Financing Options for Cannabis Companies
Drew: We come across a lot of businesses in the early-stage startup phase. They have cash, though often they’re still not profitable. We’ve also seen companies that have a pitch deck, a good board, and have raised $1-2 million. They have a plan to begin operations, but they need more capital than they can raise from family and friends, so they have to go to market.
Other companies are ready to scale. They’ve got a traceable history, good tax and financial records, customer relationships, and brand recognition. They’re more attractive.
Established companies need enough capital to deploy a large strategy. They should have gotten their cash from U.S. or Canadian banks, but due to federal restrictions, they had to go to Canada to IPO/RTO. You can’t become a multi-state operator, build testing labs, or invest in R&D without lots of capital. These cannabis companies need hundreds of millions of dollars for M&A and expansion, whereas an early startup might only need $2-10 million.
Tony: There are many factors a company should consider when raising traditional debt capital. We base our investment decisions on the same attributes any other lender would look at, including cash flow, collateral, how much equity or convertible debt is in the company’s capital structure, the state it’s located in, and the quality of its management team. I would also like to point out that while current positive cash flow is not a requirement for a deal, a pathway to profitability is vital for us to be able to service the loan.
Drew: When my group does valuations on companies, we’re often valuing companies that have been acquired for financial reporting purposes. A lot of the same things matter and play into how we value businesses. We’re mimicking what Tony does on a daily basis. We often work collaboratively – there’s mutual synergy.
Tony: I can give a high-level checklist. First, what is the company’s financial condition? Is there cash flow now, or can we underwrite to a realistic pro forma? This is important because the company needs to prove its ability to make loan payments.
Second, collateral. While we will consider other asset classes in the future as the industry grows, right now we predominantly lend on real estate and to a lesser extent equipment. For real estate, we will consider lending against cultivation and processing facilities, warehouses, greenhouses, and retail locations. With equipment, we are a little more selective, and the key variable we consider is how well it maintains value over time.
The third attribute on which we focus is the quality of the company’s management team. Do they have a proven track record of success? How much hands-on operating experience do they have? Despite all the exuberance around cannabis, it’s still difficult for a business to become successful due to the regulatory burden and continually changing legal environment. When making a loan, we in essence form a partnership with the operators and owners of that business, so it’s vital that they execute their plan succesfully. We look to help in any way we can after the deal is done.
Drew: Most state-level cannabis regulations are well-intentioned, but in some instances, they’ve created a lot of chaos. In California, for example, companies that thought they were operating legally have been raided due to issues rolling out temporary and permanent state licensure. In addition, compliance with federal and local taxes has been a real burden on consumers and businesses. The corresponding and effective tax rates make a lot of dispensaries less profitable.
In addition, opponents to adult-use as well as complications with local community priorities are reasons why states like New Jersey and New York have struggled to further their recreational agendas. Florida voted overwhelmingly for medical approval, but cities there have put severe restrictions on where dispensaries can be located. Some have even banned dispensaries outright. As a result, private lenders must have up-to-the-minute regulation information to make sound financing decisions. Many may only choose to do so in specific states. Tony and I are in the camp of believing that national banking isn’t going to happen in the near future.
- A company’s lifecycle stage impacts both its financing needs and options.
- Three key factors that lenders evaluate are companies’ financial condition, collateral, and the operators or management team.
- Cannabis companies that have a bank account and detailed financial records are more likely to access capital. Companies that have not been recently audited may be required to undego an audit.
- Financiers look for companies that are using reputable professional service firms.
- Cannabis companies in states with heavy or uncertain regulatory or tax burdens are less attractive to lenders.
This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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