As the cannabis business environment evolves and new markets open, there has been a boom of licensed operators entering the industry. From the outside, it may appear that the cannabis industry has limitless potential and is ripe for get-rich-quick thinking. But those of us who have been working in the industry for years know that it is not so simple. There are mounting obstacles to cannabis business success, from punishing tax regimes and complex regulatory structures, to unpredictable consumer behaviors, supply chain disruptions, and razor thin profit margins.
Having served the cannabis industry for nearly ten years, the accountants and advisors at GreenGrowth CPAs have seen it all. We’ve seen first-hand that only organized, strategic, focused and inventive cannabis operators are able to thrive in this competitive marketplace. In the following we’ll list out the most common reasons we see cannabis businesses fail, and provide our expert guidance on how to avoid these all too common pitfalls.
1. Running out of money
When working with cannabis business throughout the US, we often start with a simple question: “Are you currently profitable?” And surprisingly, few operators genuinely know. In response, we are often pointed to a safe loaded with cash. But as we dig into the financials of the operation we see that $50,000 on-hand hides hundreds of thousands of dollars in back taxes, unpaid invoices, operational overhead, and other burdens dragging down the bottom line.
The simple fact is: running any business is complicated … and running a cannabis business is VERY complicated. Many operators we meet have entered the cannabis industry because they are passionate about cultivation, about sales, about the healing power of the plant, or its potential for social justice. But very few operators are passionate about financials or accounting. Many cannabis industry owners simply lack business management, fiduciary responsibility, and other technical skills associated with company ownership, stewardship, and maintaining proper compliance standards. In addition, a lack of financial analysis and accounting skills often leads to difficulty for the business owner to identify unprofitable business models and make adjustments to business structure to increase growth and profits while decreasing costs and overhead.
Adding to this are the numerous reasons why taking out small business loans is so complicated, if not impossible, for cannabis operators. So all too often, an entrepreneur gets some start-up capital, spends tens of thousands on licensing, operations, and product. Only to find at the end of the year that they’ve spent far more than they’ve earned. Deep in the red… they have few places to turn beyond selling.
How to avoid running out of money…
It all boils down to financial accountability and reporting. The value of being able to close your books every month and say with confidence whether you’ve made or lost money is immeasurable. With even the most basic accounting best practices you can lower your tax liability and plan for tax payments (avoiding end-of-quarter surprises), track and optimize inventory performance, and keep an eye on overhead costs.
Keeping all this data organized and on-hand also makes sure you can pay vendors and staff, make rent every month, and reinvest in growing your business. Everyday we help cannabis operators establish and monitor these basic financial and accounting practices. If you can’t answer the question: “are you making money?” It is time to reassess your financial and accounting practices.
2. Rapid Growth and Over-Expansion
All too often cannabis operators hit the ground running, expand quickly to “seize market share” and find themselves over-extended and not seeing the profits their business plans promised. This happened extensively during the “Green Rush” of 2018-19 and we are still seeing the fall out with hundreds of distressed assets and licenses available.
In the cannabis industry, many markets offer significant growth potential as new legislative measures increase the availability of cannabis to the consumer through legalization. But poor fiscal management and unrealistic business plans have contributed to many cannabis businesses failing in rapidly growing markets after losing touch with their customers’ wants.
Moreover, the industries’ need for products and the fluctuations in price and raw materials can impact the bottom line. Cannabis business owners constantly face changes in flower prices, labor costs, Covid-19 restrictions, and other shortages associated with increasing costs and inflation.
How to avoid over-expansion…
When flush with early investor capital there is an understandable desire to rush out and build a business as quickly profitable, thinking “if you build it, they will come.” But the lessons of 2018-19 have shown that there are still many obstacles to profitability in the cannabis industry. You must understand this is a long game, and strategic investments now will likely pay off in the future, but you have to survive to that future point. To accomplish this it is best to focus on sound business principles. The rush of investor money into industries like technology have created an illusion that start-ups become “unicorns” overnight. But the sad reality is that for every unicorn there are hundreds of dead donkeys. Don’t be a donkey. Build business plans on sensible and verifiable market data. Create a long-term roadmap with growth in stages spurred by tangible achievements. For example, don’t open a second dispensary location until the first is stable and profitable and you can afford to take a loss for several quarters. The cannabis industry has shown that slow and steady is the best path to success. Don’t extinguish your enthusiasm, simply channel it into long-term plans.
3. Failing Tax and Regulatory Compliance
Considering how well publicized the issues with cannabis tax and regulatory compliance are, it is shocking how often we encounter operators who simply have not been paying their taxes… or have been ignoring letters from local regulators for non-compliance. Bad news is bad news whether you ignore it or not. It is of the utmost importance that you do not ignore the bad news.
The first responsibility for cannabis business owners and operators is maintaining compliance with shifting regulations, paying and filing proper taxes, and ensuring operating licenses are secured and maintained. In the previous examples, the consequences of running out of money are bad, but they can be solved with capital infusions and other solutions. But failing tax and regulatory compliance is a do-or-die proposition. Losing your operating license means the end of everything. Do not let this happen. And the risk of failing tax compliance is financial problems like you can barely imagine. Tax authorities can go after your house, your car, even issue jail time in certain circumstances. The potential consequences here are so dire they must be treated as such.
How to avoid failing tax and regulatory compliance…
Tax and regulatory compliance is complicated. There is no question about that. So the first recommended step is to bring on a partner who specializes in this. For example, GreenGrowth CPAs are cannabis tax experts. We can help you plan, optimize and maintain tax compliance, ultimately saving you money and helping you avoid IRS audits. What you ultimately pay experts like us in fees gets returned in peace of mind (and more than a little tax savings). This is similar to regulatory compliance, if you cannot staff a full-time compliance officer, it is best to outsource this function and make sure all the processes and controls are in place to ensure you never lose your licenses.
The second step is implementing, following, and updating appropriate internal controls. From the tax/financial side, this is as simple as closing your books, producing P&L statements and other key financial data. In many circumstances you can automate these processes to further lower overhead. The same goes for regulatory compliance, appropriately robust internal controls will save time, money and major headaches down the road. The last point is that these functions must be reviewed and updated on a regular basis or you risk falling out of compliance yet again.
4. Failing to Market Correctly
Another reason cannabis establishments fail is their lack of marketing experience and inability to reach their target audience. Business owners often lack the necessary knowledge to market online effectively. In addition, many cannabis company owners fail to identify and reach their target audience. The average cannabis consumer’s purchasing habits have shifted due to legalization, the Covid-19 pandemic, and changes to society’s acceptance of cannabis use. Purchasing patterns are directly related to brands that reach their target audience by providing a unique and quality experience that meets the demand and provides consistent customer value. Cannabis dispensaries that cannot offer quality flower or excellent customer benefits have difficulty retaining customers, especially in highly competitive markets.