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It wasn’t until August that Mark Noble realized what was happening.

As the executive vice president of ETF strategy at Horizon ETFs, Noble had a perfect perch from which to watch cannabis stocks. “This was a bubble that burst,” he says. Horizon’s Marijuana Life Sciences ETF, which holds names like Canopy Growth, Tilray, and Aurora Cannabis, plunged from over $20 in 2018 to around $7 this month.

He still remembers the day things changed. “At the time we didn’t think we’d go below $15, and it hit $14 on August 26—from there it kind of just continually went down,” Noble recounts to Fortune. A slew of disappointing earnings reports for the 2nd and 3rd quarters last year were only the beginning of a sell-off in pot stocks that has caused most of the biggest names to lose over 50% of their market caps.

Last year, investors clamored to buy into the burgeoning cannabis industry in a moment of market zeitgeist. A new kind of investor was coming of age—millennials poured money into the flashy new stocks that promised growth and green. In fact, back in June, the most popular trade on Gen Z and millennial investment app Robinhood was Aurora Cannabis—beating out tech giant Apple.

But within six months those wide-eyed investors were looking at an entirely different picture. Wall Street grew weary as major cannabis companies reported disappointing earnings, laid off employees, and even in some cases, faced compliance scandals. Pop! The bubble had burst.

Big names like Aurora and Tilray plunged around 70% and 60% respectively from June to the end the year. The Canadian Marijuana Index (which tracks some of the biggest public pot companies like Tilray, Canopy, and Aurora) is down over 77% from March of last year.

It’s an incredible disconnect with the widening popularity and spreading legalization of pot in the U.S. And the catalysts are many. But one thing is for sure: in a very short time, a lot of money went up in smoke.

Green management?

Perhaps no company better illustrates the wild ride of the past year better than MedMen.

According to an ongoing lawsuit, James Parker, the former CFO at MedMen, alleged that executive management including co-founders Adam Bierman and Andrew Modlin, the firm’s ex-CEO and chief brand officer, respectively, were engaged in unlawful behaviors that forced Parker’s ousting in November of 2018. The suit alleges that the unlawful behavior included “profligate spending of company funds for [the co-founders’] own personal benefit,” attempts to buoy MedMen’s stock, and a work culture “replete with racial, homophobic and misogynistic epithets and slurs,” Parker’s suit claims. The allegations have been denied by MedMen.

According to the suit, executives at MedMen spent company money on “24-hour armed Executive Protection (security) for the CEO, President, and their families,” private jets, … and “tens of thousands of dollars apiece on multiple extravagant custom conference room tables,” despite burning cash at a rapid rate, according to the lawsuit.

MedMen declined to comment to Fortune. In a statement, Bierman denied the allegations, stating that “Mr. Parker’s inflammatory allegations are a transparent attempt to gain attention for his meritless lawsuit.” Fortune was not able to reach Bierman or Modlin for further comment. MedMen’s board also issued a statement calling the allegations “baseless.”

MedMen co-founder and CEO Adam Bierman (second from right) with State Sen. Tick Segerblom (D-NV, second from left).
Wire Photograph: Bryan Steffy/Getty Images for MedMen

Regardless of the legal situation, cash problems abound. An email viewed by MarketWatch shows (and the company confirmed) MedMen has been trying to offer stock as payment to vendors for cannabis products, as the company’s dire cash situation has prompted them to “[modify] payment terms,” per a statement from MedMen to MarketWatch. Since February of last year, the stock has shed about 90% of its market cap.

But MedMen wasn’t alone in giving investors a bad trip.

Over the summer, a regulatory scandal unraveled at one of Canada’s biggest cannabis companies, CannTrust. The company made headlines last summer when internal communications and emails came to light showing members of the company’s C-suite were aware that cannabis was being illegally grown in unlicensed rooms—sending the stock plummeting over 20% when news broke.

That was preceded in 2016 by several compliance violations with Health Canada—including having $6 million worth of seized product in its vault at the time, four times more than it was licensed to have, and having mold in the grow rooms—according to inspection findings by Health Canada.

Since February of last year, CannTrust has lost over 90% of its market cap. CannTrust told Fortune in a statement that since the summer, the company is “focused on remediation and governance activities,” and that “significant steps have been taken to improve the company’s corporate culture and regulatory compliance and remediate its facilities.”

CannTrust Holdings Inc. made headlines last summer when internal communications and emails came to light showing that the company’s C-suite were aware that cannabis was being illegally grown in unlicensed rooms—sending the stock plummeting.
Wire Photography: Galit Rodan/Bloomberg—Getty Images

When he first started working with cannabis companies in 2014, Maruf Raza, the national director of the public companies practice at Canadian accounting firm MNP, was tasked with handling audits and accounting for public cannabis companies. What stood out about the management? Namely, their products weren’t the only thing that was green.

