With traditional funding mechanisms mostly out of reach, cannabis entrepreneurs are finding opportunities with new financing options

By Andrew Kaye

Imagine you are shopping for a new suit. It is possible to walk into a store and grab something off the rack that fits like a glove, but if you fall anywhere outside the accepted “norms,” you will most likely require a custom fit. Well what is true in fashion is often true in finance – particularly for industries operating in a legal gray zone like cannabis. Sometimes a custom fit is not just the best solution, but the only solution.

Launching or growing a business requires financing or investment (i.e., a loan) to build, buy or lease facilities, purchase equipment, stock inventory, hire staff, etc. Even traditional businesses face hurdles securing financing, unless they have an extensive operating history, good cash flow and plenty of collateral. That said, businesses that check all the boxes can walk into almost any bank and be evaluated for a loan on the spot, with options that tend to be broad, and interest rates that are typically competitive.

As any cannabis entrepreneur knows, this is not the case for cannabis businesses, which face harsh legal restrictions and a thicket of state-by-state regulations that draw scrutiny other businesses do not have to manage. Strapped for cash and viable options, many cannabis businesses are forced to accept equity investments to fund their business growth, thereby diluting their ownership and reducing future potential profits.

All of this makes cannabis businesses far more difficult to start, grow and maintain than similarly sized businesses in less nascent industries. Fortunately, the times are changing and financing options are beginning to change with them.

Opportunities opening up for cannabis funding

Today’s cannabis industry faces far less resistance and stigma than when regulated markets were first created nearly a decade ago. The accelerating rate of legalization in states across the country and a dramatic increase in public support for such legislation is reducing investor resistance to the industry. Even investments in plant-touching businesses with cannabis licenses, which have historically stirred uncertainty among investors, are becoming more attractive. As a result, more private lenders are entering the space and bringing with them innovative approaches to working with cannabis businesses. These lenders are not afraid to maneuver around historic industry barriers to financing, and are opening up to cannabis companies lending opportunities that have been available to other industries for decades.

For starters, cannabis businesses with assets can now use those assets as collateral for a loan. If the business already owns property or a building, for example, or if it has substantial stockpiles of equipment, these assets can be utilized to take out a loan against the value of these assets. These loans are classified as real estate loans or equipment loans.
Because the lender can recoup some of the value of the loan if the business defaults, interest rates tend to be better for this kind of financing. This is an incredible example of financing that, until very recently, would have been unthinkable in the cannabis space.

Another possibility is revenue-linked financing, known colloquially as a line of credit. As its name suggests, a line of credit tends to be linked to accounts receivable and is generally used for things like inventory and new hires. Rates for this type of loan will tend to be higher than an asset-backed loan because, if the business defaults, there are no assets to seize. However, the ability to engage a line of credit for month-to-month business operations is a tool that was non-existent in the earlier years of the cannabis industry. Today, these line of credit opportunities are becoming increasingly available.

In addition, there are similar options to lines of credit like Senior Secured Term Loans, which are growth capital loans made to businesses for a range of operating purposes, and are secured by the assets of the company. With these loans being secured by an asset, the rates are typically lower than unsecured loans or any type of revenue linked financing.

What investors seek remains the same

At present, cannabis enterprises cannot change the difficulty they face in acquiring the capital needed to start and grow their business, but they can give themselves a competitive edge by thinking about the process from the perspective of the investors who might be signing their checks. As with any business, what investors seek from cannabis investments is no different from any other industry:

• Investors look for signs that a cannabis business will be well-run, profitable and as unproblematic as possible. The best way to soothe doubts is by having a leadership team that is responsible, mature and competent. The tone of a business is set at the top, and when those in charge take their roles seriously, everyone else will too.
• As important as a CEO or company president is, sales, marketing, middle management and the cleaning staff are crucial as well. Potential investors will want to see that a cannabis business has given thought to every part of their team, from the bottom to the top.
• In addition, investors want to see a clear path to a return on their investment. The point of financing a business is to eventually make more money than they put in, after all, so a clear business plan and realistic expectations will go a long way to convincing them that a cannabis business will be able to make money.
• Nothing shakes investor confidence like sloppy bookkeeping. Having a company’s financial records in order displays sound management practice. If all strategy, financial and planning documents are organized in one place and can easily be reviewed by a lender, a business will be ahead of the game and can significantly speed up the process.
• Make sure historical financials are clean and tight, keep any projections promising but realistic and always provide proof of future revenue potential. This means keeping track of distribution contracts, partnership contracts, assets on hand and how you use funds.

Though cannabis businesses seeking capital do face substantial obstacles, by paying attention to detail, focusing on building a quality team and taking all record keeping very seriously, it is possible to get the kind of custom financing solution which will fit them like a tailored suit.