In Cannabis’ Credit Desert, Debt Financing May Be the Oasis Companies Need
By Andrew Lines, Valuation Partner, CohnReznick
Most cannabis companies encounter a similar hurdle: lack of access to capital. Traditional banks simply won’t lend to them, and firms that do offer financing typically compensate for increased risk by setting higher interest rates. Other challenges, including a confusing regulatory environment and higher effective tax rates due to U.S. Code § 280E, also add complexity. Yes, equity financing is still an option – but in an industry with such high growth potential, giving away shares of one’s company can be costly.
Cannabis companies need a solution to this now. Luckily, there are some emerging debt financing options that can help cannabis companies access capital.
Sale-leaseback transactions trade optionality for security
Today, larger cannabis companies often secure financing through a sale-leaseback transaction. In this arrangement, a cannabis company sells its assets (typically, real estate) to a buyer, who then leases back to them with interest for a fixed period of time.
However, while this option provides capital on day one, it also has key downsides. First, sale-leaseback transactions require cannabis companies to surrender ownership of their assets, similar to how equity financing requires borrowers to give up shares in their company. Additionally, this arrangement can limit future financing options. A typical sale-leaseback agreement lasts 10 to 15 years – a significant time commitment in an industry where regulations and opportunities are rapidly shifting.
Asset-based lending preserves ownership, but standards are high
For cannabis companies that want to keep their options open and retain ownership, term loans against real estate or equipment represent one promising path forward.
Asset-based term loans function like a typical mortgage. Ideally, credit funds work closely with a reputable partner to assess the value of property or equipment. Based on that evaluation, cannabis companies can typically borrow 40% to 75% of the assets’ value.
However, standards for these transactions are high. For real-estate based loans, good numbers from an appraiser won’t be enough. “You can get appraisals that say anything,” says Tony Cappell, managing director and head of underwriting at Green Ivy Capital, a specialized cannabis finance firm. Lenders like Green Ivy will look for businesses with recent comps close to major urban areas, which makes for value that is more liquid.
In addition, the borrower must keep clear, up-to-date financial records. Formal banking relationships are a must. “If a prospect does not have a bank account, that’s beyond our comfort level,” says Cappell. If a borrower has not been audited before receiving the loan, the lender will usually require it as a post-closing item.
Additionally, lenders prefer experienced operators who have already personally invested significant capital in their businesses and have a proven track record, even in another industry. Ultimately, lenders are betting on the business’ success, so they want to be confident in their prospects. “We’re going to be the company’s biggest cheerleader,” says Cappell.
Due diligence can help cannabis companies make the right choice
To pick the financing option that is right for their company, a cannabis entrepreneur should start by calculating their full cost of equity, ideally with input from experienced valuation experts. They should also consider factors such as the current regulatory environment in their home state and the stage at which their company is at in its lifecycle.
Watch for our next article in this series, as Tony Cappell, of Green Ivy Capital, delves more deeply into considerations that cannabis companies often make about how to finance their growth.
For more information, please contact CohnReznick.
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