In 1971, philosopher John Rawls came up with the “Veil of Ignorance.” The concept is pretty simple: You start with the idea that you know nothing of your circumstances at birth—wealth, gender, education, etc.—and then ask yourself if you would be ok with the current social contract in which you live.
Let’s conduct this thought experiment for the current cannabis industry: Imagine you do not know anything about your current situation—capital, abilities, partners, etc. Would you sign up to make a go of it in today’s cannabis industry with its poorly implemented regulations, federal illegality, non-experts peddling their expertise, and the still thriving illicit market? Probably not. But, given you are reading this you are most likely in the cannabis business (as we are), and the best course forward is to deal with the cannabis world as it is, not as you want it to be.
Here are the six lessons we wish we had learned prior to our entrance into the cannabis industry in hopes that they might lead you to better outcomes.
1. Be wary of “experts.”
The order in which you learn your hard-knock lessons depends on your circumstances. Sooner or later, you learn not to trust experts with steering your business decisions. Whether lawyers, accountants, consultants, or your stoner uncle, do not take advice without a heavy dose of skepticism. Take the advice as input into your decision process. Ask around for multiple opinions. Even on a hard and fast legal matter on which you are being advised has no maneuvering room, allow for the possibility the expert might be wrong.
In our experience, there are no experts in legal cannabis, just a bunch of people in this newly created legal industry with differing levels of ignorance. Illicit-market operators going legit have a lot to offer, but keep in mind they might not have any experience operating in a regulated environment. Additionally, newly minted experts, as a rule, do not have significant expertise in newly morphing industries.
2. Be mindful of the most expensive inputs into your business.
There are three inputs into your cannabis business that are company killers: the cost of labor, the cost of real estate (whether purchased or leased), and the cost of the inevitable mistakes you will make (yes, this is an input).
This last input usually is ignored when making a budget and therefore no margin of error is calculated in go-to-market timelines and capex budgets. Delayed regulatory time frames or hiccups in the first flower or extract batches can completely shatter even the most detailed budget if you don’t leave yourself any room to breathe.
When it comes to real estate, the lowest cost option that satisfies your business plan is the best option. Leave your ego out of where your business is located if you can meet your pro forma (which, by definition, is usually wrong, as it is a single projection in time without much information from hard-to-get comparable company data in a new industry).
Labor also is a highly disruptive expense. If you overpay your employees, then when you can’t meet payroll (which, for many in this industry, is inevitable), you will lose the very people you need to run the business. This is especially true in cannabis, a developing industry subject to so many risks. The overall comp package is more important to most people than whether they are maximizing base salary. Equity participation and other benefits go a long way and give a deserved sense of ownership to all employees.
Courtesy of High Desert Flower
3. Do not personally guarantee anything.
This lesson should really not have to be pointed out, but the level of enthusiasm we’re seeing among people eager to enter the business often blinds them to the concept of contingent liabilities that can destroy their financial lives and potentially their personal lives.
Bankruptcy is a process overseen by the U.S. Department of Justice that allows companies and people to start over if they followed all the rules and just got over their heads in legitimate activities. Because cannabis remains federally illegal, bankruptcy is not an option for your business. When you personally guarantee a repayment of any kind, you have no backdoor by which to get out of your situation.
Compounding this is that many landlords and their attorneys insist on getting personal guarantees in order to “keep people focused on the business.” This counter-intuitive idea causes businesses to implode much more quickly if a cannabis operator is backed into a corner. It makes no sense to create a limited liability entity, whether corporation or LLC, only to personally sign to repay an uneconomical debt. It is much better to work into a lease or any other contract remedies such as asset forfeitures and receivership provisions so that all parties going in understand the risks.
If you get a sense, for example, that your landlord does not understand the cannabis business, then being aware of these issues is paramount to your survival. All cannabis businesses eventually hit financial bumps in the road. Lay the groundwork to not wreck your life.
