By: Dominic J Bartolone
The medical marijuana landscape is changing in California. While the dispensary business has been steadily growing over the past few years, several pieces of legislation are on the ballot this November seeking changes to the Medical Marijuana Regulation and Safety Act (MMRSA). Industry observers believe the legislation can be viewed as both positive and negative for the industry. Positive proposals include bills that protect those with criminal records to be exempt under current regulations, or allowing more businesses to obtain state licenses. But there are also some bills that could have a negative impact on the industry, such as new taxes on both retail and wholesale sales. One thing is sure – the cannabis industry is growing very quickly.
The Cannabis Business Boom
Over the next few years, there are very few sectors of the economy projected to grow by triple-digits. Analysts are predicting the legal marijuana industry will grow 500% over the next five years. For savvy private investors and lenders, now is the right time to invest in legal cannabis. But understanding how to invest the correct way is the difference between cashing in on the high-rewards of the legal marijuana industry, and exposing yourself to legal risks.
Currently, only 24 states have legalized marijuana use. While more states are considering medical marijuana in 2016, California residents will be voting on the Adult Use of Marijuana Act (AUMA) this November that will put an end to the prohibition of marijuana for casual use. Whether that law passes remains to be seen, but you can be certain that the industry will continue to grow regardless. With growth comes a need for capital.
What The Cannabis Industry Needs
All startup businesses need proper funding if they are to succeed in their market. This rule is no different for the cannabis industry. Cannabis startups need capital to begin operations, as well as loans to help them purchase additional equipment, lease retail space, or expand their business. Given marijuana’s federal illegal designation, many bank loans are hard to come by for cannabis shops. These companies have been turning to private money or angel investors to fund operations. As laws change and political views soften, financing marijuana businesses may face fewer obstacles in the future. But for the time being, those willing to provide funding to these operations get to reap the rewards.
There are a few companies providing venture capital to dispensaries or grow operations. But they usually require a significant stake in the enterprise. While they don’t often indicate they want any control over the process, business owners would prefer a commercial loan rather than give up equity.
Why Banks Are Refusing Cannabis Businesses
Although marijuana is legal for medicinal purposes in California and 23 other states, it is still prohibited under federal law. FinCEN Guidance binds banks that are federally insured or are National Associations with strict rules prohibiting interaction with cannabis operations. The FDIC will not insure banks that conduct business with operations deemed illegal under federal law. By lending to cannabis businesses – at least those openly operating as such – federally insured banks could open themselves up to sanctions from the federal government, including expulsion from the FDIC.
The DOJ has held that it will not prosecute marijuana crimes in states where it is legalized, yet banks are shying away from the industry as a whole to avoid the appearance of impropriety at the federal level. A few local banks and credit unions have begun opening up credit to cannabis businesses and equipment providers, but the need for private capital is still overwhelming. There currently is a huge demand and profitable opportunity for investors willing to step in and provide those funds that the banks will not.
How Marijuana Business Loans are Structured
Recently, some financial firms have begun actively financing marijuana businesses. You may see cannabis companies that have no access to bank capital, yet have very strong financials. As banks reject the business, private equity firms and venture capitalists have filled the void. While financing is available, it is not cheap. Some lenders take a substantial equity stake in exchange for start-up capital, while others charge high fees for short-term, high-interest financing.
Some financial companies are taking the approach of a combination of debt-equity financing to structure loans that are both secure and provide a higher, double-digit rate of return not seen in traditional commercial lending.
To provide funding, they require a cannabis business to:
- Be incorporated (S-Corp, LLC, Ltd.)
- Be a dispensary or growing operation that has been in business for at least six months
- Have a business banking account
- Have monthly gross sales above $10K
- Qualify based on personal credit
Much of the private lending now available to cannabis companies is structured similarly to small business finance or hard-money loans. The company qualifies based on their monthly revenue, and a repayment plan is organized with weekly or bi-monthly payments. Dispensaries or grow operations that have been in business for even a short amount of time are usually receiving a daily revenue stream and therefore have no problem meeting payment obligations. Due to the restrictions placed on the industry by the big banks, business owners turning to private capital are more than willing to pay higher fees and interest rates to satisfy their funding needs.
Participating in a $20 Billion Marketplace
Commercial lending for marijuana business is a niche industry that requires a fair bit of due diligence on the borrower, as well as the financial rules surrounding the federal Schedule I designation. Most private lenders, who are dealing in this space, do so with the help of a legal team that understands the industry and knows how to conduct a proper risk assessment to avoid pitfalls.
While marijuana business lending is not for everyone, if structured correctly with proper risk aversion, a private investor can be confident that they are compliant with state laws as they profit from a legal business that is growing faster than any other economic sector.
