Cannabis on fire: How debt financing hurts small and medium-sized cannabis businesses
Nobody will tell because nobody really wants to admit it: the cannabis industry is on fire. We are seeing massive downturns in many frontier states due to market contraction and, of course, overtaxation. Yet we have known this for some time and understand the danger that overtaxation poses to small and medium-sized businesses in particular. This is also a problem for large companies, but the glaring difference is that large companies have access to more capital than small and medium-sized companies. Many small and medium-sized businesses are owned by women, people of color, and immigrants who don’t have access to capital during this downturn or any other downturn.
It’s a three-alarm fire. What are we doing?
It’s often said that being in the cannabis industry means constantly putting out fires. What actionable items need to happen to put out the three-alarm fire we currently find ourselves in or at least slow it down until federal legalization? Some people would say that means we need to cut taxes, but we’re not going to see a significant drop in taxes because the states need the money. Despite the rhetoric, there is no state in the union that legalizes because of the factory – they legalize because of the money.
And taxation is not the only fire. Anyone currently raising capital for plant-related deals knows that it has become increasingly difficult to raise equity in recent months. It used to be that backers were looking for unicorns to invest in. That has changed, and now companies are looking for backers willing to invest in small and medium enterprises. These backers, well, they’ve become the unicorns. To say that equity funding has dried up over the past few months is an understatement, as the Viridian chart below shows.
Equity financing is drying up
The lower dark green bars on each chart represent equity issues smaller than $10 million. They have always represented a small fraction of the capital raised in the business of touching plants. This year, this bar disappeared. Small businesses are being shut out of the market before our eyes. Dark blue bars represent disappearing $10-25 million deals for mid-sized businesses. Do you see the illuminated area? This light blue area shows the debt financing available to the few in the industry. Right now, equity financing is nearly impossible to find if you’re a small or medium-sized business. Over 90% of all equity financing that exists is for multi-state operators, who have already gotten a lot of equity financing and lost it. Now the billions of dollars raised are for debt financing, and that’s where the cannabis industry has set itself on fire.
Going from equity financing to debt financing as the primary means of financing the cannabis industry is terrible, especially given some of the debt structures on offer. These credit facilities are often complex and punitive, hello 28% interest, or as we call them, payday loans.
Solvency in crisis
But what kind of financing is needed? Before we can understand what kind of financial products we should put in place for the cannabis industry, especially for small and medium enterprises and especially for social equity companies, we need to understand the failure of our financial institutions . In general, we need to understand the rubric currently used to identify who has creditworthiness for investment, equity or debt, who would be most likely to be successful at scale, and who has market share. It doesn’t work in the cannabis industry. This leaves a lot of people behind to get the first licenses, which isn’t a problem in normal industries because there wasn’t quite a market before non-cannabis industries sprang up.
We need to start opening our minds to different ways to identify the creditworthiness of cannabis businesses run by people who have traditionally not been considered creditworthy for anything in the entirety of this country’s existence. We need to value the power of their intellectual property over the past 80 years, their ability to create and scale a market for their companies, and the innovation they have brought and continue to bring to the industry. They have real value that is well worth your investment.
When we consider this in terms of upcoming recreational states, we have to look at New York.
What will New York do?
To use the credit rubric as it exists today in the cannabis finance industry is to understand that equity (ideal) and debt (less ideal) financing do not exist for people who obtain the first licenses in New York. It certainly didn’t help those who got their first licenses in California. It also didn’t help the social equity people who came after the fact in Colorado and other states. We need creative new financial products that are fairer without giving up reasonable to excellent returns. We need to create a thriving legal market, not just in New York, but across the United States. We need to change the rubric that funders, financial institutions, and foundations use going forward to truly support this revolutionary industry and provide financial products equitably to those less likely. qualify, but more likely to succeed in the cannabis industry.
Although New York is starting with a $200 million debt fund, that’s for real estate, not start-up or OPEX capital that will be needed to open a retail store. Without the cost of real estate, starting a cannabis retail store requires between $1 million and $2.5 million to open the doors. Then add 30% to that number for New York.
Where will this capital come from and in what form? What are the options for low cost start-ups and OPEX capital? And where to start?
Financial education beyond Quickbooks
We start by providing financial education on how to run a capital-intensive business beyond just using Quickbooks. The financial industry, setting up equity trading, loan facilities and everything else, needs to talk with formerly incarcerated people, BIPOC or women at scale to see what they need from their financial products . Financial products should solve a problem, not create a new one. What good is a golden ticket if you can never use it because you don’t have access to fair capital, and the capital you have access to, you may not understand how to take full advantage of it, or it can be so detrimental that you risk losing your business? Building stacks of capital for all possible eventualities is not something that is taught to new founders entering this complex industry.
On the other hand, funders need to create attractive financial products that support the whole industry, not just a select few. And last but not least, governments – local, state and federal – must be prepared to step in to create the low-interest loans and grants needed to build a new industry, as they did with cars. electric, solar energy, wind, steel, railroads, etc., but that’s my next editorial.
To continue to act like the cannabis industry is like any other industry is to continue to fund an industry that will not reach its full potential. This will be reflected in the net result of your investment. It is in the best interest of the industry and its investors that small, medium and large operators exist in synergy. We must all work together to move forward together or we will remain a fractured industry and market that willfully contribute to a continuous prison pipeline for the very people who built the industry.
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