While the past few years have been no picnic for companies struggling to turn a profit, it looks like 2023 could be the most challenging year yet. A triple threat of high-interest debts, inflation, and overdue taxes is looming over some entities, which will have to make difficult decisions in order to survive. Meanwhile, consumers across the country continue to zig-zag between illicit and legal markets, hampering the anticipated growth of the industry from coast to coast.
Mergers and acquisitions (M&A) slowed dramatically in 2022, and with ongoing reports that access to capital has all but dried up across the United States, the trend likely will persist. After a record $10.3 billion in M&A deals in 2021, 2022 saw only $3.2 billion in deals, according to New York-based Viridian Capital Partners. While larger, vertically integrated companies surely will snap up distressed assets this year, smaller and less well-capitalized businesses may simply fold or mothball their operations until there is a more favorable outlook for the industry.
We already are starting to see this on the West Coast, where Flow Cannabis Co., one of the largest operators in the Emerald Triangle, has ceased cultivation operations and is leasing its facilities and selling real estate.
“I see four or five deals a month where people are asking us to either acquire them or merge with them and their debt,” said Gary Allen, chief executive officer at New Frontier Data. “They’re like, ‘Listen, we’ve gotten some [merchant cash advance] debt, and we’re kind of in trouble. We have plenty of revenue, but this debt is killing us.’”
Merchant cash advance (MCA) loans are one of the most insidious types of debt that has crept into the industry. Similar to payday or cash-advance loans for individuals, MCA lenders advance money to businesses in exchange for a claim against their future income. This instant funding carries a number of red flags, which can include personal guarantees, claims on future income and assets, and more. The daily and weekly payments carry a significant premium, and in most cases the original loan amount is multiplied many times over by the time it’s been paid off.
Inflation has been another thorn in the side of the industry, as rate hikes have made it even more difficult for companies to secure capital. Meanwhile, fears of a recession may decrease consumer spending for products that aren’t considered essential items. In the past, Allen said, cannabis companies have been able to find high-risk loans with annual percentage rates ranging from 17–22 percent, but these days even those go only to larger companies with good cash flow.
Another potentially dire situation is developing for companies across the country that have punted on paying their taxes: They could be in for a rude awakening from the Internal Revenue Service this year. By issuing levies, the IRS and/or local and state authorities can seize property or demand hefty payments from revenues. “We’re starting to see—in California, Colorado, Massachusetts, and some of the other significant states—where companies have been kicking the can down the road on taxes, and now a tax collector is issuing levies. Some of these are 55 percent of the actual revenue of the dispensary,” said Allen. “That’s going to kill a significant number of smaller retailers, and it’s going to happen over the next sixty to ninety days.”
And then there are the continuing struggles for companies on the West Coast. Most estimates suggest illicit sales represent about 70–80 percent of the California market. For the first quarter of 2022, the state collected about $294 million in cannabis revenue tax—lower than in the fourth quarter of 2021, when the state collected around $317 million. That suggests either Californians are buying less cannabis or more consumers are buying from the illicit market. Allen explained New Frontier conducted an analysis in 2022 and found fewer than 15 percent of dispensaries have more than 1-percent market share among their local consuming population. For companies hoping to survive in areas with stiff competition from illicit operations, the only solution is to find ways of luring consumers back into the legal market.
“There are about 100 million possible consumers out there who are not in the legal market, and the dispensaries are all fighting for the same one-third of the total who are, so the industry is a bit in peril,” Allen said, noting 50–60 million new consumers would create about $33 billion in retail value. “However, unlike other nascent emerging markets, I believe the industry has a clear path out of that danger. My mission is to rally around the retailers, bring them the customers they need, and let them laugh at the shitshow that is the government trying to make sense of one of the most valuable and profitable [consumer-packaged-goods] markets in history.”