How do business loans in the cannabis industry work?

The cannabis industry is exploding in size, and new states continue to legalize and decriminalize the sale of cannabis for medical and recreational purposes every year. Are you a future marijuana business owner? Did your state just legalize recreational marijuana? With so much opportunity in the marijuana industry, it’s no surprise that entrepreneurs are excited to get in on the action; everyone wants to be the first in their state to set up shop. What many would-be business owners in the cannabis industry are surprised to find is that obtaining conventional funding through mechanisms like small business loans is simply not an option due to the legal regulations surrounding cannabis.  Even in states like Colorado and California which have flourishing legal industries in recreational use (by state law) and seem to have a dispensary on every corner federal law prohibits small business loans to any marijuana business from federally insured depository institutions (banks and credit unions). No matter how legal cannabis might be in your state, it’s still illegal at the federal level, which means that traditional lenders can’t help you grow your business. Not to be deterred, new options for cannabis business loans have started popping up to provide funding for burgeoning businesses. If you’re interested to know how cannabis business loans work, there is a lot of vital cannabis industry specific knowledge that any business owners should be aware of before attempting to secure a cannabis business loan.

Why are cannabis industry business loans so hard to find?

There are now 11 states that have legalized marijuana for recreational use and 33 states where medical marijuana is legal, and eager business owners are ready to get in on the action and join this booming industry. You’d think that with such a huge movement towards decriminalization, finding financing would be easy as long as cannabis is legal in your state, right? Wrong. Would-be entrepreneurs are having bank door after bank door shut in their faces and left with few financing options. It is difficult for many marijuana businesses to even obtain a bank account at a federally insured bank or credit union. Because cannabis is still illegal at the federal level, getting financing through a small business loan is nearly impossible, as financial institutions cannot legally handle capital that is connected to cannabis.   It’s still possible to get to the green (both the money and the cannabis) one way or another, but you’ll have to be a little more creative than simply walking down to your bank and applying for a business loan. Financing options exist, however, business owners should proceed with caution to prevent any unwanted visitors from the federal government. 

Can a cannabis business borrow through a bank?

Probably not. The big banks and credit unions are all regulated by the federal government, which views transactions connected to cannabis as illegal activity. It is important to remember that even financial institutions that are state-chartered still also report to a primary federal regulator (FDIC, Federal Reserve, or OCC).  You might think that if you’re only using the loan to purchase real estate or market your business rather than buy inventory, it would be ok, but the federal government considers this to be money laundering. Banks are subject to the same regulations around money laundering that individuals are, so traditional financial institutions won’t go near cannabis-related, marijuana businesses with a 10-foot pole. It may be possible to work with a local or state-chartered bank or community credit union, but all banks are subject to a regulation called the Bank Secrecy Act that requires banks to flag transactions of 5,000 dollars or more that may be associated with illegal activity, including cannabis sales. This is a primary impediment to business owners in the cannabis industry. Any cannabis business even primarily engaged in ancillary activities to actual sale of the substance will find these financial regulations as an impediment. 

However, change may be on the horizon. The SAFE Banking Act was passed by the House of Representatives in December 2019 that would allow financial institutions to legally participate in the cannabis industry, and the bill passed with broad bipartisan support. However, the bill has yet to be passed by the Senate, where it faces considerably more opposition. Cannabis businesses and business owners strongly favor its passage. 

Can a cannabis business use  a commercial lender?

It is possible to use a commercial lender to finance your cannabis business if you know where to look. The first licensed commercial lender focusing on the cannabis industry was founded in 2018, so this option is relatively new. 

What types of financing options are available to cannabis business owners?

There are two main types of financing options available to cannabis business owners: debt funding and equity funding. Debt funding generally involves financing your business through either taking out loans or using a business credit card. The lender is then paid back the original loan amount plus interest. Equity funding involves offering shares of the company in exchange for capital. The investor receives their money back in the form of dividends or profit when the business is sold. Since equity funding assumes that the company needing working capital already exists and holds value, debt funding through loans and credit is the method most cannabis business owners will need to use to fund their businesses at the beginning. Cannabis business and dispensary loans generally fall into four different categories: private loans, real estate loans, equipment leasing loans, and dispensary cash advances.

Private loans

Private loans are available from non-bank lenders and typically come with rates of between 8 and 25 percent. Lending terms are generally from one to three years, and funding is typically available in seven to fourteen days. In general, lenders prefer to focus on business funding the growers and manufacturers of cannabis products rather than funding the dispensaries themselves, although exceptions can be made for companies with proven revenue. Private loans primarily come from venture capital firms, which can be problematic because of the difficulty in connecting with these firms, particularly for women and minority-owned businesses. 

Real estate loans

If you’re looking to purchase land on which to grow cannabis or real estate in which to house  your business, a real estate loan may make the most sense for you. Bridge loans, hard money loans, and shorter-term mortgages are all available to cannabis companies and medical marijuana dispensaries. Interest rates typically range from 8 to 20 percent and terms are 1 to 5 years in length. Funding takes approximately 30 to 60 days to obtain from the time of application. 

