Debt Financing Is on the Rise

September 13, 2023 · MG Magazine

With cannabis stock prices stalling and sliding over the past few years, companies increasingly have turned to debt financing as a means of raising funds. Last year, debt made up more than 90 percent of capital raised by American cultivation and retail companies and 55.7 percent of capital raised in the United States industry overall, according to data collected by strategic advisory firm Viridian Capital Advisors.

In October 2022, multistate operator (MSO) TerrAscend Corp. secured a $45.5-million loan from real estate lender Pelorus Equity Group to help fund its New Jersey and Maryland operations. The loan, which matures over five years, began with a variable annual interest rate of 12.77 percent but is based on a variable rate tied to the one-month secured overnight financing rate, with interest-only payments for the first thirty-six months.

While MSOs like TerrAscend have access to this type of loan thanks to significant cash flow and equity, it’s more difficult for small and medium-sized companies to secure something similar. In the past, securing any type of loan in the cannabis industry was a rare event and a double-edged sword, with sky-high interest charges making credit card rates seem like a steal. One particularly insidious type of debt that has crept into the industry is merchant cash advance (MCA) loans, which are similar to payday or cash-advance loans for individuals. MCA lenders advance money to businesses in exchange for a claim against the borrower’s future income.

Gary Allen, chief executive officer at New Frontier Data, said MCA debt is a major Achilles heel for companies across the U.S. and often is a dealbreaker when it comes to mergers and acquisitions. “The payday loan scenario is appealing for a lot of companies, because they will quickly approve you and even fund you the same day,” he said. “In order to be in cannabis, you have to be the eternal optimist anyway, right? So they get you on the crack pipe—and we’ve had to use them too—and it takes a Herculean effort to get off.”

There are other options available for cash-starved companies.

  • Real estate investment trusts (REITs) sometimes offer sale-leasebacks for entities that own valuable real estate or other business and personal assets they can use as collateral.
  • A handful of credit unions offer “market-rate” loans, but these are primarily for companies that have an existing account with the financial institution, excellent credit, and significant cash flow.
  • There’s also the age-old “friends and family” loan, but these types of loans usually are for smaller amounts of money and don’t account for a significant portion of the debt in the industry.

None of these funding methods are particularly appealing for small and mid-sized companies. One of the only options left is to work with a specialty finance company. These operators, which are becoming increasingly common, design loans at appealing rates and can be a reasonable proposition in some circumstances (buying new equipment, short-term loans to take advantage of market opportunities, et cetera). While specialty lenders offer different types of loans, most of them are based on assets or cash flow and allow the borrower to operate on a month-to-month basis.

Adam Stettner, co-founder and CEO at FundCanna, is a veteran of the loan business who turned his attention to the cannabis sector during the coronavirus pandemic. After studying the supply chain, banking rules, regulations, and state and federal taxation, he began offering loans designed to address the industry’s unique dynamics. One of the key differences he discovered between cannabis and other industries is the ubiquity of cash-on-delivery sales and how cash-only transactions impact operators up and down the supply chain. While a cultivator might lay out money for three to six months (or even longer) during a cultivation cycle—growing, harvesting, trimminglab-testingpackaging, distribution—before receiving any revenue, an extraction shop or edibles manufacturer generally has a shorter production cycle. For different types of companies, Stettner reasoned, there should be different loan terms.

“I took a look at these timelines and designed products that are short-term in nature but also give the operator flexibility to shorten the duration and thereby reduce the cost of capital,” he said. “Basically, I’m giving them the wheel so they’re in control. What we do is look at the dollar need and the timeline need. We’ll go longer sometimes, because that makes the smallest serviceable payment. And we always make sure the payment is comfortable, with the idea that when revenue hits, [the borrower has] the choice to pay down [the interest] and keep [the loan] going, using the [principle] to fund growth or other areas of their operation. Or they can pay [off the entire balance] and start the cycle again.”

Earlier this year, Reuters reported the average interest rate for loans in the cannabis sector was as high as 20 percent, compared to 6–8 percent for small-business loans from traditional banks.

But until there is a significant rise in stock prices or banking legislation like the Secure and Fair Enforcement (SAFE Banking) Act passes at the federal level, cannabis companies likely will continue to use debt financing as a primary source of fundraising. (Full Story)

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