The cannabis industry is estimated to generate $3 billion in revenue this year, with annual sales projected to increase to $8 billion by 2018. As of early November 2015, 23 states (and the District of Columbia and Guam) permit medical marijuana and cannabis programs. In addition, 17 states allow more-limited access to marijuana products, and four states have legalized recreational marijuana. In connection with the implementation of these statutes, and the U.S. Justice Department’s August 2013 updated Marijuana Enforcement Policy (which indicated the Justice Department’s intention to defer prosecution of participants in medical and certain recreational cannabis businesses which comply with state laws and meet certain other requirements), new businesses are being formed to serve this new market. These ventures include dispensaries, cannabis cultivators and adjunct institutions, such as financial institutions or other businesses servicing dispensaries and growers.
Like any new and growing industry, cannabis-related businesses need to raise capital and have generally accomplished this through private sales of securities (either debt or equity). Much like any business without a significant history of operations, the materials provided to potential investors often include projections as a way to estimate potential investment returns. Not surprisingly, projections regarding cannabis-related businesses typically reflect returns on capital significantly greater than investments in more-established industries that have less implicit legal risks.
But, in the words of Niels Bohr, “prediction is very difficult, especially about the future,” and prediction in the cannabis industry is made especially difficult due to certain unique issues facing cannabis businesses. How those issues are addressed in the assumptions that underlie a business’s projections when it is seeking capital can cause the results of those projections to vary widely. Below are a few issues that potential investors and capital raisers need to consider when creating projections for cannabis businesses.
How much product will be sold
Typically, revenue and profitability figures are directly linked to the sales projections of a business. We have found that the assumptions that underlie these calculations can vary widely. To determine projected sales, one must assume both the percentage of people who the business can serve and the average amount each customer would purchase. Each of these factors can vary greatly. The percentage of population becoming customers depends on the specific conditions for which cannabis may be prescribed (which varies from state to state), as well as the general demographics of the area for the potential base of customers (which can vary as, for example, state dispensary laws may limit dispensary customers to those living within a certain proximity to that dispensary). Next, one must also determine how much cannabis an eligible customer would actually purchase. Although the amount of cannabis that a customer can purchase is limited under most state laws, the amount of product actually purchased is often a small percentage of that maximum amount. Amounts purchased will vary based upon the conditions for which the customer is purchasing the products (made more complex by the fact that dosage information is limited, and often is self-selected by the patient), as well as the method of consumption (smoking, vapor inhalation or ingestion).
Overhead and other costs
Moving down the projected income statement from income to expenses, projection creators and users should realize that the cost structures of cannabis can be markedly higher than those of businesses in other industries. Access to services – particularly banking-related services, armored car and security-related services – are limited for cannabis businesses due to the fact that possession and sale of marijuana is still illegal at the federal level. Federally chartered financial institution and other business engaged in interstate commerce will often refuse to service these businesses. For example, according to the U.S. Treasury, only 220 of the 7,600 federally chartered banks will accept the proceeds from cannabis sales. As a result, the costs for these basic functions can be significantly higher, or expensive alternative approaches may be required (for example, large safes and increased security to store cash). Further, state regulations may impose significant and expensive requirements with regard to dispensaries or growing operations regarding personnel, building requirements and reporting. All of those factors need to be factored in for accurate projections. A careful look at the assumptions that underlie projections for a cannabis-based business, including how legal requirements affecting that business will affect those assumptions, is critical to determine whether a potential investment truly makes sense.
Barry Fischer is a partner in Thompson Coburn's corporate and securities practice. He can be reached at (312) 580-2233 or bfischer@thompsoncoburn.com.