Kentucky’s burgeoning medical cannabis industry represents a significant opportunity for licensees; however, entrepreneurs must approach the market with a strategic and informed perspective. Lessons from other states show that early economic conditions can be misleading, particularly when it comes to capital raising, commercial agreements, and wholesale cannabis pricing. By understanding these dynamics, licensees can avoid mistakes made by predecessors in other states and set themselves up for long-term success.
As the market for buying and selling licenses cools, many operators are focused on raising capital in order to launch their businesses. Raising capital in the cannabis industry comes with unique hurdles. Unlike traditional industries, cannabis businesses face limitations due to federal prohibition, making it difficult to access conventional capital sources, such as bank loans. As a result, companies often turn to private investors, venture capital, and alternative lending sources, like existing cannabis operators. Such capital is often limited, expensive, and comes with stringent terms.
Kentucky’s new operators should be selective when choosing investors and partners. While it may be tempting to accept any available funding, securing capital with unfavorable terms, such as high interest rates or loss of control, can be detrimental in the long run. In particular, debt can be attractive as it avoids dilution for founders, but even the most thoughtful business projections are often materially different than reality in the cannabis industry. In other states, what were once attractive debt deals, often evolved into future restructurings that were more dilutive and punitive than what founders initially hoped to avoid. Accordingly, it may be preferable to take a slower, more measured approach with modest and realistic business plans that necessitate less up front capital.
The same should be said for strategic partnerships, like management, supply, licensing, white labeling, and distribution agreements. While these arrangements can provide essential resources and expertise, they also come with long term risks if not structured properly. Kentucky’s cannabis entrepreneurs should conduct thorough due diligence on potential partners, ensuring alignment in business goals and values. Economic terms of these agreements should also allow for what is frequently a dramatic evolution of market conditions. Lack of planning for such issues in other markets has resulted in strained relationships, burdensome sunk costs, unused assets, uneven agreements, and sometimes litigation and failed businesses. On the other hand, thoughtful and comprehensive agreements can provide stability and security, while also accounting for future uncertainty.
Indeed, the key uncertainty with any new cannabis market is price fluctuations as a result of shifting supply and demand. In many states, wholesale prices have tended to commence at high levels that provide a windfall for early operators. But almost inevitably, supply increases through new entrants and operational efficiencies, resulting in price compression that is often rapid and dramatic. A big unknown in Kentucky is also the demand side of the equation, as the medical program has limitations and hurdles that could impede quick adoption and prevent the early boom seen in other states. Kentucky licensees should plan accordingly, maintain cash reserves, and ensure that their business models are resilient. Strategies such as diversifying product offerings, managing inventory, thoughtfully deploying capital, and engaging with flexible and resilient partners will be critical to maintaining operations as the market stabilizes.
Kentucky’s cannabis market is in its infancy, and those licensees who approach it with a forward-thinking mindset based on the lessons the industry has already learned will have the best chances of long-term success. The Dentons team has deep experience managing these issues and we are here to help licensees navigate and succeed in this emerging market.
