Unserviceable debt was unexpected. Layoffs, unimaginable. Both are in the business news.
Little over a year ago, in October 2018, recreational cannabis was legalized in Canada. In the Green Rush, a sprint to market, many entrants hurriedly created verticals, to keep all from production to retail in-house―and expected returns in company coffers.
Large Canadian pot producers have a median of 6.5 months of cash, Bloomberg reported in February 2020.
He continues: “There has been some discussion about whether the emerging situation is a result of IFRS (International Financial Reporting Standards) that require cannabis plants to be measured at fair value. But, the accounting standards are not the issue. Companies overspent based on overly optimistic projections.”
Statistics Canada data shows that recreational cannabis resulted in $908 million in sales between October 2018 and September 2019; analysts projected $4.34 billion for the first year after legalization.
“Revenue has not been as expected,” notes David Linton, a partner with BDO Consulting. “Cannabis organizations are struggling to keep the cash flow positive, which is resulting in layoffs, mothballing cultivation facilities, diminishing expansion capabilities into other countries… The slow roll out of retail in some provinces, the slow clamp down on the illegal cannabis market, the slow introduction of additional cannabis products, commonly known as Cannabis 2.0, resulted in legal cannabis that is approximately twice the price of product on the black market. Excise tax on recreational and medical product, and complex accounting standards added operational complexity, in addition to the general compliance and government reporting requirements to maintain and manage cannabis operations.”
“And, to ensure growth requirements and product availability were met at legalization, the industry relied heavily on convertible debt or equity financing,” adds Hamid Shekarchi, a senior manager in Financial Advisory Services. “The timing of interest payments and the maturity of these issuances will be a key factor in determining whether the companies will be able to meet their obligations. It's important that cash inefficiencies are located to maintain current levels of operations, or proper financing is obtained. Right now, markets are taking a very grim view on cannabis companies, and companies are raising capital at a fraction of the publicly quoted market price, which causes the stock price to plummet—but they need to do that in order to pay existing convertible-debt obligations or they face financial challenges that lead to formal proceedings.”
“It could be a long-term storm in this industry,” observes Jervis Rodrigues, a BDO partner and senior VP focused on restructurings, turnaround, and refinancing of underperforming businesses. “Before we consider formal restructuring, or CCAA (Companies' Creditors Arrangement Act), or insolvency, or bankruptcy, one of the key areas to focus on first is cash-flow management, including cost reduction and operational efficiencies to help them weather the storm—and hopefully it is a short-term storm.”
Jervis continues: “The second key area is an operations review of the entity to see where we might be able to provide areas where the cannabis organization may be able to internally restructure, reduce their management structure, their operational structure, their production costs, etc.”
“And, the third area is early-stage renegotiation of terms with investors, with lenders, and that could be all the way to negotiating an appropriate forbearance agreement on behalf of the troubled cannabis company and its investors, financiers, bankers, private equity, etc., so that they can avoid CCAA, bankruptcy.”
“We have seen this in other industries, in mining, in tech. It's something we're used to dealing with. These issues that we're seeing in the cannabis industry, we've seen these things happen before,” continues Armand. “Startups in various industries have historically liked to list on the TSX-V (Toronto Stock Exchange Ventures Exchange) and the CSE (Canadian Securities Exchange). This is nothing new for us. It's relatively common in startups to see renegotiating debt to extend the maturity.”
Alan Mak, National Forensics Practice Leader at BDO adds: “Startups are driven by entrepreneurs with great ideas, who may have expertise or specialties—in this case, in the cannabis industry. They're not necessarily financially inclined, or they may not have any experience in dealing with banks or raising capital. But, they had a great idea, or they got into it early. So, they got the money they needed upfront quickly because investors were keen, but if the organization didn't have proper controls, or they weren't paying attention to the regulatory details, now they're in trouble. Many did overspend, to Armand's point, and that speaks to not having the right people in management positions, people with expertise monitoring cash flows and projecting what their needs were going to be.”
BDO's corporate mandate is people helping people achieve their dreams.
“At BDO, we help advise on whether cannabis organizations should restructure, lay off, adjust their cash flow, delist, and so on, then help them execute that plan, whatever that plan may be,” David explains.
“We don't know what a client needs until we've had an opportunity to sit with them and hear them out to know what their challenges are—what they perceive their challenges to be,” Alan agrees. Often there are complementary services within the BDO suite that would be beneficial to the client. BDO does a great job teaming to meet the needs of the client, and add value.”
To learn more about how our team can add value for your cannabis organization, contact us.