The Canadian cannabis industry’s new era of compliance

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The Canadian cannabis industry has arrived at an impressive level of financial success following a sometimes rocky road to recreational legalization. In just a handful of years, we’ve seen the use of cannabis go from social taboo to widely accepted, and the cultivation and sale of the plant go from shady criminal pastime to one of the most sought after investment opportunities in recent financial history. With such a rapid growth trajectory, and such an overwhelming cultural paradigm shift, it shouldn’t come as a surprise to anyone that the industry would experience some growing pains along the way.

Until now, the industry has been characterized by a strong spirit of entrepreneurship, with many founders taking on the role of CEO. While the passion of an owner/operator can certainly fuel rapid growth, acting as the CEO of a billion dollar publicly traded company is very different from managing a small private business. While cannabis entrepreneurs may be skilled at the cultivation of high quality crops, they often require assistance in building their expertise in business operations, finance, management, and governance.

The shift begins
It’s been clear for some time now that the industry would eventually undergo a shift toward greater regulation and compliance. In a previous blog post, we identified three of the biggest challenges facing the Canadian cannabis industry. Two of the three challenges pertained to corporate structure, management, and governance. Since we published the blog post last year, we’ve seen some of Canada’s largest Cannabis companies take very high profile tumbles as a direct result of these challenges.

Last week, CannTrust[1] admitted to growing approximately 5,200 kg of cannabis in unlicensed rooms from October 2018 to March 2019. Some of that Cannabis had already been sold prior to the receipt of a non-compliance report from Health Canada. In its wake, CannTrust placed a voluntary hold on products, and saw its shares plummet from $13.45 at the end of March to $3.52 following the revelation.

Canopy Growth Corp.[2] has also seen some tumultuous changes, having recently “terminated” founder Bruce Lipton following a $5 billion investment by Constellation brands last fall. Insiders have pointed to a lack of harmony between Linton’s strategy for long-term growth and Constellation’s push for interim profitability.

More money, more problems?
As bigger brands invest and consolidate, they bring board members who will push for tidy corporate governance. As sales increase and product lines expand, regulatory compliance steps into the spotlight. We’ve entered a new era, and many cannabis companies have simply outgrown their original organization. To step into the next level of profitability, they’ll need to establish a firm new foundation, built on 4 key assumptions:

1) Upholding business standards
The standards considered to be “normal” in other industries will now need to be met and maintained within the cannabis industry. These include:

– Meeting corporate expectations for each quarter
– Valuations based on multiples of EBITDA (Earnings before interest, taxes, depreciation and amortization)
– Strong corporate governance, including business acumen and experience in the C suite
– Respect for regulation and rule of law

2) Reduced valuations
Granted, the calculation of business valuations in the cannabis industry can be somewhat challenging. Given the recent market frustration with severe delays in achieving profitability in this sector, we can expect valuations in the future to be based on more traditional multiples of EBITDA and traditional functions of revenue.

3) Corporate consolidation
As we’ve discussed in our prior blog post, M&A activity in the Cannabis industry is quite likely to increase over time. While this may hinder the growth of smaller, craft organizations, it’s critical that producers and other market participants have an understanding of this very important market factor.

4) Increased regulatory control
Enhanced regulations are a natural consequence of industry growth. That being said, CannTrust’s recent non-compliance mishap has surely fueled the government’s desire to button down the monitoring and maintenance of regulatory standards. To prepare for this highly regulated future, cannabis companies must institute strict compliance procedures to maintain standards and abide by regulations.

Seeking guidance from the experts
Royal Bank of Canada analyst Douglas Miehm has been quoted2 as saying the cannabis industry is facing several “transitional and volatile” quarters as it struggles to stabilize following the “clear the decks” behaviour of new CEO’s. During this transition period, the only companies who will weather the storm will be the ones committed to seeking outside support and guidance from subject matter experts.

Reliable reporting and creative, knowledgeable professional advice will be paramount to achieving success in this new era of increased compliance. To learn more about how Zeifmans can help, reach out to us today.

[1] Leafly, “CannTrust Halts Sales as Health Canada Investigation Expands”, https://www.leafly.ca/news/industry/health-canada-investigating-canadian-lp

[2] Financial Post, “Canopy Growth’s High Profile CEO Bruce Linton Ousted in Surprise Exit”, https://business.financialpost.com/cannabis/cannabis-business/my-turn-is-over-high-profile-canopy-growth-co-ceo-bruce-linton-steps-down?utm_campaign=magnet&utm_source=article_page&utm_medium=related_articles