4. Understand the revenue cycles of your particular cannabis businesses.
Each business has a different revenue cycle. A revenue cycle starts with the first day an input to the business is put to work until the last day when that original input is monetized into cash. The cycle restarts when you use that cash to purchase additional inputs. .
A grow operation needs a long lead time to get started. Location selection, licensing, and finally that initial planting. An outdoor crop gets planted in the spring and sold in the fall. Assuming the crop doesn’t go bad and is sold, the cycle is around 8 months (planting, growing, drying, curing, sales, and collections).
When you start up a grow operation from scratch and add the timelines of start-up to planting and from planting to cash back in your hand, 18 months easily can elapse. We’ve never seen a pro forma for a cultivation start-up admit to this timeline. Usually the presenter shows “Month 1” with immediate sales and, more surprisingly, profit. Obviously grows done in greenhouses and indoors turnover more (4 to 6 times a year).
Oil extraction is a much shorter cycle. Raw material in, process to oil or distillate, then sell. Assuming the buyer gets net terms of 14 days, the cycle can be as little as 30 days.
For a dispensary, you can literally bring in product, on terms, and sell the same day.
These are the main verticals—testing labs and wholesalers also have their own revenue cycles. You should pull together all your revenue and expense cycles into an Excel pro forma model. Most businesses, once up and running, are driven by a handful of variables (say, revenue, labor, yield, etc.) and understanding their sensitivities to changes will make you a much smarter operator.
“This industry is hard enough without you making it worse for yourself.”
5. Understand your state and local regulatory landscape.
One of the traps newly minted cannabis entrepreneurs fall into is spending too much time looking at the federal level, following minor bills in Congress with only a few co-sponsors, chatting about what this politician said or what that public figure stated. None of it means anything unless actions, laws, and regulations are implemented in your state.
Spend your time close to home learning the nitty-gritty of your state’s licensing process, your local approval requirements, the ebb and flow of raw product in the market, and anything else that will come into play in your day-to-day decisions. Figuring out how you are going to sell your flower to the 20 dispensaries within half a day’s drive from your grow is a much better use of your time than what some politician said about banking regulation.
Time management is not a concept that really works in cannabis. You won’t be able to manage everything in the time you have during waking hours. The key is priority of time expenditure. Meaning, what tasks can you focus on today that will give you the biggest return for your time invested by getting you closer to your goals? Not everything is going to help you move toward your objective.
6. Expend the necessary energy obtaining a cannabis bank account.
Nothing screams legitimacy and offers a higher level of validation than a depository institution taking your cannabis company on as a client. The accounts are not easy to get, and sometimes it requires a concerted effort not only to find an institution that works with cannabis companies, but also to get through the application process and the quarterly reviews.
While the monthly fees can be high, it is still worth it. Having a bank account helps you keep better books, and makes it easier to pay your bills and manage a payroll system. Probably the most important reason to get a bank account is a lot of third-party investors won’t even consider you for investment without an account. To an investor, your ability to pass the state’s and depository’s hurdles to get and keep an account makes it easier for them to conduct due diligence on your firm and your directors.
Dedicate one person on your team to getting a bank account for the business. Even if it takes months, the person should stick to constantly working on this objective.
Wrapping It Up
The above is not an exhaustive list of the lessons that we learned too late. But by spending time avoiding what we, the battled-scarred authors can attest, have observed and experienced, you increase your chances of not committing unforced errors
This industry is hard enough without you making it worse for yourself. Remember your high school-level risk management math. If you need to succeed in five critical areas to have long-term success, and each of those areas has a 80 percent success rate, you do not have an 80 percent chance at success. Compounding risk is a multiplicative function, meaning your chance of success is 32.8 percent (0.8^5), or a 1 in 3 chance of making a successful go of it in cannabis. Something to keep in mind when deciding where to focus your efforts.
Loren Picard is CEO at High Desert Flower Inc. in Oregon.
Andrew Olsson is vice president at High Desert Flower Inc. and is the co-founder of Engineered Extracts LLC, also in Oregon