SMBs Are The Engine Of The Cannabis M&A Economy, Report Says

Small and mid-sized cannabis businesses are taking the lead in merger and acquisition activities, a new report reveals.

Arizona-based law firm Bianchi & Brandt has published a trend report titled “The Great Correction in Cannabis M&A” on cannabis M&A activities during a period of market correction.

The report assesses the current trend in M&A activities in an environment that lacks access to the federal legality of cannabis and access to traditional banking services.

The cannabis market has undergone a realignment due to some significant contractions.

Notably, there has been a considerable decline in the average size of equity raises, decreasing by 44% from 2021 to 2022, according to the data from New Frontier Data cited in the report. The figures show a drop from $22.2 million to $12.4 million. Similarly, debt raises have experienced a significant decrease year over year, plummeting from $45.7 million to only $21.5 million.

As a result, the cannabis industry has experienced reduced valuations due to adjustments made in response to market realities.

But despite the noticeable decrease in available capital, companies are still engaging in M&A activities. They are particularly focusing on SMBs involved in such transactions.

The report emphasizes that market corrections are essential for the long-term health and sustainability of the cannabis industry.

The report states that Bianchi & Brandt has actively collaborated with clients and partners to anticipate what they call”The Great Correction,” ensuring preparedness for the evolving direction of the market.

Laura Bianchi, founding partner at Bianchi & Brandt, pointed out that a scarcity of cash is the primary factor contributing to the reduced M&A efforts within cannabis businesses.

“M&A requires an outlay of cash, so businesses are shifting focus to the things they can do to streamline and be more efficient before they thin themselves out with more expenditures. We’re also seeing the conflation of a multitude of stressors, including bad debt and the slow rollout of state programs that are forcing businesses to focus on what they can do today to set themselves up for better deals in the future,” she said.

Despite the initial cannabis boom triggered by adult-use legalizations in Colorado and Washington in 2012, the industry struggled to sustain early successes.

Bianchi highlights that business owners often spend cash without a clear plan or discipline, opting for parties and hiring friends rather than establishing robust business and legal teams capable of navigating the rapidly changing landscape of a federally illegal industry.

Nevertheless, she maintains optimism regarding the ultimate outcome, saying that those who persevere in the industry are dedicated to building robust businesses and shaping their trajectory for the long term.

“This bust, painful as it is for many, has shifted us into the much-needed reality that cannabis is, in fact, a business,” Bianchi said.

Amid the so-called “The Great Correction,” Bianchi explained that cannabis SMBs showcase agility and strategic partnerships, outperforming MSOs. While the latter focus on fortifying their foundations post-“green rush” oversights, SMBs are making a significant impact across U.S. sectors, including cannabis.

Current mergers are driven by mutual recognition of complementary strengths and weaknesses, often without an immediate need for capital.

Patient operators are exploring unique opportunities, acquiring distressed businesses at significant discounts with thorough due diligence.

Emerging markets, characterized by financial potential and predictable cycles, become attractive M&A targets. The sudden legal access to cannabis generates high demand, making these markets strategic for M&As.

While traditional M&A focuses on market share, core competency, and efficiency, cannabis M&A introduces additional considerations like complex licensing structures, real estate zoning restrictions, and vertically integrated operations across cultivation, manufacturing, and retail. The diverse state regulations and legislative frameworks further complicate these transactions due to the decentralized nature of cannabis regulation at the state level.

In this context, SMBs actively participate in heightened mergers and joint ventures. Some are consolidating to expand their footprint, while others are pooling resources and capitalizing on distressed assets to fortify their position for future growth.

“The key driver is assets,” Bianchi explained. “In some states, we’re even seeing split licenses, where one party with expertise in retail is merging with another who is exceptional in cultivation, for example,” she said.

Stricter cannabis license regulations have inadvertently fueled the rise of illicit businesses, observed notably in California and, more recently, in New York. Despite these challenges, Bianchi emphasizes that cannabis programs need to evolve in order to succeed in these markets. Anticipating the future, strategic actions taken now can contribute to success in the cannabis market five years down the line.

“If you have that long-haul game plan and the capital to do it, it’s going to be the best way to go about it because it’s a very challenging market right now,” she said.

However, there are two significant federal-level events that can propel M&A operations forward and revitalize its economy.

One would be the final approval of the SAFER Banking Act, which would provide traditional banking access to cannabis businesses, and it has recently passed the Senate Committee. Bianchi explained that cannabis businesses hardly have access to traditional banking services, and when they do, they face high expenses for basic business accounts due to substantial fees and additional entry barriers, including compliance demands for sensitive information requiring legal assistance.

“SAFER banking will eliminate some of those barriers and create more competition in the banking marketplace, which is what is needed to create a fair climate for banking. Banks are already coming to us wanting to get prepared for the passage of SAFER banking legislation, so we know that the parties involved ultimately want to do the same thing,” she said.

But the major driver to increase M&A operations would be the rescheduling or descheduling of cannabis at the federal level.

“One of the biggest impacts will be from a tax perspective. We will hopefully see Internal Revenue Code 280E go away, which is a practical benefit. Right now, cannabis businesses can’t take any of the normal business deductions, so their tax rates can soar to 40% or 50%. If they’re carrying that tax liability because they can’t or don’t pay, they’re immediately unattractive in the M&A market. M&A will still happen from a licensing standpoint because the license itself is very valuable, but the elimination of 280E would ease the tax burden and free up funds for M&A transactions,” Bianchi said.

Bianchi highlights that the possible rescheduling of cannabis has big implications. While marijuana is classified as Schedule I, similar to heroin, some are hesitant to join the industry. But if it is rescheduled or even descheduled, more private funding could come in, boosting the industry with capital and attracting traditional business expertise during this transformative “Great Correction.”

This industry moment is perfect for strategic thinkers with a skilled team and long-term goals, according to Bianchi. Licensing, operations, and real estate hold significant potential, with current assets undervalued compared to the industry’s peak. For those comfortable with risk, this is a chance to benefit while others hesitate or leave.

Bianchi argues that before SAFER banking and rescheduling become widespread, there’s a window for lucrative deals as the industry rapidly changes with larger players entering from outside the cannabis sector.

“The current big players in cannabis are nothing compared to the big players outside of cannabis. Before that happens, you have a window of time where I think you can get some great deals before things really start to change and evolve—and that happens fast,” she said.

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