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The old days of back-alley loan rates are giving way to better financing.
As any operator in the U.S. cannabis industry knows, securing financing can be a little like climbing Mount Everest — it’s incredibly hard, you may not make it, but if you get to the top, it’s a great view. There are now signs that the climb might be getting easier.
The difficulty with securing financing is cannabis is still considered a Schedule 1 substance (the same classification as heroin) even though over two-thirds of U.S. states have legalized cannabis in some form. Traditionally, emerging companies have been able to easily access financial institutions such as Goldman Sachs or Citigroup to borrow money on favorable terms. But due to the current rift between federal and state laws in regard to cannabis, most financial institutions refuse to provide traditional banking services to the cannabis industry. As a result, the annualized cost of capital for a U.S.-based cannabis company has been as high as 30-40% (after factoring in the value of warrants or unregistered shares, commonly associated with debt financings in the cannabis space). Rates this high are generally associated with back-alley loan sharks and payday lenders, not with a legitimate, emerging industry.
U.S. cannabis companies have few options given the virtually nonexistent debt markets. This has forced numerous U.S. cannabis companies to access the equity market, which traditionally is considered a last resort given that raising capital in this matter is dilutive to existing ownership.
That said, some U.S cannabis companies have been able to access debt by going to smaller, private lenders or hedge funds.
For example, my company, KushCo Holdings, Inc. was recently able to make a private placement of a $21.3 million unsecured note without warrants or conversion features of unregistered shares. If the note is held to maturity, the cost of capital is approximately 13.3%. Although 13.3% may sound high, ultimately it is in line with traditional high yield market rates. In April, Harvest Health, a vertically integrated cannabis company, also announced a private placement of $500 million of convertible debentures with an annual interest rate of 7%. Harvest Health was able to obtain a lower rate due to the conversion feature embedded in the loan, which allows the note holder to convert their debt to equity. (The “optionality” provided to the note holder increases the cost of capital above the stated 7% interest.)
In stark contrast, many Canadian cannabis companies would be appalled by these rates as their cost of capital is well below 10%. Cannabis was legalized in Canada last year and as a result, many financial institutions are competing to capture market share. Look no further than the 80 million Canadian dollar credit facility secured by cannabis investment firm Canopy Rivers from the Bank of Montreal in the mid 5% per annum rate over its three-year term.
While federal legalization in the U.S. is still uncertain, banks may soon get the green light to work with legal cannabis companies, thanks to the Secure and Fair Enforcement (SAFE) Banking Act approved by the U.S. House Committee on Financial Services in March. A full House vote is expected in the next few months. The bill may run into some trouble in the Senate but industry watchers are hopeful that it will pass and be the change they’ve been waiting for.
This will be huge for the industry. Instead of having to climb that mountain every time a cannabis company needs more funds, they’ll just have to go for a strenuous hike (funding is never totally easy). Instead of spending excessive amounts money simply to finance operations and growth, they’ll be able to better allocate existing capital. In short, the SAFE Act will allow the cannabis industry to finance itself (not unlike any other legitimate industry) — and the resulting growth will be a boon for cannabis entrepreneurs, banks and investors alike.
May 9, 2019 at 07:34AM
Forbes – Entrepreneurs