We work with many large cannabis businesses and many small ones too. It’s fun to talk up the bigger fish, but I have a soft spot for the little guys. I really enjoy small business at the end of the day. I like seeing financial statements of disciplined, privately held companies doing maybe $5m to $20m in annual sales; where the owners are getting good margins in a low-ego, no-drama environment; where the workforce is relatively stable; and where they only call me when it’s time for something sensible. Those are great little businesses.
These well run, profitable companies are also somewhat rare in the cannabis industry. Due to intense competition, heavy taxation and other business challenges, I don’t see as many of them as I’d like. Instead, the headlines are gobbled up by larger outfits that may or may not be run very well.
So, how are some of these cannabis businesses thriving? Here are five hallmarks of a successful, privately held cannabis company.
They control expenses
Controlling costs is important in any line of business, but it’s especially important for cannabis businesses where nothing beyond direct costs of goods sold (COGS) can be deducted from taxable income. We all know IRC § 280E is a bear.
If a cannabis business is spending money on advertising, for example, those ads or sponsorships must have ROI. If you show me a P&L with high advertising costs, high employee travel costs, significant meal expenses, outsized dues and subscriptions, etc., I won’t expect to see much margin there.
Expenses in cannabis are hard because everyone wants to charge these companies a premium. Also, when a small business owner is handling so much cash, it seems to make spending easier. The best companies have an owner in a “controller” chair of sorts, and the first c-suite hire may be someone in financial operations.
They don’t raise money
I’ve seen too many cannabis businesses undone by bad money raises. In an ideal scenario, founders would bootstrap everything and not raise money at all.
The pitfalls of raising money range from securities laws issues to onerous business terms. Over the past five or six years, we’ve probably handled more cannabis litigation around investment than any other topic.
Hard money loans are common in cannabis. These loans typically feature high interest rates and aggressive repayment schedules. Lenders often disregard even basic underwriting concepts. Exacerbating this dynamic, some states don’t have usury interest prohibitions for most written loans. You’d be astonished at some of the terms we have seen in Oregon and elsewhere.
Another common misstep is for a small cannabis businesses to onboard a large number of private investors in a single raise. Maybe the business raises $1 million from a few dozen individuals. When loan repayment becomes difficult, or when minority owners do not receive distributions or dividends, the business owners spend half of every day fending off emails.
If a cannabis business absolutely has to raise money, in my view it should: 1) take as little as possible, 2) based on sound forecasting, 3) from investors who understand and believe in the company, and 4) paper the transaction carefully. And maybe still don’t raise money.
They expand carefully
It’s easy and tempting to expand in cannabis. Failed businesses abound; much is for sale. Customer preferences constantly evolve within and across categories. Money is still relatively cheap and plentiful. Etc. etc. There are many reasons to expand.
The big cannabis pubcos are notorious for reckless expansion, but we see it frequently with smaller shops too. Conversely, the best operators find where they excel and leverage it relentlessly. They think really, really hard before taking on a new facility, or even pushing out another SKU. When they do expand, they often stick the landing. And that’s because they thought it through.
They treat people well
Good cannabis businesses have higher employee retention than their competitors. They pay vendors timely. They are respectful of competitors. Their customers love them. They are an open book with regulators. Etc.
We have a couple of clients that are great at this stuff, and it’s impressive. All of that goodwill accrues to the business and the brand, and ultimately, to the bottom line. It can also come in handy if the business gets into a tight spot.
They have good advisers
I’ve seen too many promising or profitable ventures undone by bad advice– and not just on the front end. We’re dealing a botched sale now: the lawyers had limited experience in cannabis and seemingly in business overall. The end result is a lot of waste and a smaller payday for the business owners.
As to CPAs, we’ve seen accountants take positions that clearly cut against the revenue code and companion cannabis tax cases, resulting in painful audits. We’ve also seen plenty of regrettable tax advice on entity set-up. In extreme scenarios, a partnership owner will be saddled with taxable income exceeding profits.
We’ve written plenty about suspect business structuring and what to watch out for with lawyers and other advisers in the cannabis space. Find a good one, listen to them, adhere to the guidelines above and other commonsense practices. With any luck you’ll be one of the small cannabis businesses that turns a handsome profit without a lot of fanfare.