Finding credit within the cannabis industry is tough, and the current crisis hasn’t helped. NewTropic CEO Alex Rowland shares 7 ways operators can secure credit.
It’s a cruel twist of fate that when you need credit the most, it can be the most difficult to come by. The cannabis industry has notoriously lacked access to the same financial solutions as other industries, and credit tops the list. This reflects a combination of both the perceived risk (which many argue is a misconception), as well as the lack of federally backed programs, such as FDIC Insurance and federal bankruptcy protection. Add to that the uncertainty surrounding a global pandemic and you currently have a bonafide credit crunch. Whether a company is looking to scale and needs capital for growth, or just needs some time to pay bills while waiting on receivables, having credit available is not only prudent, but can mean the difference between a business staying alive and going under.California, in particular, has been at the forefront of the cannabis legalization movement since the 1970s, and was the first state in the U.S. to legalize medical cannabis back in 1996. This foresight has positioned the state to be the largest legal cannabis market in the world today, and while it still has a ways to go in its evolution towards optimal regulations, the state nonetheless generated an estimated $635 million in tax revenue in 2019 from legal cannabis sales.
According to Alex Rowland, CEO of NewTropic, there are 7 primary avenues for a cannabis company looking to borrow, some more attractive than others:
1) Secured by Real Estate: One option for a business is to sell any real estate assets it controls to an entity like Innovative Industrial Properties. The property company can then lease the building back to the operator. “This allows for bringing in real estate investors to help in the process,” says Rowland, “at a much lower cost of capital.” Rates for this kind of arrangement usually go for 8%-14%, depending on the type of property.
2) Secured by Receivables: Companies are sometimes able to borrow using their receivables as collateral. When factoring receivables, a business ends up selling invoices at a discount to collect the funds faster. Rowland advises that you can usually receive an advance of about 70-80% of an invoice amount. Then, depending on how long it takes to collect on that invoice, they’ll subtract that in the form of a finance fee ranging from 0.5-1.25% weekly. Overall, this can ease short-term cash flow, but will damage overall profitability.
3) Secured by Inventory: Inventory is much harder to finance, and understandably so. Most lenders cannot take possession of cannabis. Generally speaking, a credit facility is considered secured if the borrower can collect on the underlying assets, and the lender can step into the borrower’s place should a default occur. An unlicensed bank or financial institution typically can’t foreclose on a borrower and then collect against the assets. Interestingly, NewTropic, as a licensed cannabis manufacturer (not in a lending capacity), has developed a way to take possession of inventory and to provide credit in the form of manufacturing services to qualified companies. “This typically wouldn’t be an available option in the general market,” says Rowland. “But we saw a need so we’ve made this type of option available to brands who qualify.” Rowland says NewTropic is charging 0.1% daily for this kind of credit facility.
4) Equipment Financing: Equipment value can be difficult to quantify once it’s been used, therefore it’s generally more expensive to finance. However, equipment financing does allow businesses to borrow using their property, plant, and equipment (PPE) as collateral. You can expect annualized rates ranging from 12-24% per annum, in addition to discounted loan-to-value levels, to borrow against PP&E depending on the type of equipment and depreciation schedules.
5) Purchase Orders: In certain instances, credit can also be secured on a purchase order. Instead of borrowing off of inventory or accounts receivables, credit from purchase orders is based solely upon orders received. Because a transaction has yet to be completed there is another element of risk, which means it’s effectively unsecured debt. Expect rates of 36-48% per annum or higher (often sold in conjunction with receivables financing).
6) A Hybrid of Debt and Equity: A hybrid of debt and equity works similar to a convertible note: you raise capital that is structured as debt with a set maturity date, upon which the debt converts to a predetermined amount of equity. Typically, this type of debt will command a 4-10% per annum coupon.
7) Unsecured Loan: Unsecured loans are collateralized by a personal guarantee. Outside of friends and family, these are virtually non-existent.
Every cannabis operation is different, especially considering the variation between a cultivator, manufacturer, or a retailer. Simply put, all companies’ rates of borrowing and amount of cash for equity are going to be based on the present value of future cash flows, and of course, what assets are available to secure against. Rowland recommends booking time with a specialist to go over the benefits and drawbacks of various options. Knowledge of finance in the cannabis industry is evolving and complex, so having an expert on your side can greatly improve the ability to compare opportunity costs for both financing options as well as capital investment.
Alex Rowland is Chairman and CEO of NewTropic, a leading cannabis manufacturer that provides professional-grade supply chain solutions to California brands, cultivators, manufacturers, and distributors. Mr. Rowland is also a co-founder of Ensemble Brands, a cannabis brand accelerator.