Understanding the options to protect your cannabis business

Many cannabis companies are struggling as Canada’s retail market has failed to meet early expectations. Corporate leaders are facing difficult decisions to keep their businesses operational in a challenging market.  Entrepreneurs, boards of directors and management that recognize the signs of financial distress and take early action are more likely to weather the storm.

Business challenges for the cannabis industry

Licensed producers and others in the cannabis industry are facing headwinds – many outside of their control. Despite initially bright projections and a flood of investment, the market for legal recreational cannabis in Canada has failed to live up to the promises made in the lead-up to legalization. Cannabis companies are struggling to overcome hurdles and compete effectively with the black market, as only slightly more than half (53%) of cannabis users are buying from legal sources, according to Statistics Canada. Legal producers are facing significant barriers to compete with a black market that is better able to serve customers in terms of cost, location and supply.

Burdensome regulations, a slow licensing process, issues with opening physical stores in certain provinces, underwhelming online sales, restrictions on advertising and marketing, price disparities and an imbalance in supply and demand are converging to create a tumultuous market environment. CIBC analysts expect cannabis producer sales to reach $2.2 billion in 2020 – well below the $6.5 billion consensus revenue estimate of other analysts in the cannabis sector earlier.  Although “Cannabis 2.0” – which includes new products such as beverages, oils and other edibles – was initially expected to buoy the market, a slow approval process is hindering growth.

Investor pressure is mounting as cannabis companies report lackluster results and fail to reach profitability. Companies are pursuing different approaches to weather the storm – from cost cutting and more cautious spending, to mergers and acquisitions or partnerships outside the cannabis space – but for others, more aggressive strategies are required.

Financial models – an invaluable navigation tool in a turbulent market

In times of crisis, a financial model can provide valuable insight into impending business challenges and spot liquidity issues before they manifest. A financial model can also serve as a vital communication tool when dealing with lenders, customers, suppliers and other stakeholders. Armed with this information early on, businesses can explore solutions such as cost cutting, re-negotiating payment terms with suppliers, partial divestitures or consolidation with a competitor and understand the impact before execution.

A financial model can be particularly helpful in a sector such as cannabis, where there is a long cash conversion cycle as significant working capital is tied up while the crop is grown. For licenced producers, reaching the point when the crop is ready for harvest requires substantial capital investment. Again, a model can help a company demonstrate the value of the investment needed to its stakeholders.

While any company facing financial headwinds can benefit from the data and insights from a robust financial model, many companies lack the skillset to put together a professional financial model in-house. In addition to modelling expertise, an outside advisor can provide support to management in presenting plans to the company’s lender.

Ultimately, a financial model can provide management and owners maximum control over an enterprise’s fate.

Formal insolvency options

Despite decisive action by skilled management, there may come a time when a company is unable to fund its future obligations, particularly in a challenging sector such as cannabis. In such instances, understanding the options available early on can help management be prepared and achieve the best outcome.

In Canada, there are two main statutes to help troubled businesses seek protection from creditors and maintain some control of the process: the Companies’ Creditors Arrangement Act (CCAA) and the Bankruptcy and Insolvency Act. Under both statutes, a stay of proceedings protects the company from legal action by suppliers or other parties, providing breathing room as the company continues to operate and works to develop a restructuring plan. Once tabled, accepted by the creditors and approved by the Court, the plan developed under either statute becomes binding on all stakeholders. Agreement from most of the creditors can be used to bind dissenting votes from other creditors.

In 2019 there were three cannabis companies which filed for bankruptcy protection under the CCAA: Ascent Industries, AgMedica and Wayland Group. By being proactive, they were able to potentially avoid a receivership initiated by their lenders. Also in the same year, two companies found themselves subject to receivership proceedings.

The end game

Being proactive and addressing issues early on could mean the difference between losing control or saving your company. Companies facing financial distress who don’t have a meaningful and well-structured plan in place are more likely to find themselves subject to a receivership or other enforcement proceedings. Many entrepreneurs provide personal guarantees for their company’s obligations, so success of the company can also mean the difference between maintaining or losing personal assets.

Grant Thornton is a trusted leader in the restructuring space in Canada. We pride ourselves on the many positive outcomes we have achieved for our clients. We helped several different cannabis clients navigate the difficult market environment today and look forward to continuing to do so in the future.