Business

Non-Paying Vendors Snarl Calif.’s Supply Chain

By Willis Jacobson
Dec 15, 2020
Photo by Add Weed on Unsplash

When MedMen Enterprises confirmed in January that it had fallen behind on payments to several vendors, including some in California, the news raised concerns throughout the California cannabis marketplace.

The apparent cash crunch surprised many, as the California-based MSO had spent the past two years raising capital and rapidly expanding its business. Adam Bierman, who co-founded MedMen and served as its CEO until resigning in February, had frequently expressed his desire for the company to be the Apple of cannabis.

Its financial travails since then – the company is operational following a series of cutbacks –  spotlit an issue that continues to plague an industry with high taxes and often-thin profit margins: One weak link – such as a distributor or retailer that doesn’t pay its bills – can expose businesses throughout the supply chain to significant fiscal and, ultimately, operational harm.

Because cannabis companies largely rely on each other to operate in a closed-loop, state-restricted market, when a business falls behind on payments to another company, it can trigger domino effects with wide-ranging consequences, said Ryan Bacchas, president of the California Cannabis Coalition (CCC), a 10-year-old reform group made up of consumers, operators and advocates.

MedMen, as an example, was accused of falling behind on payments totaling more than $150,000 to California-based 710 Labs, a cultivation and distribution company that said it was left in the lurch for at least five months. A representative of 710 Labs was among the first to go public with allegations against MedMen early this year, amplifying what had mostly been a chorus of whispers regarding vendor payment issues within the industry.

“It’s a very sticky situation,” Bacchas said. “The margin for error is very slim in this industry, so [supply chain disruptions] can be a very big cost.”

[Update, Dec. 16: A spokesperson for MedMen wrote in an email that the company “values and prioritizes our relationships with our vendors” and that it “strives to uphold all of its contractual obligations, and will continue to do so. We are currently in good standing with our product vendors and greatly value their partnership.”]

Past-due bills

The cannabis industry’s segmentation by state makes it very relationship-driven, since operators are limited in who they can work with throughout the supply chain. 

Those relationships among companies within the California market are improving, but still aren’t ideal, Morgan Paxhia, a managing partner of Poseidon Asset Management, said during a recent MJBizCon panel. 

Among the issues cited by Paxhia:

  • There has been an “unbelievable acceptance” of companies not getting paid from other firms in the supply chain.
  • Some firms have been owed payments after as many as 180 days. “After that, it’s just not happening,” Paxhia said, adding that these delinquencies can compound over time and lead to several businesses being shortchanged due to one company’s bad actions.

Several industry insiders have pointed to MedMen, in particular – thanks to its size and grand aspirations – as having helped create an ecosystem in which failing to pay bills became accepted.

MedMen is not the only major player to be accused of stiffing its peers.

Ignite International, a CBD brand and retailer, was recently sued in California state court by KushCo Holdings, an Orange County-based provider of ancillary products and services. KushCo alleges that Ignite owes it more than $586,000 in unpaid bills and fees for products Ignite purchased from KushCo in 2019.

Nick Kovacevich, co-founder and CEO of KushCo, told WeedWeek his company is a lot more discerning about who it now does business with.

“We’re looking to clean up bad debts that people still owe us,” he said. (Ignite didn’t respond to a request for comment.)

Root causes

While some businesses have fallen behind on payments due to poor or intentionally deceptive business practices, others simply cannot afford their bills due to high operational costs and low profit margins.

  • Taxes can “come up and bite you really fast,” Paxhia, with Poseidon Asset Management, said of businesses that don’t properly account for their tax obligations on a regular basis.
  • Some businesses have also fallen behind on tax bills due to using those funds to cover operational expenses, or vice versa. This will continue to be a problem as long as taxes remain at such high rates, according to several industry operators. Cannabis companies face significantly more taxation than traditional industries and are also unable to claim many common business deductions on federal taxes, due to federal prohibition.
  • A lot of financially strapped companies are in their position due to massive tax liabilities to the state, Paxhia said. This can be avoided with proper, routine accounting.

Each point along the cannabis supply chain is subject to state taxation, as well as local municipal taxation, if applicable. These costs can easily disrupt cash flow throughout the supply chain and lead to the domino effect of businesses falling behind. 

  • Reducing taxes and/or other regulatory costs associated with running a licensed cannabis business are among the ways that supply chain issues can be addressed by regulators, according to industry insiders.

Finding relief

The courts are not always an affordable option for businesses looking to collect on debts.

  • Often, the costs of litigation can extend well into the six figures and exceed the amount being sought. 
  • Many of the cannabis companies that find themselves either unable to pay their bills, or unable to pay the court costs to sue for relief, have expanded too rapidly without the proper level of attention to finances and compliance, said attorney Joe Rogoway, a managing partner of the Los Angeles-based Rogoway Law Group, which serves the industry.
  • More established companies and business owners who were in the California MED market pre-2018 have done a better job avoiding non-paying suppliers, according to Bacchas, with the CCC. He noted that newcomers are at increased risk due to their unfamiliarity. 

Because much of the issue falls back to accountability, it will be mostly up to operators – not regulators – to find solutions for an issue that continues to impact the entire marketplace.

  • “It doesn’t just make a few people look bad; it makes all of us look bad,” Bacchas said of operators shortchanging each other. “Sometimes regulation has to come from within our own camp.”

Part 2 of this series will look at some other issues affecting the California supply chain and what specific steps can and are being taken to address these concerns.