There are tons of articles out there detailing the cannabis licensing processes, the high valuations of cannabis companies, and the astronomical costs associated with getting started in this industry. As an entrepreneur new to this space, you may read blog posts and see videos about how licenses are probably one of the most expensive costs of the business.
Some even call cannabis business licenses the golden ticket to the industry. But in most cases, it couldn’t be further from the truth.
Our experts field plenty of phone calls from clients and prospective clients who are very uninformed about the value of their license – and sometimes, even about the value of their business. The key issue is that most people don’t know the difference between owning a license and owning an actual cannabis business operating with positive cash flow. The difference between these two assets could not be bigger.
The failure rate of new cannabis companies is high, even in a country where 20% of all small businesses fail in their first year. We’ve seen an ongoing trend of entrepreneurs shelling out a ton of money to get started in this space, only to bleed cash and ultimately close their doors.
In this post, we’ll cover some considerations you should make before you spend big on a cannabis license or a cannabis business, and explain what the difference is between buying a license and buying an actual business.
Consider this post a healthy dose of reality: by the end, you may want to buy into a laundromat business instead of diving headfirst into cannabis.
Is Your Market Ready for New Entrants?
The first question you must ask before investing in either a cannabis license or a cannabis business is whether or not the market is ready. Consider the maturity of the medical cannabis market that you are getting into. That will weigh heavily into whether or not you even want to try to compete for a license or buy a business.
The oldest medical cannabis market in the country is California. Despite the fact that this market has been around for 20 years, there are still plenty of quirks that can make doing business difficult. For instance, a long-existing medical cannabis market usually means an equally thriving black market exists. This means that the local cannabis businesses, both legal and illegal, have been building relationships with their customers and cementing their place in the market for years. The longer that a medical cannabis market has been around, the smaller the incremental bump will in sales be when your state allows recreational cannabis.
Case-in-point: when California opened up the market for recreational cannabis, there was no flood of new customers flocking to licensed shops. There was a relatively small new group of consumers (an incremental bump in demand), and the black market still is thriving nearly three years later.
Bottom line: the younger the medical cannabis market, the better the business opportunity.
Buy a cannabis license, or buy a cannabis business?
If you believe the market is ready for your investment, then the next step is to decide whether you will pay for a cannabis business license, or buy an existing business. We want to preface this with one thing...there is no answer to this question. It depends on many factors including your risk tolerance, your experience, growth/exit plans and much more!
A license, in most cases, is just a checkbox; a green light by the powers that be, authorizing you to open a business. A license says you can go ahead with the next steps to starting a cannabis business, but it doesn’t ensure that you win customers or make a profit.
The process of getting a license is incredibly costly and there is no guarantee that you will actually get it. Once you do, the clock starts ticking for you to build a valuable business.
There are two good reasons to buy a cannabis license:
When looking for licenses to purchase, especially retail licenses, make sure that the market makes sense and you’re not just getting overzealous about having a cannabis license. Make sure this license will unlock some type of financial benefit for your current business. Cannabis cultivators, manufacturers, and distributors can be more flexible because you can drive to get to your clients, so you need to make sure you look at the financials behind operating the business and find the cheapest cost of doing business.
On the other hand, businesses are sets of processes, people, and property that create value. If you’re looking to buy a business, the most valuable ones are obviously those that are already profitable. Look for cannabis companies that have strong SOPs, amazing staff and repeatable success built-in. This goes for retail businesses and all other cannabis verticals. If you don’t look beyond profit, you risk taking on tons of liability with a company that doesn’t have the right compliance measures and documentation procedures in place.
And one last point on buying a business is that you MUST have self-awareness as to whether or not you can actually operate a business. There is a significant difference between being an owner and an operator. Just because you own a business doesn’t mean that you will be able to run it well. Operators have a multi-disciplinary skill set that allows them to handle the many facets of running a business from HR, to finance, to supply chain and everything else that comes with it. This is where the power of having a team is important. If you know you are not an operator then you have two options:
The “Green Rush” Myth
The media loves to write headlines about the so-called “green rush.” The green rush refers to the spread of legal recreational cannabis across the US, alluding to the Gold Rush of the 1800s and the money-making potential of this industry.
In reality, the green rush is mostly hype. It’s a storyline pushed by the media that’s become ingrained in cannabis lore, only to be proven wrong at every turn. From our experience, don’t let these news stories or crazy high valuations of public cannabis companies trick you into thinking that cannabis is going to make you rich. Most of the time, it won’t. Once you look at real numbers and the amount of added complexity from working in this highly-regulated industry, you’ll see that making it in cannabis isn’t as simple as digging for gold.
Tips for getting started in the cannabis industry
If you’re still considering investing in the cannabis market, then we strongly recommend making your decision as rationally as possible. Do your research, think about the cash expenditure required, and calculate how much you stand to earn on that cash. This is above all a financial decision, not an emotional one.
Before you buy a cannabis business, do a very thorough analysis of the financials and the opportunity that you’re buying into. Don’t let the green rush narrative cloud your judgment. You are making a financial decision. Ask yourself, what will this investment yield?
In most instances, businesses are a more valuable investment opportunity than licenses, especially if they are break-even or profitable, have an aggressive tax strategy and have a stable set of clients.
Budgeting for Your Investment
Now that you know the difference between the value of a license and an operating business, think about your budget.
If you have less than $100,000 in cash, you’re going to have an extremely hard time getting directly into the licensed cannabis business as a sole owner. The only market that you could reasonably get into with a budget of that size is in Oklahoma. At this time, this state has a much lower cost for licensing. The cost of doing business in Oklahoma is also lower. However, you need to be an Oklahoman resident for two years to get approved.
If you’re not an OK resident, you may want to find partners to pool funds together. Buy into part of a business or create an ancillary business that helps cannabis businesses succeed. For example, can you get into the waste removal business, set up security cameras, or start an electrical or construction firm that specializes in cannabis cultivation operations.
If your budget is around $200,000-500,000, you’re in the range of being able to take over and turnaround a struggling cannabis business. Recognize that just because someone owns a cannabis business now, doesn’t mean that they are good at running it. There are many great opportunities out there to take a business and run it profitably. Early cannabis operators were excited, got into the industry and really have no idea how to build a business to profitability. Their inexperience is now your opportunity to get into the market.
At this level of investment, we don’t recommend starting from zero and going through the entire licensing process, paying rent that entire time. If you do get approved, you will need to build out a business facility, stock it and then have enough operating capital to run it – and that’s a big IF.
If your budget is in the $500k-$1.5MM range, then you have many more options. Consider buying an existing business and using that cash flow to finance the rest of your enterprise. It may need a bit of a turnaround, but that cash can float the rest of your business.
When buying a business (and sellers, pay attention) you need to make sure that the valuation that you’re buying the business at is reasonable. Many operators think that their business is worth more than five times their existing revenue. The green rush causes some owners to over-value their business at a multi-million dollar price tag, but if there isn’t any bite to back up that bark, then the business isn’t worth much. Check out our M&A videos/posts for more info on how to value a business.
If you need help with evaluating your deals and bringing financial sense to your next M&A prospect, then please reach out to us today.