Lending and Borrowing in the Cannabis Industry
The marijuana industry in America is like an exciting thrill ride, bound to twist, turn, rise, and fall in the years ahead. There’s a lot of cash to be made on pot in the U.S., but uncertainty continues to lurk in the shadows. With medical marijuana now legal in 31 states and nine states boasting full-blown recreational/adult-use, the industry is moving quickly, and demand continues to rise with no end in sight.
Cannabis is still a federally controlled substance in the U.S., and a conflict exists between State and federal laws on the legality of all of its various uses.
Despite these challenges, the industry is thriving. Many foresee the legal marijuana industry growing 500%+ over the next five years, and entrepreneurs want in on the gravy train, yet remain unaware of the complex nature of the beast and how difficult it is to secure funds from reliable sources.
Operating a cannabis-based business requires capital to purchase equipment, facilities, lease space/real estate, and expand operations. Borrowing money is almost always challenging as the vast majority of the financial industry considers marijuana businesses very high risk. Until a determination on whether to remove cannabis from its current Schedule I classification, banks will not take a marijuana-related loan application. This leaves only a small pool of non-bank lenders for the entirety of the U.S.-based legal cannabis industry. Only a few non-bank lenders are willing to originate a loan for marijuana businesses – a process that can take months to get back to applicants, and the end result is denial more often than not.
However, the reality is that almost all startup or existing businesses need funding at some point in order to succeed, and this is no different for the cannabis industry. Many businesses are small, family-run operations that lack the level of experience larger investors are seeking. Consequently, loans & investments in the cannabis space are still not meeting operational needs in comparison to other industries, but hope remains.
While the investment climate has continued to gradually improve, many entrepreneurs resort to crafty, creative, and sometimes legally dubious measures, seeking to fund their businesses personally by tapping into savings, asking relatives, turning to non-institutional sources and utilizing credit cards to launch their companies.
Other sources of capital seen in the industry today:
- Private equity firms
- Venture capitalists
- Angel investors
- Alternative financing companies
- Real estate mortgages
- Working capital
- Equipment Leases
- Bridge loans
With these sources, cannabis business owners can secure funds outside of common pathways, and while many lenders won’t deal with marijuana businesses, the number of those that those that do continues to grow.
Sure, there are obstacles to overcome, but getting a commercial loan is not impossible for today’s cannabis operators. However, these entrepreneurs must exercise caution to avoid bad money and excessive loan obligations. Borrowers need to be mindful of predatory lenders who regularly seek out companies in trouble. While their loans functionally act keep a company afloat temporarily, sky-high interest rates can spell ruin down the road. More and more lenders are springing up across the country willing to loan money in the cannabis space at overly aggressive or even predatory rates. Burdensome loan obligations soon lead to feelings of regret.
Reputable lenders will require a full analysis of the borrower’s financial situation and must perform due diligence and reviewal of business documents, historical financials, projections, operational information, and compliance information to reach a loan decision. Essentially, they will dig through everything short of a thorough pat down.
After reviewing and underwriting in excess of 150 cannabis applications, not all borrowers are prepared for what lenders require of them, which is clearly a painstaking amount of detail. When it comes to getting a loan, borrowers often compound the challenges by creating their own problems along the way. (As demonstrated below)
The Under-Prepared Borrower
Being unprepared as a borrower means not possessing the proper financials, projections, appropriate paperwork, and/or a thorough accounting on the commercial property to be financed. It’s analogous to a taking a trip to the pool and leaving behind your bathing suit. Not having the proper paperwork makes it nearly impossible to get a commercial loan approved promptly, if even at all. Borrowers must ensure they provide accurate and timely information to the lender and commit to following up quickly each time the lender makes a request.
The best solution for this type of borrower is to seek out professional assistance. Specialists such as cannabis financial advisors, attorneys, tax professionals, and the like are invaluable partners when securing a commercial loan for Cannabis endeavors. Some are sure to turn into quality after-hours drinking pals too.
The Overly-Optimistic Borrower
This borrower is their own best cheerleader. However, when developing pro forma statements or making income projections about Cannabis commercial properties and business, a healthy dose of reality is in order.
Before starting the pro forma process, borrowers must collect the appropriate information and make sure they know what the average go-forward projected costs will be, the cost of goods sold (COGS), and the other costs associated with the business and property; including sometimes tricky to find historical info such as taxes, insurance, and maintenance.
The Borderline Borrower
Borrowers must have legitimate plans and liquidity to withstand a decrease in income from their operations so as to avoid falling short of their various financial obligations. I.e., more than just selling T-shirts and free hugs.
While the lender loans money based on the value of the property and other collateral, they also must protect themselves from borrower-default, so they will be looking at cash reserves, debt service coverage ratios (DSCR) and other loan covenant ratios.
The Obstinate Borrower
All Borrowers want the best possible terms for their loan. Everyone wants their ideal Loan term, rates, and amortizations. Yet, if the borrower insists on and/or expect terms that the lender is not prone to approving, the loan request is most likely doomed to fail.
The borrower and lender are two different animals but exist codependently like the bee and flower. On both sides of the table, from each viewpoint, borrower and lender must be judicious about who they choose.
Marijuana businesses seeking funds should assemble a strong management team with a bright, profitable vision for the company’s future. Investors weigh these factors as particularly important when evaluating the investment potential of privately held cannabis companies.
Lenders require a cannabis business borrower to provide complete and detailed paperwork and to have all appropriate state and local compliance documentation. On the flip side, borrowers must find the perfect lending outfit to meet their financial needs and be available to reach out to when necessary.
Lender’s and buyers will ultimately decide if they want to work together or not, but the opportunity is real. Securing a commercial loan takes concerted effort but knowing the common roadblocks one will face ahead of time can make the experience smoother, less painful, and potentially more fruitful.
Preparation for the ride ensures one will keep the contents of their stomach inside their stomach, which in the end, benefits everyone in the nearby vicinity.