Purchase Money Financing: What Is It and What Are the Benefits?

Every small business owner dreams of getting that one massive order that will put their business on the map, but what happens when the order arrives and you don’t have enough cash to purchase the raw materials to fill it? Small business owners in every industry, including the cannabis industry, face this issue every day. Although cash flow challenges aren’t entirely unique to cannabis business owners, cannabis business owners do face other unique challenges in financing their businesses. Federal regulations surrounding the cannabis industry prevent banks, credit unions, and credit card companies from financing cannabis businesses, leaving them to operate on a primarily cash basis. With no available line of credit to provide an influx of cash when demand for their product increases, cannabis business owners may struggle to meet the demand for their products, directly limiting business growth. Purchase money financing offers a viable opportunity to business owners looking to ensure that they’ll be ready to fulfill the next big order when it comes in.  

What Challenges Do Cannabis Business Owners Face When Seeking Financing?

Recreational cannabis might be legal in 11 states and medical cannabis use might be legal in 33 states, but that doesn’t mean that the banking and financing industries are ready to play ball with cannabis business owners. The reality is that cannabis business owners still deal with serious roadblocks when it comes to obtaining financing, no matter how legal their product might be in their state. Cannabis remains Schedule I controlled substance at the federal level (making it illegal), which means that getting financing through a traditional financial institution, such as a bank or credit union, is nearly impossible. Because of regulations surrounding illegal substances and activities, federally insured financial institutions cannot legally handle capital that is connected to cannabis. If you’re a cannabis business owner looking to apply for a loan or open a checking or savings account, traditional financial institutions will not be able to work with your business. some credit unions in legal states such as Colorado, CA, WA, etc. do actively bring on cannabis operators so I’m not sure if you want to mention that or just not be so adamant about the fact it’s not an option. They usually don’t provide lending services so these are not competitors to Bespoke but usually are partners This can be a big problem when you are trying to come up with the money for a down payment or closing costs on a real estate property for your business. Additionally, banks and credit unions are subject to the same regulations around money laundering that individuals are, so these institutions also cannot provide real estate or equipment loans, among other things, to cannabis businesses; any money tied to cannabis in any way, no matter how small, is off-limits. All banks are also 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. Fortunately, commercial lenders specializing in cannabis business loans, such as Bespoke Financial, have stepped up to fill the funding gap facing cannabis business owners, so funding availability is increasing.

What Is Purchase Money Financing?

Purchase money financing is a type of financing that provides a way for businesses that lack the cash flow to access the raw materials they need to complete customer orders. This type of funding is received by the borrower prior to delivering goods to customers and invoicing them.  Sometimes, business owners receive a large order from a customer, but they do not have the cash on hand to purchase the supplies or delivery means needed to fulfill the order. Purchase money financing offers cannabis business owners the opportunity to receive financing for up to 100 percent of the purchase price for raw materials, allowing the business to fulfill purchase orders and grow. Unlike some other types of financing, funds are not sent from the lender to the borrower directly. Instead, the lender sends the borrowed money directly to the supplier, essentially purchasing the goods on the business owner’s behalf. The business that is requesting the finished product from the cannabis business owner then pays the invoice to the lender, who retains the loaned amount plus any accrued interest or fees. While some lenders, including those who deal specifically with the cannabis industry, like Bespoke Financial, may be willing to finance up to 100 percent of the cost of the order, other lenders may only be willing to finance a portion of the cost. Purchase money financing does not move as quickly as some other types of financing so it may not be the best option for cannabis business owners that need immediate access to capital. 

What Are the Steps of Purchase Money Financing?

There are four main steps in purchase money financing, including the following example:

  1. First, a cannabis business owner receives a purchase order for finished goods from a retailer. The cannabis business owner issues a purchase order to a supplier to purchase raw materials.
  2. Next, the lender pays the supplier directly for the purchase of raw materials by the cannabis business owner.
  3. The cannabis business owner then receives the raw materials and creates the products needed to fulfill the purchase order.
  4. The retailer then pays the invoice to the lender. The lender retains the advanced amount paid to the supplier plus any accrued fees or interest, sending the remaining balance of the payment to the cannabis business owner. 

Under the terms of purchase money financing, the vendor receives payment directly from the lender and interest only accrues when the funds are used. Repayment terms are generally about 90 days in length, and fees are approximately 2.5 to 3.5 percent of the invoice amount and are assessed every 30 days. 

What Are the Benefits of Purchase Money Financing for Business Owners?

As previously mentioned, purchase money financing offers an excellent opportunity for cannabis business owners to increase their purchasing power and help manage cash flow. This type of financing allows cannabis business owners to pay cash-on-delivery (COD) to their vendors, which can reduce the cost of inventory due to price discounts. With purchase money financing, cannabis business owners are able to capitalize on periods of increased demand and see their businesses grow. This type of financing also offers the opportunity to improve unit economics, reducing the cost per manufactured item.  Purchase money financing allows business owners to focus on what’s important – growth – rather than worrying about finding enough cash to purchase the supplies they need to meet demand. With purchase money financing, you won’t have to turn down large client orders. Purchase money financing also offers an opportunity for businesses with less-than-perfect credit to receive financing, as these types of loans have less stringent requirements for approval than a private loan or line of credit because the purchase order acts as a type of collateral to back the loan. Your lender will likely be more concerned about the payment history of your customer since they are the ones who will be responsible for paying their invoice upon delivery of the product. 

What Are the Benefits of Purchase Money Financing for Lenders?

Purchase money financing isn’t just beneficial for business owners. Lenders also like purchase money financing because the purchase order serves as collateral for this type of financing, unlike lines of credit or credit cards, which are often unsecured. Risk is limited for lenders provided that the payment history and credit of the ultimate customer is good since it is assumed that the customer wants to receive their product and will pay their invoices. Thus, purchase money financing is a form of financing that can be extended to borrowers whose credit may not be perfect or who may not have other collateral to offer.

Who Should Consider Purchase Money Financing?

Purchase money financing can be beneficial for cannabis business owners operating in nearly every aspect of the cannabis industry, but it is especially recommended for cultivators, distributors, manufacturers, cannabis brands, and ancillary companies. Purchase money financing can also be appropriate for some other components of the cannabis industry, including dispensaries, under the right set of circumstances. 

Where Can I Get Purchase Money Financing?

Cannabis business owners might be prohibited from working with traditional financial institutions, but commercial lenders like Bespoke Financial have been created specifically to address the needs of the growing cannabis business community. One benefit of working with a cannabis-specific lender is that these lenders understand the financing challenges faced by the industry and are likely to offer industry-appropriate financing options, including purchase money financing. They also won’t be scared off by what remains a risky industry due to the legal grey area surrounding cannabis businesses. When speaking with lenders, be sure to explain your financing needs and ask for guidance in choosing the loan product that is right for you. You should discuss the interest rate, monthly payment, and any fees before signing on the dotted line. 

What Do I Need to Apply for Purchase Money Financing?

Because purchase money financing is based on the likelihood that your customers will pay for their invoice in the future, some lenders will request evidence of your customer’s payment and credit history. Some lenders may also want to see evidence of a strong reputation for your supplier so that they can be assured that you will receive the goods that are paid for. Remember, 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 score, and loan amount. Lenders who cater to the cannabis industry may also want to review a list of the current owner, key management personnel and a list of all active cannabis licenses held. 

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