California pot industry facing 'extinction event'

Industry insiders are warning that hundreds of pot shops could go out of business this year

Lester Black, SFGATE

May 18, 2023

California’s pot industry could be on the verge of an “extinction event,” with pot shops going out of business as they miss tax payments and sink under millions of dollars of debt.

Debt problems have plagued the industry for years — a 2022 report estimated that the industry was collectively sitting on over $600 million in debt — but a change in tax law that took effect this year has stakeholders worried the mounting debt bubble will finally become fatal. A San Francisco politician introduced a law this year in the state legislature that would crack down on pot businesses that don’t pay their debts.

State law recently shifted the burden for paying cannabis excise taxes from distributors to retailers, with the first tax payments due May 1. Retailers have historically had the most trouble paying their bills, and it appears that many shops lack the cash to pay their state excise taxes, according to new state tax data obtained by SFGATE.

Over 13% of California’s retailers, or 265 pot shops, failed to make any tax payment by the May 1 deadline, according to the California Department of Tax and Fee Administration. Those businesses are now facing a 50% penalty on the taxes they owe, which could be a death blow to many shops.

And the number of shops affected could climb higher. The state agency said it's still processing 581 tax returns, which could include retailers that failed to pay.

Michelle Mabugat, a cannabis attorney at the Greenberg Glusker firm in Los Angeles, told SFGATE she expects debt problems to shut down many shops in the state.

“There’s a debt bubble that’s been building over the last few years that’s getting close to bursting,” Mabugat said. “I do anticipate a lot of retailers going out of business this year, just like we saw a lot of cultivators go out of business last year.”

Ali Jamalian, the owner of Sunset Connect, a cannabis manufacturer in San Francisco, said he’s seen pot shops with over $500,000 in unpaid bills, and he expects the new tax structure to cause an “extinction event” for pot shops in the state.

“I’ve been in the weed game, so I’ve seen a lot of cycles. But this will have a real impact. ... The extinction event is when the government wants its taxes, and no one can pay it,” Jamalian said.

The entire cannabis supply chain has faced a chronic debt problem: Farmers report never getting paid for thousands of dollars in product, distributors say retailers don’t pay them and have started blacklisting some shops, and even the federal government is getting stiffed. An analysis done last fall by Green Market Report found that 10 of the largest pot companies in the country owed over $500 million combined in unpaid taxes.

These debt problems have attracted scrutiny from lawmakers. Assemblymember Phil Ting, a Democrat from San Francisco, proposed a bill this year that would require pot businesses to pay their cannabis suppliers for any transactions worth $5,000 or more within 15 days or face a penalty. Ting blamed the problem on federal prohibition, which blocks pot entrepreneurs from accessing the loans that are typically used to maintain cash flow at other businesses.

“For years, restrictions at the federal level have left our state's legal cannabis operators with limited options for financing and capital. This has led to a severe debt bubble across the supply chain from cultivators all the way through to the retailers,” Ting said in a news release.

The proposed law is supported by associations representing distributors and manufacturers but has been opposed by some cannabis retailers in the state. It's on the agenda for the House Appropriations Committee's May 18 meeting.

Without traditional bank loans, pot companies have turned to issuing loans to each other by selling products on credit. Pot farms often give products to distributors and retailers with no money down but with the expectation that they will be paid later, usually within 30 or 60 days.

 But the retailers frequently take months to pay — if they pay at all. Some California retailers are holding more than a million dollars in debt to other pot businesses, according to Brett Gelfand, the managing partner of CannaBiz Collects, a cannabis-focused debt collection agency.

“We’re seeing the same debtors over and over again. Sometimes we have 20 different clients submitting their claims against the same debtor, so the debtor is drowning in debt,” Gelfand said.

Ting’s bill would specifically target these repeat offenders by creating a system that tracks and penalizes companies that don’t pay their cannabis suppliers.

These debt-ridden retailers are now at risk of going out of business thanks to the state’s recent tax payment change. The state’s decision to shift tax payments from distributors to retailers both removed a form of financing — retailers were using excise tax collections as a way to finance their businesses — and created a big penalty for cash-strapped retailers.

Mabugat said retailers had been “hoping and praying” that they would come up with more cash before they had to pay the excise taxes. But with the May 1 deadline past, hundreds of pot shops were unable to come up with the money and could be headed toward failure.

As Mabugat said: “That kind of financing model, if you can even call it that, is a really easy way to go upside down fast.”

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