Banking Reform for the Cannabis Industry: Don’t Bank On It

As federal legislation stalls, specialty-finance platforms
are fueling a cash-starved emerging industry

By Andrew J. Kaye

Federal banking reform for the compliant cannabis industry is an obvious next step in the evolution of the industry. Today, there are 37 U.S. states that have legalized cannabis for medical purposes, and 21 permit its recreational use, employing more than 400,000 Americans, and grossing an estimated $25B in retail sales nationwide, the cannabis industry should, in theory, have the same access to loans, deposits and credit cards as all other industries. And considering its legacy of illegal cultivation and sale, having all
that hot cash floating around unaccounted for is insane, right? Right!

But not so fast. Despite repeated attempts to pass banking and tax reform for the cannabis industry, there has not been legislative consensus or the political will to get it done. The typical alphabet soup of legislation from both the U.S. Senate and the House of Representatives from both sides of the aisle -SAFE, MORE, CAOA – haven’t been able to pass, despite seven attempts to get it done. And the results of the recent midterm elections don’t portend any immediate breakthroughs.

So, what’s a hard-working compliant cannabis company to do to get the capital it needs to establish, cement and expand its business? Raising additional equity is the obvious answer, but doing so is increasingly difficult and dilutes the ownership interest of the founders and insiders. Borrowing from “friends & family” is an option, but that is usually capped at under $1 million, unless you know Elon Musk.

Go to one of the REITs that are awash in cheap capital from the public markets for a sale-lease back or other financing? Good luck, unless you are one of the top 20 multi-state operators. Approach
your local credit union or savings & loan bank for a “market-rate” loan? Ain’t gonna happen, unless you have valuable, unencumbered real estate or substantial personal assets to pledge.
But there is a fifth way – borrow from one of the non-bank specialty finance companies that have emerged to specifically service the capital needs of the cannabis industry, especially for SMEs. These companies, with specific cannabis expertise, have stepped-up to fill in the gap where banks will not (or cannot) tread.

These non-bank lenders fall into several categories: Trade Finance, Equipment Leasing, Working Capital Finance, Real Estate Finance. Most such lenders are monoline – they provide financing in only a single sector or related sectors – but a few provide whole enterprise solutions that can finance several areas of need in a cannabis business. These specialty finance platforms generally fall into two broad groups: asset-based lenders and cash flow lenders. Asset-based lenders take a security interest in assets owned by the borrower.

While these pledged assets are typically “hard assets” like real estate, equipment and inventory, they can (and often do) include “soft assets,” such as the state-issued cannabis licenses and receivables. At closing, the lender will file a mortgage lien and/or a UCC statement in each state where the collateral resides which
alerts the world that it has a “first-lien perfected security interest” in the collateral and that any other lender would be second in priority. The second category, cash flow-based lenders, look solely to the cash flow of the borrower to provide the source of repayment to the lender. Generally, payments into the borrower, whether B2B or B2C, are “locked-boxed” so that the lender has access to the money before the borrower to satisfy the required interest and principal repayments. In many cases these loans are month-to-month and the borrower can pay off the loan at any time.

Many potential borrowers believe that specialty finance is “very expensive,” but this perception is based on misinterpretation of the circumstances. Very expensive as compared to what? First, all cannabis finance is expensive for all borrowers in the industry, and it will remain so even after some form of banking reform is implemented on a federal level. The risk inherent in a new industry is always priced into financing rates. In addition, the state-by-state regulatory and tax scheme, which is likely to remain no matter what federal initiatives are implemented as tax receipts to the states are the driver for legalization, makes the cannabis industry structurally inefficient and extremely complex, resulting in higher costs of everything, including money. Second, specialty finance companies are generally borrowers themselves, and they do so on a “spread” lending basis, so every time the Federal Reserve raises interest rates the cost to the lender goes up and lending rates follow. That is the way of capitalism.

Finally, even the biggest cannabis companies are paying more than they let on in their press releases. The “face interest rate” cited in the press releases generally does not reflect the actual cost of capital. To paraphrase President John F. Kennedy’s remarks in 1962 in connection with America’s ambition to be the first nation to land on the moon, “we do it not because it is easy, but because it is hard.” Cannabis lending is hard, damn hard! So, while you wait for the Feds to legalize cannabis and provide access to more lending sources, consider
the cost of not borrowing to grow your cannabis business today. The calculation is always that the cost of capital is more than offset by the expected increase in revenues or decrease in costs. And time is money, so as you wait to “hit the bid” on your next financing your competitors are expanding their cultivation sites, adding a gummy machine to their processing facility, or opening that third retail location. So, federal banking reform in the long run may lower borrowing rates, but in the meantime, I wouldn’t bank on it.

Andrew Kaye is Chief Commercial Officer of Sweet Leaf Madison Capital. He can be reached at
[email protected].