How Your Distressed Cannabis Company Can Navigate the Struggling Market
Article

How Your Distressed Cannabis Company Can Navigate the Struggling Market

by Michael Hogan
October 05, 2022

The disruption in the economy has many cannabis companies looking for options to deal with a struggling business. Market forces such as reduced demand, prohibitively high tax rates and pressure to cut prices amplify the existential challenge some cannabis organizations face: they don’t have enough working capital to survive.

As the trend to legalize the medical and recreational use of marijuana continues in many states, federal law and bankruptcy courts have not yet followed suit, which limits the available choices for financially distressed cannabis companies.

What Are Your Options?

Due to market, regulatory and internal challenges, the strategic options available to struggling cannabis companies differ slightly from other industries. They include:

Improving cash flow

With every distressed company there’s usually a set of tools that a financial advisor is going to recommend, which generally revolve around cash control. (Companies need a 13-week cash flow to know how much time they have.) There are standard approaches your business can take to extend your runway, such as finding ways to accelerate cash inflows, creating new revenue streams, and managing expenses or noncore operations. You can also look at ways to drive receivable collection or sell inventory at a discount to free up working capital.

When dealing with vendors, it may be beneficial to renegotiate liabilities, such as restructuring a lease or extending payment timing to reduce the monthly spend. Often, companies look first to make reductions in staff, but if not done strategically, this is just a reactionary measure.

Outside investment

If you’re in trouble, your first option is likely to go and find new investors or lenders to inject capital into your business. But most financial institutions aren’t capable of lending to a cannabis company. If you don’t have investors lined up, you can look to sell your business and achieve a soft landing, or you can reach out to a hard money lender, which uses your real property to secure the loan. These types of lenders tend to be individuals or companies instead of banks and can be more expensive than a traditional loan from a bank.

If a new lender or investor is available to you, it’s important that the provider specializes in the cannabis industry and understands the unique needs of your business today and in the future.

If your business is in extreme distress, the time to seek new investment may have already passed, and you may need to restructure or liquidate the company.

Assignment for the benefit of creditors (ABC)

ABC is a state-law mechanism for the orderly (structured) liquidation of assets, similar to federal Chapter 7 bankruptcy, but less expensive and faster. In an ABC, the company’s assets will be monetized and the proceeds distributed to any creditors. Here, you can select your assignee — the person who manages your assets and decides the best way to monetize them to repay your debts.

It’s important that cannabis businesses designate an assignee who’s familiar with the industry and is well versed in the licensing requirements in the relevant jurisdictions and situations, and the ABC is one part of a more complex plan to transition the business.

To begin the process, you’ll need approval from your secured creditors and shareholders. Keep in mind that only around 35 states have enacted ABC laws, and each one is different. Additionally, ABCs are liquidations that can transfer operations to a buyer and don’t offer your company a way to restructure and continue to operate.

Direct negotiation

An out-of-court or direct negotiation is an option to work with a lender or group of creditors for a workout agreement to renegotiate obligations. This process can be arduous, and it’s important here as well to work with an established advisor that is experienced in the cannabis industry, has thorough knowledge of licensing requirements and how to transfer them, and can accurately value them and negotiate with all parties in a timely manner.

State court receivership

Like an ABC, financially distressed cannabis companies can opt for a state court receivership. Here, a receiver would be appointed to lead a state-court-approved liquidation. However, unlike an ABC, a receivership can get court approval to continue operations. But in a receivership, the company’s owners have little to no control over the restructuring or liquidation.

The cannabis industry also faces challenges with pursuing a receivership because it is subject to inconsistent state courts, some of which limit a company’s ability to select a receiver. Further, it’s difficult to move quickly since all major decisions require court approval.

(Lack of) bankruptcy protections

Many cannabis companies have attempted to file for bankruptcy protection. But as long as marijuana remains illegal federally under the Controlled Substances Act (CSA), bankruptcy courts are unlikely to accept cases from cannabis companies. However, following the passage of the 2018 Farm Bill, hemp and CBD companies can now file for bankruptcy protection. Unfortunately, the application process has been difficult, and many have been rejected by the courts.

Key Considerations

Regardless of which choice you think aligns best with your situation, there are two important factors you should consider when looking for a path forward.

Parallel processing

You can’t pursue your options in a linear, one-at-a-time way. For example, it would take too much time and resources if you were to look for an investor to put capital into your business and wait 60 days, and then if that fails, you move on to another investor or a different option.

Look at all your options and pursue them in parallel. You can still search for a hard money lender, an investor or a company to acquire yours. But you also have to consider out-of-court restructuring, a receivership or an ABC. These should be done in a way to ensure the preservation of assets, especially your licenses. This is unique for cannabis companies because for the transfer of assets, you don’t have the ability to use bankruptcy if the company is insolvent.

Transferring licenses

There’s a lot of confusion around licenses — especially transferring them. Most attorneys know how to procure licenses and maintain compliance. But when it comes to transferring them in a distressed environment with compressed timelines, it’s a complex endeavor. Additionally, your cannabis business probably has multiple licenses (e.g., cultivation and distribution) and they could be in multiple jurisdictions: state, county, city or any combination of the three.

The transfer process between a company and a new investor or buyer can take four months or longer. For each type of license, you should understand the unique requirements because, in some cases, it may change your options. A dispensary may have a different approach to license transfers compared to a manufacturer/extractor, for example. The approach may impact your entire restructuring.

Your advisors should know the deep specifics, have creative options and take measures to compress timelines for what’s normally a much longer process. If the transfer is estimated to take three months, you have to keep the existing company alive for that three-month period. You should identify how to get the money to do that and work with the buyer collaboratively to achieve the transfer.

Many companies think a transaction happens on a certain date and it’s done. In reality, it’s a process with multiple inputs around it and multiple levers you can pull. Flexibility and creativity are key because the direction can change, and your advisor needs to be able to educate not only your company but the buyer and investor as well. For instance, if your company has licenses in multiple parts of the industry and an investor wants you to close offices, that could result in the loss of your license and inhibit the ability to move inventory.

Moving Forward Strategically

Industrywide, demand is down, and many believe taxes are too high — making it difficult for cannabis organizations to survive. While every company knows about growing their business, it takes a different skillset when the company goes into a decline. It’s hard to find the best way to right the ship, especially with cannabis’s complex and developing regulatory environment.

But, just like in other industries, cash is king in cannabis as well. If you don’t have enough of it on hand, working with an expert that specializes in helping financially distressed cannabis businesses could help you free up the necessary cash to extend your runway. The longer the runway, the more time and options you’ll have to turn around operations or create an exit.

When your company is in distress, every decision is amplified in importance. You should be looking for solutions and advisors quickly and considering every possible option to put your company in the best position to maneuver in an adverse market.

If you have any questions or want to learn more about corporate finance or restructuring options for your cannabis business, contact our experts.

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