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Q&A: What Capital Sources Look For When Providing Financing To Cannabis Companies

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Q&A: What Capital Sources Look For When Providing Financing To Cannabis Companies

By Andrew Lines, MAI, CohnReznick

For cannabis companies seeking financing, it can be difficult to understand the factors which lenders consider when evaluating a business's eligibility. In this interview, Andrew Lines, MAI, and a valuation partner at CohnReznick, and Tony Cappell, managing director and head of underwriting at Green Ivy Capital, provide insight to how the market makes decisions on lending to cannabis companies.

How should cannabis companies weigh their financing options?

Drew: We come across a lot of businesses in the early stage, start-up phase. They have cash, though often they are still not profitable. We have also seen companies that have a pitch deck, a good board, and have raised $1 million-$2 million. They have a plan to begin operations, but they need more capital than they can raise from family and friends, so they must go to market.

Other companies are ready to scale: They've got a traceable history, good tax and financial records, customer relationships, and brand recognition. They're more attractive.

Established companies need enough capital to deploy a large strategy. They should have gotten their cash from U.S. or Canadian banks, but due to federal restrictions, they had to go to Canada to IPO/RTO. You cannot become a multistate operator, build testing labs, or invest in R&D without lots of capital. These cannabis companies need hundreds of millions of dollars for M&A and expansion, whereas an early start-up might only need $2 million-$10 million.

Tony: There are many factors that a company should consider when raising traditional debt capital. We base our investment decisions on the same attributes which any other lender would look at – including cash flow, collateral, how much equity or convertible debt is in the company's capital structure, the state it is located in, and the quality of its management team. I would also like to point out that while current positive cash flow is not a requirement for a deal, a pathway to profitability is vital for us to be able to service the loan.

Drew: When my group does valuations on companies, we are often valuing companies that have been acquired for financial reporting purposes. A lot of the same things matter and play into how we value businesses. We are mimicking what Tony does on a daily basis. We often work collaboratively – there's mutual synergy.

What else is involved in due diligence?

Tony: I can give a high-level checklist. First, what is the company's financial condition? Is there cash flow now, or can we underwrite to a realistic pro forma? This is important because the company needs to prove its ability to make loan payments.

Second, collateral: While we will consider other asset classes in the future as the industry grows, right now we predominantly lend on real estate, and to a lesser extent equipment. For real estate, we will consider lending against cultivation and processing facilities, warehouses, greenhouses, and retail locations. With equipment, we are a little more selective, and the key variable we consider is how well it maintains value over time.

The third attribute on which we focus is the quality of the company's management team: Do they have a proven track record of success? How much hands-on operating experience do they have? Despite all the exuberance around cannabis, it is still difficult for a business to become successful due both to the regulatory burden and the continually changing legal environment. When making a loan, we essentially form a partnership with the operators and owners of that business, so it is vital that they execute their plan successfully. We look to help in any way that we can after the deal is done.

What role do financial records play?

Tony: If a prospect does not have a bank account, that is beyond our comfort level. Additionally, it is very important to have good books and records. We need to rely on those numbers to make our decisions. We all know that there is a lack of quality financial reporting in the industry. If a company uses a reputable firm such as CohnReznick, that is a real differentiator. Ultimately, if the borrower has not yet been audited, we will likely require it as a post-closing item.

How does the overall regulatory environment impact financing?

Drew: Most state-level cannabis regulations are well-intentioned, but in some instances, they have created a lot of chaos. In California, for example, companies that thought they were operating legally have been raided due to issues about rolling out temporary and permanent state licensure. In addition, compliance with federal and local taxes has been a real burden on consumers and businesses. The corresponding and effective tax rates make a lot of dispensaries less profitable.

In addition, opponents to adult-use and complications with local community priorities are reasons why states like New Jersey and New York have struggled to further their recreational agendas. Florida voted overwhelmingly for medical approval, but cities there have put severe restrictions on where dispensaries can be located. Some have even banned dispensaries outright. As a result, private lenders must have up-to-the-minute regulation information to make sound financing decisions. Many may only choose to do so in specific states. Tony and I are in the camp of believing that national banking is not going to happen soon.

Key takeaways:

  • A company's lifecycle stage impacts both its financing needs and options.
  • Three key factors that lenders evaluate are each company's financial condition, collateral, and the operators or management team.
  • Cannabis companies that have a bank account and detailed financial records are more likely to access capital. Companies that have not been recently audited may be required to undergo an audit.
  • Financiers look for companies that are using reputable professional service firms.
  • Cannabis companies in states with heavy or uncertain regulatory or tax burdens are less attractive to lenders.

For more insights on cannabis company valuations, visit CohnReznick or Green Ivy Capital.

This content has been prepared for informational purposes, is general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without first obtaining professional advice specific to, among other things, your individual facts, circumstances, and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees, and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

The post Q&A: What Capital Sources Look for When Providing Financing to Cannabis Companies appeared first on New Frontier Data.

Image sourced from Pixabay

Posted-In: cannabis industry New Frontier DataCannabis News Financing Global Markets General

 

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