“Initially, there was a lot more hand holding,” working through accounting and audits with young companies, Raza recounts to Fortune. He says it’s not unusual for younger companies in general with smaller teams to need more assistance at the beginning, but that challenges in raising capital in the private markets had pushed these companies into the public eye perhaps sooner than others in different industries would be pressured to.

“The genesis of these companies is that a lot of [them] were effectively startups four years ago,” says Raza. “They’ve gone from zero to now, in some cases, multi-national companies with multi-billion dollar market caps.”

But now, Raza says that the board composition at these companies is “night and day” from even four years ago. Professionals from Fortune 500 companies have been slowly filling seats at some of the top cannabis companies and “driving the bus,” like at Canopy Growth (where many of the seats are filled by current or former executives at beverage giant Constellation Brands, which owns a nearly 40% stake in the company).

From the vantage point of David Belsky, the founder and CEO of FlowerHire, a cannabis-specific executive search and staffing company, there’s more demand from cannabis companies for C-suites and lower management with turnaround experience. FlowerHire is now helping companies fill roles in investor relations and communications.

Although there may have been some tense C-suite departures, Raza says, many founders and management teams are realizing on their own that they are not the right teams to lead companies into their next phase as large public companies.

The revenue problem

Meanwhile, supply and demand issues have wreaked havoc on that Holy Grail of pleasing Wall Street—earnings estimates.

Despite the roll-out of legal marijuana in Canada, many companies struggled to gauge demand and product mix amid a lackluster number of retail stores in Canada, resulting in an oversupply of product for some. And in the U.S., where cannabis is still federally illegal, the regulatory climate and a vaping crisis last summer only exacerbated cash problems.

Back in September, one of the biggest names in the public markets, Aurora Cannabis, missed guidance it issued for its 4th quarter and full year earnings, estimating roughly $75 million to $80 million USD in net revenue after accounting for net excise taxes paid. Instead, the company posted roughly $74 million in net revenue—an over $1 million miss from guidance it provided weeks before reporting. Canopy Growth, another heavy hitter in the space, wildly missed earnings estimates in its 2nd fiscal quarter for 2020—reporting a loss of about $0.72 in USD per share versus roughly $0.30 estimates.

Cannabis producer Hexo was also hit hard after warning of a fiscal 4th quarter revenue miss of $10.9 million in USD to roughly $12.4 million, well below Street estimates of $18.5 million in October—sending investors into a frenzied sell-off.

As GreenWave Advisors founder Matthew Karnes (who describes himself as someone who isn’t “ra, ra, ra, pot, pot, pot”) tells it, “There was a big hype and sense of over-exuberance, but when push came to shove, and these companies reported, they didn’t come near it,” sending valuations into a nosedive for many. “Managing Street expectations has been challenging, and I think that’s really been driven by lack of experience throughout many of these organizations,” he says.

Another challenge for many cannabis companies has been navigating the arcane tax and accounting burdens for a product that largely falls into a legal grey area.

A sore spot for Canada-based cannabis companies (like Aurora Cannabis and Canopy Growth) is that they are required to estimate the market value of their products when they’re sold while they are still growing them—called “fair value.” Or, as Raza surmises, “you’re effectively recognizing income before you’re selling the product.” Cannabis companies are required to fair value their growing plants as biological assets under the International Accounting Standard 41 Agriculture (IAS 41), by the International Financial Reporting Standard (IFRS).

The problem when this standard is applied to cannabis companies is that, unlike other companies producing more traditional agricultural goods (like wheat or cattle) that have commodity-based pricing and futures to help them fair value their product, “cannabis is not there yet,” Raza says. “As a result, you have a lot of estimates and judgement that’s gone into some of the accounting.” While one strain may go to market for a certain price one month, it might be worth more or less the next. These estimates and judgement have created a somewhat uneven playing field across different pot companies—it’s not “apples to apples,” says Raza.

But Raza maintains these inconsistencies aren’t nefarious: “Most of these cannabis companies, if not all, would like nothing more than to not apply this agricultural standard,” he argues, and instead recognize the income when they sell it. But despite the drain on time and resources estimating the value of companies’ growing products, “Unfortunately they’re handcuffed by the standard,” Raza says.

As an auditor, MNP’s Raza says he sees these companies trying to “figure out what the right bridge for the actual versus the projected [is],” which has made things a bit messy for MNP as auditors and for management, “so there’s been a lot of criticism about the math involved.”

Case in point: in Aurora Cannabis’ Management’s Discussion & Analysis filed with the Securities and Exchange Commission, the company disclosed that, in the quarter ending in March 2016, Aurora’s net income (of roughly $1.9 million in USD) was “primarily attributable to the unrealized gain on the changes in fair value of biological assets,” whereas in the quarters ended September 30, 2016 and June 30, 2016, the net losses (of roughly $4.2 million in USD and $5.6 million respectively) were primary due to a “decrease in unrealized gain” on changes in fair value.

This is a frustration point for investors because it shows that, due to the challenges of estimating fair value, companies might have to substantially report different income or losses depending on how their fair value estimates actually match up with what they make off the plant—making it a challenge for investors or analysts to determine which cannabis companies have the most efficient production (and which are performing the best).

