Navigating the evolving landscape of cannabis lending

In recent years, the cannabis industry has experienced unprecedented growth and evolution, fueled by shifting regulations and changing consumer attitudes. As the industry continues to mature, one critical aspect that demands attention is cannabis lending.

Access to capital is essential for cannabis businesses to expand operations, invest in infrastructure, and navigate the complexities of compliance. However, the landscape of cannabis lending is unique, presenting both opportunities and challenges for entrepreneurs and financial institutions alike.

Increase in lending solutions

Despite the regulatory complexities surrounding cannabis, there has been a notable increase in lending options for cannabis businesses. Traditional banks, credit unions, and specialized cannabis lending firms have entered the market, recognizing the industry’s growth potential.

The growing acceptance of cannabis legalization at the state level has led to a more favorable lending environment, along with advancements in financial technology platforms offering streamlined processes and flexible terms. Additionally, there has been a significant shift towards refinancing existing debt rather than providing initial cash-out financing, representing progress in the industry.

However, despite these advancements, many cannabis businesses still face challenges such as high-interest debt and short-term maturities, highlighting the ongoing need for more permanent financial solutions.

Challenges persist

While the landscape of cannabis lending is evolving, several challenges persist, primarily due to the federal illegality of cannabis. Cannabis remains classified as a Schedule I controlled substance under the Controlled Substance Act, which creates significant hurdles for banks and financial institutions. As a result, some traditional banks and credit unions remain hesitant to engage with the cannabis industry.

Another challenge for many operators in the cannabis industry is qualifying for bank financing, which typically offers the most favorable terms. Both banks and credit unions have strict credit criteria, often requiring “stabilized cash flow.” For owner-operators, this means demonstrating at least one to two years of business history with sufficient profitability to service the loan.

Similarly, for landlords or real estate investors leasing to cannabis businesses, lenders also seek stable cash flows.

What to consider when seeking financing solutions

The requirement of one to two years of operating history poses a challenge, especially in new and rapidly growing markets where licenses are issued. To overcome this challenge, lenders explore creative solutions, such as including additional businesses, revenue streams, or assets in the loan package to qualify companies for favorable financing terms.

Operators should also be aware that various lenders, including conventional banks and credit unions, are active in the cannabis lending space. To qualify for conventional financing programs, the ability to demonstrate profitability and collateral, preferably real estate, can be highly advantageous for securing favorable financing terms.

Locking down the best deal

For operators and businesses, the primary consideration when seeking financing is the cost of capital. Qualifying with conventional lenders typically yields the most favorable terms, including lower interest rates, longer terms, and longer amortization periods.

While some institutional lenders in the cannabis space can provide competitive rates, they often have conservative underwriting standards similar to banks and credit unions to mitigate risk.

Recently the competitive landscape for deposits has significantly intensified. Major operators are keenly aware of this dynamic, which has been accentuated by notable failures such as those of First Republic Bank and Silicon Valley Bank last year, leading to the competitive environment for deposits becoming fiercely competitive nationwide and across various industries.

Emphasis on assets and deposits

For cannabis businesses seeking loans, qualifying based on revenue and pledging underlying assets as collateral, such as real estate, is crucial. However, banks increasingly require a minimum deposit requirement alongside the loan.

For example, a $5 million loan might come with a covenant mandating a minimum liquidity of $1.5 million to $2 million to be maintained at the bank. While this benefits banks by growing deposits, it can pose a challenge for businesses.

Different financial institutions may have varying ratios, but the emphasis on deposits remains a common motivation, which can be both advantageous and a potential hurdle for operators.

Impact of the federal landscape

The potential rescheduling of cannabis will undoubtedly have a significant positive impact on the cannabis industry, particularly with the elimination of IRS tax code section 280E. While this may not dramatically improve an operators’ on-paper financial performance, it would substantially increase their actual cash results by an estimated 20% to 30%, providing opportunities for growth and expansion.

This change would enable cannabis businesses to make acquisitions and pursue other ventures, fostering increased activity within the industry.

While the cannabis lending landscape has made significant strides, there are still challenges to overcome. However, with innovative solutions and an evolving regulatory environment, the future looks promising for cannabis operators seeking financial stability and growth opportunities.

Dan Roda is the chief operating officer of Safe Harbor Financial, which facilitates banking, payments and financial services to the regulated cannabis industry.