For U.S. cannabis companies, options for capital are limited due to traditional banks being hamstrung by federal law, and rarely doing business with them. At the same time, the federal tax code bars cannabis companies from taking tax deductions from normal business operations. Cannabis companies could have to follow separate wind-down proceedings in every state in which they own assets.
Since March, stocks have dropped by about two-thirds and capital markets have largely frozen for all companies, except the strongest. This could be the start of a cannabis liquidity crisis that companies may soon have to face.
It was only a year ago that growth enveloped the cannabis industry. Legalization happened and the potential for growth seemed unlimited. However, that bubble has finally burst as the reality of a difficult regulatory landscape took shape.
Stock markets are down due to the cannabis liquidity crisis
Currently, a cash crisis is leaving some on the verge of bankruptcy. Due to the illegal status of cannabis under U.S. federal laws, firms are blocked from seeking protection in bankruptcy court.
The industry’s problems have become so severe that a top executive of a large cannabis company predicted that up to a dozen smaller companies could go bankrupt in the second quarter of 2020.
The executive, who asked not to be identified and declined to name specific firms, said that in the past three months, companies have been calling more frequently with urgent, last-ditch attempts to be acquired.
The crisis will be a big problem for U.S. companies
“Some of those companies, which are public and private, are two to four weeks away from missing payroll and none of them is an attractive takeover target,” said the executive.
For U.S. companies, this poses a problem. Bankruptcy is governed by federal law which considers cannabis an illegal substance.
This means that cannabis companies cannot get Chapter 11 protection from creditors or a centralized sale process. Without that, the result could be a state-by-state struggle by creditors for assets.
The great risk for small players
“The U.S. bankruptcy trustee has taken a hard-line position on this,” said Sean Gordon, a partner at Thompson Hine LLP. “It is incredibly difficult for a cannabis-related business to file and not get their case dismissed,” he added.
While smaller players are at greater risk, better-known companies are also dealing with a cannabis liquidity crisis. Headquartered in Los Angeles, MedMen Enterprises Inc. said last week it reduced corporate staff by more than 40%.
It also issued $27 million shares at $0.43 each, 14% below the stock’s closing price on Dec. 10.
Dealing with the cannabis liquidity crisis the “Canadian way”
Meanwhile, cannabis companies with operations in several states would have to follow separate liquidation procedures in each state in which they hold assets.
There may be an alternative for U.S. cannabis companies listed on Canadian stock exchanges.
“We are actively exploring the use of Canada as a jurisdiction for U.S. operators doing business in Canada,” said Michael Smith, a New York-based partner in the law firm of Greenspoon Marder LLP.
He is meeting with Canadian lawyers and accounting firms to discuss the possibility of U.S. companies declaring bankruptcy in Canadian courts.
“Over time, having a shakeout, and seeing some companies sink to the cannabis liquidity crisis will be very helpful to the industry. We need to see the marketplace get cleaned up,” said Vivien Azer, an analyst at Cowen & Co.
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