Sources at the IFRS Board tell Fortune that investors have raised concerns with the Board regarding insufficient information provided through the standard to help assess profit margins of some of these companies. While the IFRS does have standards for fair valuing biological assets en masse, there is no specific literature addressing how to fair value cannabis in particular (and their requirements of what information cannabis companies need to provide in their income statements regarding fair value are “not very prescriptive”). Sources at the IFRS Board tell Fortune there are currently no plans to reexamine IAS 41 in regard to cannabis specifically, but the Board is in the process of proposing to require companies (not limited to the cannabis industry) to report more detailed financial performance, including operating profit or loss and non-GAAP transparency.

Tax and accounting complexity

GreenWave Advisors’ Matthew Karnes has seen a thing or two in his day as a former auditor.

He recalls touring a pot facility once and asking an employee (“not just a low-level employee”) who kept the company’s books for auditing. “[The employee] is like, ‘what do you mean, like the library books?'”

“So I’m thinking to myself, ‘Houston, we have a problem,'” Karnes recounts to Fortune. But while inexperience may have been the thorn in the side for certain companies, he asserts there’s a bigger issue—altogether above-board—that’s hurting cannabis companies’ bottom lines.

Some pot companies in the U.S. have been hit hard with massive tax burdens due to the nature of their product—in other words, the cost of prohibition. U.S. pot companies operate under Section 280E of the Internal Revenue Service tax code—which has been draining many pot companies of cash.

Under Section 280E, businesses aren’t able to deduct ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act. In other words: most of the operating expenses for pot companies are nondeductible (although certain overhead costs can be allocated to cost of sales, but Karnes says this provides an opportunity for some companies to “push the envelope,” which could make them targets for IRS scrutiny).

“Even if they’re suffering losses, they still have to pay taxes—[which could be] millions of dollars. That’s a drain on cash that would otherwise be [deployed] as reinvestment into these companies,” says Karnes.

According to an analysis by GreenWave Advisors of public U.S. cannabis companies with a market cap of over $500 million (with the exception of MedMen), tax rates among the only three companies that were profitable in calendar year 2018 had varying effective tax rates, from 30% to 59%—but generally, depending on how the companies are structured, the tax benefit of operating loss carryforwards (which are intended to reduce tax liability by applying the current year’s net operating loss to future years’ net income) for cannabis companies are generally not permitted to offset future income.

The eight publicly-held multi-state operators (MSOs) GreenWave examined from the 1st quarter of 2018 through the 3rd quarter of 2019 collectively incurred net losses of roughly $542 million. And of those eight companies, all but one of which was operating at a net loss for the first nine months of 2019, GreenWave Advisors’ analysis estimates a total loss of around $114.5 million of lost net operation loss tax credits. (In short: in the worst case scenario, these cannabis companies are missing out on over $114 million in tax credits).

What’s next for cannabis stocks?

The fallout? Significant job cuts at some of the bigger cannabis companies. In the past several months alone, the sector has seen around 2,000 jobs cut across various companies.

Embattled MedMen cut 190 jobs in November. In February, Tilray announced it would cut about 10% of its staff in a ploy to reduce costs. That same month, Aurora Cannabis followed suit, cutting about 500 jobs. Canopy, CannTrust, MedMen, and Aurora have all replaced their CEOs.

Raza likens it to public startups: “The reality is, a lot of the stuff that’s happening in the public markets normally plays itself out in the private market. When you think of Silicon Valley, how many tech companies does the Silicon Valley ecosystem fund? Thousands. Of those companies, how many ultimately survive?”

The overenthusiastic (and often missed) revenue estimates of 2019 will likely no longer fly in 2020 —”[Investors] are going to come back in with a chip on their shoulder, saying, ‘no, fool me once, shame on you. Fool me twice, shame on me,'” FlowerHire’s chief revenue officer Sloane Barbour notes.

Still, from an operational standpoint, MNP’s Raza thinks many of these companies may be only in “the second inning.” And Morningstar’s Kristoffer Inton suggests cannabis investors need to think of themselves as venture capitalists—”They don’t think about one year’s time—they think about the market [potential],” he says.

That growth potential is there, experts say. MNP’s Raza believes many will end up getting to where they said they would, but it’s a “function of time and patience, and as we know, public markets are not always going to be patient,” he contends. But just as dozens of hopeful startups in nascent industries have choked out before hitting their stride, not all cannabis companies are created equal.

“The entire rise and fall of these companies is being played out in a public setting,” Raza says. “And not all of them are going to survive.”

Horizon’s marijuana ETF still hasn’t recovered. Noble says that at $7, the ETF is trading at $3 less than the price it began trading in 2017. But Noble hasn’t entirely lost faith. He says he remains committed long term to the potential of the space, and that “there’s more doom and gloom than upside priced in.”

In other words, the sector may currently be at a low. But you never know, there could always be another high around the corner.

This article has been updated to clarify language.