The 5 Common Disruption and Extinction Events Driving Cannabis M&A Deals
Top photo: © alphaspirit | Adobe Stock
As the cannabis industry continues to evolve, businesses can fall into peril for many reasons, from compliance with ever-changing regulations to increased competition and plummeting market prices. Left unresolved, these issues can drive companies to merge or get acquired in order to survive in an increasingly challenging marketplace.
Here, Sabas Carrillo, founder, managing partner and CEO of Adnant Consulting, a Los Angeles-based accounting and consulting firm, outlines five common disruption and extinction events that are driving M&A deals in the cannabis space.
1. Changing Regulations and Licensing
Regulation rollout and permitting continue to disrupt the cannabis market and cause companies to fail, Carrillo says. In states where a gray market transitions into a regulated industry, such as California, cannabis businesses must obtain licenses when rules go into effect, which puts a strain on operators even now, more than a year after California’s legal adult-use market launched in January 2018.
“That caused a bunch of people to scramble,” Carrillo says. “Some people went out of business, and a lot of people really, really struggled. Right now, what we’re seeing is that this is a topic of conversation amongst a lot of small- and medium-sized companies that are kind of hanging on by a thread.”
In 2018, California’s cannabis business owners put a heavy focus on compliance with the new regulations, which led to increased operating costs as they hired additional staff, such as compliance officers and team members dedicated to tracking licensing applications and renewals. Licensed businesses also had to start paying taxes, all while still competing with unlicensed companies that maintained lower operating costs.
In addition, some companies in California that have been operating with temporary licenses have simply been denied permanent annual licensure. “That’s … [a] wake up call, and that’s really scary,” Carrillo says.
In West Hollywood, for example, Adnant has seen many dispensaries spend several million dollars building out storefronts, only to later learn that they were not going to receive permits.
“I think some of those companies that are already hanging by a thread are about to collapse,” Carrillo says. “That’s going to force them to try to go do some deals to sell themselves, to merge with other companies and other partners, or to do something.”
2. Falling Market Prices
Rapidly declining wholesale cannabis prices are also causing some companies to look to M&A deals as an exit strategy, Carrillo says.
“Market prices are all over the place,” he says. “Specifically, market prices are starting to come down as greater efficiencies and innovation come into the industry.”
As new extraction technology comes online, for example, the cost of extraction is decreasing.
“A year ago, having a machine that would do 100 pounds a day was huge,” Carrillo says. “Then we started seeing machines that could do 1,000 pounds a day. Now we’re seeing machines that can do 10,000 pounds a day and that are also constant feed systems. So, … there are companies that had at least a one-year agreement for pricing around their oil, and if they don’t have this innovation, … for example, all of a sudden they’re scrambling because they have these other competitors that are offering oil at a lot cheaper rates, and they’re scrambling to re-negotiate with their buyers in order to survive.”
3. Increased Competition
While 2017 and 2018 saw a flood of money from investors coming into the industry, 2019 will likely see more entrepreneurs enter the market, according to Carrillo.
“I see mom-and-pop wine makers wanting to get into the business because they’re like, ‘Well, I already own 10 acres and … processing equipment. I already have this know-how and it’s not that hard to come into this industry,’” he says. “We’re hitting a milestone in terms of the industry becoming a little more mainstream. More entrepreneurs are coming into the industry, and that’s different than just money coming into the industry.”
As more businesses pop up, competition becomes fierce, and market consolidation increases.
Published: February 21, 2019
Founder & Interim Editor of L.A. Cannabis News