A loan will need to be paid back in time, while equity means selling a part of your company. Equity partners can be hard to get unless your finances are solid and you’ve got a product that has high potential.
VC funds, angel investors, and private equity firms are all excellent options. However, there is some caution about cannabis businesses in the investment industry.
Over the years, many cannabis businesses issued shares so they could fix cash flow issues. Many of these offers weren’t directly tied to expansion plans. As a result, share prices dropped as existing shares became devalued.
These situations resulted from investors being blinded by the enormous sums of money in the industry and not necessarily the positive cashflows you’d associate with a healthy business.
Can invoice factoring help with cash flow?
We’ve discussed how cash flow problems can hamstring even the best-run marijuana business. Extensive product life cycles and long accounts receivables are significant factors that stop companies from being cash-positive. But what can businesses do when they find themselves in trouble?
Usually, a typical business can get a loan or a line of credit from the bank. However, that’s not the reality for many cannabis businesses. So what are the options when you need cash to keep the lights on?
One thing you can consider is invoice factoring.
If you’re in a situation where clients take 30, 60, or 90 days to settle their accounts, your cash flow can suffer. Invoice factoring involves the sale of accounts receivables or invoices to a factoring company.
Typically, these deals release cash to you, with the factoring company advancing between 70% to 90% of the total invoice.
There are some benefits to this approach. Your cash flow is improved, approval rates are reasonable, and no collateral is required.
However, there are some negatives to consider. The primary one is the cost. If you work in an industry with tight margins, you can’t afford to give away too much of your revenue.
It’s best to consider invoice factoring as an option of last resort. While it will improve your cash flow in the short-term, it can harm long-term profitability.
How to use positive cash flow in the cannabis industry
While cash flow problems stalk the cannabis industry, it’s not an issue for every brand. Many cannabis businesses are delivering fantastic sales figures and healthy balance sheets. So, what should you do if you find yourself in a situation where you have a cash surplus?
There are several things that you can do with extra cash. One of the most exciting things to do is invest money. You can put it into new equipment, staff, R&D, or other avenues that can help your business expand into other states.
Many cannabis businesses use surplus cash to acquire other marijuana companies. This situation can create other value streams, like moving into CBD or different cannabis products.
Alternatively, you can also invest in other areas. High inflation and low-interest rates mean that holding on to capital while it is weathered away is a poor strategy. Investing in the stock market is a good long-term move, even if 2022 has been a challenging year.
Of course, property investment could be a great way to spend cash surplus. The “green tax” adds to high rents, so buying your premises could be a great move, especially in areas with a hot property market.
There are lots of cash flow issues that affect the cannabis industry in specific ways. Regulatory problems have meant that accessing traditional loans or lines of credit is challenging for marijuana businesses.Huge operation costs and an increasingly competitive industry mean that staying cash positive can be challenging.
Sorting out payment terms and reducing rejected deliveries can significantly improve cash flow. Additionally, finding ways to reconcile your financial health, even when dealing with a lot of physical cash, is essential.
Cash management is all about having good information. If you don’t have a precise picture of your company's health, your strategies and decision-making will be subpar. Cannabis businesses are producing incredible sales. However, a peak behind the curtain shows that many of these businesses struggle to overcome high taxes and operating costs.
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