Financing is just one of a list of challenges facing the cannabis industry today. Because Cannabis remains a Schedule 1 controlled substance at the federal level, it creates hurdles for businesses in the cannabis industry. The robust economic input and job creation has led to an uptick in acquisitions. Despite this growth, the fact that cannabis is still illegal at the federal level creates a challenge for cannabis businesses looking to acquire funding. In the Cannabis industry businesses have much higher operating and financing costs than other industries. Regulatory requirements and no access to federal banking have all created obstacles for companies in the industry or looking to get into the industry.
Financing Challenges for Cannabis Businesses Industry
Another obstacle for marijuana businesses is the fact that Marijuana producers are not able to establish bank accounts or use credit card-processing services. As a result, the industry must deal primarily in cash and debit-card transactions, limiting the ability of cannabis companies to finance growth. Combine the lack of access to banks and limited supply of lenders, with a high demand for financing, and what you get is higher than normal interest rates, and companies making nontraditional loans.
Financing options for private cannabis companies come from business cash advances, purchase order financing or convertible debt. While obtaining funding for publicly traded cannabis companies is easier, they also face similar challenges regarding interest rates and loan terms. Institutional investors into the industry are still limited to hedge funds. Adding to their pain, Cannabis companies are having to deal with Section 280E of the federal tax code. Section 280E taxes gross profit by eliminating most deductions resulting in the feds taking anywhere from 40% to 70% of a company’s income. The result is the inability to use working capital to finance operations and future growth. In addition, cannabis companies do not have the legal right to declare bankruptcy, making this higher risk industry even more risky.
Debt funding eclipses equity funding for cannabis companies
Equity funding in the U.S. Cannabis industry is down nearly 65% this year as opposed to 2021. As a result, because of lower stock prices and more creditworthy cannabis companies emerging, debt financing is now the preferred method to raise funds. Prior to 2022 equity funding had dominated cannabis capital raises, but in 2022 debt funding has dominated. Still because of the challenges facing the cannabis industry debt financing in the U.S. marijuana industry is down by 39.9%. That said, year-to-date debt now makes up the lion’s share of capital raised by U.S. cultivation and retail companies. This shift is a result of more companies showing healthier balance sheets and are better positioned to repay loans.
For at least 2023 debt financing will continue to be the primary means of raising capital until economic conditions improve. Lower interest rates, higher stock prices, and federal marijuana reform or some combination of those issues may result in a shift back to equity funding. Securing financing funding in today’s environment is still a challenge for most cannabis companies and because of rising interest rates debt financing is getting more expensive.
Why Is Funding so hard to come by in the Cannabis Industry?
As the cannabis industry is growing in leaps and bounds new businesses are struggling to find the loans and cash advances necessary to start up and grow. Much of the issue is related to the legal restrictions. Because Cannabis is still illegal at the federal level, the small business administration will not issue loans and banks refuse to issue loans for cannabis businesses. Currently Cannabis is a mostly cash based industry, and because legal restrictions and cash business mentioned above make the industry high risk.
Any bank that is FDIC-insured won’t work with a cannabis business because of the FDIC’s regulations on lending to high-risk companies. Banks providing loans to businesses associated with the drug could be subject to prosecution if the business breaks state law by selling to a minor or transporting cannabis across state lines.
For a Cannabis company looking for funding, investors are typically looking to see that a company has been in business for at least six months. It is also looking see if the company is established as an LLC, or S corporation, has a credit score of at least 500, and is able to pass a background check. Finally, be prepared to articulate via a business plan describing exactly what the funding will used be. Will it be for a Cannabis business license fee, grow house costs, dispensary costs, hiring new staff, paying for equipment, utilities, and rent, land, or real estate costs?
Are you interested in learning more about the Cannabis Industry? Contact our Cannabis Industry Subject Matter Experts today at MaxQ Technologies, Inc. We’d love to help you boost the value of your business with our expertise.