(Bloomberg) — If it were like most companies on the losing end of a boom and bust cycle, Schwazze could just turn to the US bankruptcy court to keep its creditors at bay while renegotiating its debt. But unlike most businesses, its product — marijuana — is still illegal in the eyes of the federal government.
That disadvantage will make it harder for Schwazze and other cannabis companies to win concessions from lenders just as a wave of debt that the industry borrowed in recent years to expand in states where weed is legal comes due. The biggest companies, those that operate in more than one state, have as much as $6 billion in debt maturing next year, according to Beau Whitney, chief economist at Whitney Economics, which specializes in the cannabis market.
The reckoning comes as the industry has failed to turn legal weed into reliable profits. In 2022 more than 42% of dealers reported making a profit, according to a survey by Whitney. By last year, the number had dropped to about 27%. Some who can’t consolidate will fail and go out of business. Many will be forced to refinance their debt at higher interest rates and onerous contractual covenants.
“There is a huge debt bubble that could have a significantly negative impact on the cannabis industry if not addressed,” Whitney said. “Refinancing this cycle will be at much higher interest rates and the businesses will not have the cash flow to manage it.”
Colorado-based Schwazze has hired advisers to help it figure out how to restructure debt it took on while opening a chain of dispensaries in two states, according to people familiar with the situation. It’s been able to push back the due date on some of its loans but it needs more cash, said the people, who asked not to be identified discussing a private matter. However, the workout needs to take place out-of-court because of the federal prohibition.
Nearly half of US states have legalized marijuana, while a number of others have decriminalized the drug or allow it for medicinal purposes. It remains fully illegal in just four states. About 79% of the US population lives in a county that has at least one dispensary, according to the Pew Research Center. Legal cannabis companies employed more than 450,000 people and sold more than $30 billion in product last year, Whitney said.
Federal law bars people from moving marijuana across state lines and treats it as a dangerous, Schedule I drug. Prosecutors generally do not take action against individual consumers, but the laws still limit banking services for the cannabis industry. And the US Trustee, the federal watchdog for the US bankruptcy system, has successfully blocked companies from filing for Chapter 11 protection.
Schwazze, whose formal name is Medicine Man Technologies Inc., has engaged Oppenheimer & Co. and Goodwin Procter as legal counsel for its talks, said the people. A group of the company’s creditors is working with Paul Hastings, they added.
The negotiations come as Schwazze received a default notice in December due to delays in its audited financial reports, according to public disclosures. The company had to switch independent auditors and restate annual results for 2022 and 2023 following the discovery of accounting errors. In July, Schwazze was able to push back the maturity on a $15 million loan with Altmore Capital and a $17 million promissory note with Reynold Greenleaf & Associates that were due this month, according to public disclosures.
Among its options, Schwazze is looking to get incremental capital and may seek a potential below-par exchange, which could result in a dilution of equity, the people said.
“It has been this way for years,” said industry lawyer Hilary Bricken with the Husch Blackwell law firm. “These lenders have the upper hand. The terms given to cannabis companies are onerous and draconian. It is not a friendly environment.”
Last year, the US Department of Justice started the process of classifying marijuana as a Schedule III, less dangerous substance, one of the industry’s primary goals because it would allow cannabis companies to deduct normal business expenses and push “hundreds, if not thousands, of businesses into profitability,” said Aaron Smith, co-founder of the National Cannabis Industry Association.
President Donald Trump’s incoming Attorney General, Pam Bondi, declined to say during her confirmation hearing last month whether she would cancel that process. The industry has been working for years to remove as many federal hurdles as possible, with limited success, despite the majority of Americans favoring legalization.
Colorado and Washington became the first states to legalize recreational marijuana about a dozen years ago, launching a wave of small starts ups run by enthusiastic, but inexperienced, entrepreneurs. As more states legalized, either for recreational use or as medicine, investors piled in and the number of licensed dealers and dispensaries exploded. Overall sales grew steadily, with a revenue boost hitting when the pandemic ended. That’s when companies loaded up on the debt that is coming due next year.
Today the market has matured with savvier, more professional operators pushing out the mom-and-pop startups, said Bricken, the marijuana lawyer who has been advising clients since the early days of legalization. There are only a handful of lenders left who are willing to invest in the industry, Bricken said, citing two of the biggest, Chicago Atlantic Group Inc. and Altmore Capital Investment Management.
“All of the stupid money has left the space,” she said.
Representatives for Chicago Atlantic did not return a request for comment. Altmore Capital declined to comment. Messages left with Schwazze, as well as with Oppenheimer, Goodwin Procter and Paul Hastings were not returned.
Cannabis companies have struggled to compete with unlicensed dealers, who can undercut legal sales because they don’t pay for a license, comply with regulations or face any taxes said. The US saw about $44 billion in illegal sales last year, according to cannabis market tracker BDSA.
“Unless there is federal intervention, through reform, then the industry is on the precipice of collapse and large firms from outside the cannabis industry will be positioned to take over, for pennies on the dollar,” Whitney said.
–With assistance from Fiona Rutherford.
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