Equipment leasing

Special financing is also available specifically for growers who need to purchase farming equipment. Equipment leasing is a popular option for growers who need equipment but do not want to purchase it outright. The leases typically hold interest rates of between 8 and 20 percent and are funded over 1 to 7 years. Leases are available in five to fourteen days. 

Cash advance

It can be difficult for dispensaries to find funding, so cash advances are sometimes the most viable option. Cash advances are not a loan, and in order to receive one, the dispensary will need to show strong revenue. Factor rates vary from 1.30 to 1.49, and terms vary from 4 to 12 months. Funding is received quickly, typically in just one or two days, so if you need quick cash on a short-term basis, it may be a good option. However, cash advances are typically the most expensive way to fund your business, so they should only be used if you don’t have other options.

What is invoice financing?

Cannabis businesses have a long lead time on open invoices, often waiting between 30 and 90 days to receive payment on an open invoice. This cash flow lag can be problematic because businesses are left hanging in the balance. Invoice financing is a type of loan that offers partial repayment on outstanding invoices. Invoice financing is a popular option for cultivators, distributors, manufacturers, cannabis brands, and ancillary companies because it is flexible and provides consistent cash flow. Using this type of financing, you’ll only accrue interest when you use the funds, and you can borrow for up to 90 days. Fees are approximately 2.5 to 3.5 percent of the invoice amount and are assessed every 30 days. The steps of invoice financing are as follows:

  1. An invoice is issued to the cannabis business owner for goods or services. The invoice is due in 30 days and the business owner requests invoice financing.
  2. A percentage of the invoice amount (approximately 80 percent) is deposited directly into the invoicer’s account from the lender.
  3. The business owner uses the funds to increase production and profits. Financing fees accrue during this time until the invoice is paid in full to the lender.
  4. The invoice is paid in full to the lender, who completes payment to the invoicing company minus accrued fees.

What is inventory financing?

Inventory financing is a short-term loan that is backed by assets – specifically, your business’s inventory. Inventory financing is beneficial because it helps balance out your business’s cash flow and provides funds that can be used to purchase more inventory or pay for other expenses. By having your lender pay your vendors directly, you’re able to get cash-on-delivery (COD) pricing, helping you save money and grow your business. Inventory financing is an excellent option for cultivators, distributors, manufacturers, cannabis brands, dispensaries, and ancillary cannabis companies that are looking for flexible financing that can help build strong vendor relationships and demand lower prices. Under the inventory financing model, vendors are paid directly and interest only accrues when you use the funds, which can be borrowed for up to 90 days. Fees are approximately 2.5 to 3.5 percent of the invoice amount and are assessed every 30 days. The steps of inventory financing are as follows:

  1. Vendor ships product to the business owner and issues an invoice due in 30 days.
    The business owner requests financing.
  2. The lender sends an advance of the entire invoice amount to the vendor.
  3. The business owner sells the final product.
  4. The business owner pays the invoice amount plus accrued interest and fees to the lender.

What type of information is needed to apply for a loan?

Cannabis lenders might be focused on a non-traditional industry, but they’re still businesses, which means your finances will need to be on the up-and-up when you apply for a loan. Your lender will want to review your financial records (balance sheets, income statements, and bank statements), your credit risk profile, and capital needs. Lenders who cater to the cannabis industry may also want to review a list of your key management personnel and a list of all active cannabis licenses held. 

Will I need to do a monthly inventory and/or cash audit?

Traditional financial institutions, especially those administering loans for the Small Business Association (SBA), typically require monthly inventory and cash audits for the life of your loan.  Cannabis-specific lenders may not require these monthly audits as long as payments are made on time, which offers you more time to run your business and less time spent pushing papers. 

How much money can I borrow?

As with any loan, the credit limit extended to a cannabis business will depend on your capital needs and credit risk profile, which will be based on the submission of recent financial records (balance sheets, income statements, and bank statements), your credit score, management personnel information, and more. Loan sizes vary depending on the type of financing you are pursuing and the reason the financing is needed, but it may be as little as a few thousand dollars to several million dollars. A full range of alternative lenders will offer everything from equipment financing, real-estate loans, with various amounts and financing options. 

How do I know which type of funding is best for my business?

The type of funding that is best for your business will depend on a variety of factors, including your specific involvement in the cannabis industry (distributor, manufacturer, cultivator, dispensary, etc), your business model, the amount of money you need to borrow, how often you need access to capital, your expected loan term, and your credit risk profile. As a cannabis business owner, regardless of which type of funding you choose, you’ll want to make sure to work with a lender that can assure 100 percent compliance in this rapidly growing and changing industry.

How do I get started?

Prior to applying for a cannabis business loan, you should start by researching the type of lender you want to work with. Now that you know the basis about how cannabis business loans work, you’ll be able to narrow down which companies might be the best fit. Before applying for a loan, make sure you get your business and personal finances in order, because although you have a nontraditional business, your lenders will still want to see proof of your ability to pay them back. Gather information like balance sheets, income statements, and bank statements, your credit report, your business plan, and evidence of your capital needs. Make sure to be prepared to provide information on your key management personnel and a list of all active cannabis licenses held. Once you’ve got your stuff together and you’re ready to apply,  you’re ready to get started! With any luck, you’ll have your financing in no time.

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