Understanding Debt Financing in the Cannabis Industry: The Ultimate Guide
Cannabis businesses are inordinately challenged to obtain financing. Traditional lenders are unwilling to take the risk, and stigma remains due to federal restrictions in this highly regulated field. That said, some lenders understand the unique dynamics of the industry, opening doors to growth through debt financing and allowing cannabis operators to obtain the capital they need without sacrificing business equity.
So today, let’s discuss the ins and outs of cannabis debt financing. We’ll outline what you need to know about interest rates and types of financing available and provide best practices to inform your decision-making.
Cannabis Financing Challenges
Though attitudes have shifted in recent years, most cannabis companies still struggle to find lenders willing to take the risk. While there are certainly more options available today than at the outset of legalization, the debt financing landscape remains limited. Today, credit unions, private lenders, and financial institutions specializing in the cannabis industry are offering viable alternatives that do not require relinquishing a portion of company ownership.
This relatively new flexibility gives operators more control over their financial planning and provides access to funds needed to expand and grow.
If you’re new to debt financing, here’s what you need to know.
Building Creditworthiness
Having good credit is essential when seeking debt financing. Having your books in order before approaching a lender is critical, and ideally, you’ll want to bring good credit scores to the table.
Some things lenders look for are reliable revenue streams and well-organized financials. Prepare your statements in advance and check your credit scores so you won’t be caught off guard. Your due diligence will be appreciated!
A few words about credit scores
Recent years have seen the rise of cannabis-specific credit agencies, such as Cannabis Trust (CTrust). CTrust scores evaluate creditworthiness using a range of factors like tax compliance, financial performance, and operational transparency. They will also consider the state in which you operate. More cannabis lenders are now requiring CTrust scores, so it’s in your best interest to ensure it’s the best it can be.
Your CTrust score also takes into account:
· Cash flow
· Financial documentation
· Good banking relationships
· Regulatory compliance
Focusing on these areas will help you establish and maintain a good score and look more favorable to lenders.
How does risk affect your creditworthiness?
The cannabis industry is seen as volatile and high-risk to lenders. As a result, you may be forced to accept higher interest rates, risk premiums, and less flexible loan terms.
Though this landscape is softening with time, it’s important to know what to expect. Rates will vary based on your credit score, the loan amount, and the lender. A company with a solid track record and strong financials will be better positioned to negotiate more favorable terms.
If you’ve done the work and feel you are in a good position, don’t hesitate to shop around and compare terms from multiple lenders. A good credit score and financial history are excellent bargaining chips.
Types of Financing Available for Cannabis Businesses
Secured and Unsecured Loans
Secured loans, also known as asset-based lending (ABL), typically require collateral to be borrowed against, such as real estate, inventory, or equipment. The more you can bring to the table, the lower your interest rate will be, and often the terms are more flexible.
Unsecured loans are higher risk as they are not secured by collateral. As such, expect a higher interest rate. You will need excellent credit and impeccable financials to qualify.
Working Capital Loans
These short-term loans are specifically designed to cover operational costs and are often used to bridge cash flow during periods of expansion, high growth, or regulatory transitions. Rates are usually higher, and loan terms are shorter.
Private and Alternative Lenders
Non-traditional lenders, like specialty banks, private lenders, and cannabis-specific debt funds, can be an option. Terms vary, and rates can be quite high, so it’s essential to understand the details before signing.
Navigating Cannabis Debt Financing: A Step-by-Step Process
Preparation is critical to success in cannabis debt financing. Follow these steps to boost your chances of success.
1. Understand your company’s financial position
If you don’t yet have one, request your Cannabis Trust Score from CTrust. Compile your financial statements and work with your accountant to address any issues with cash flow or debt ratios.
2. Compile a list of cannabis-friendly lenders
Speak to colleagues and competitors and do some research online to find banks, credit unions, and alternative lenders that work with the cannabis industry.
3. Create a pitch deck and financial forecast
You are pitching your company, so you’ll need a deck. Pitch decks are often more effective than business plans, as they are more concise and easier to navigate. But if you have a good business plan, give it an update, as that will work, too. Prepare financial forecasts to demonstrate your forward-looking approach. Good preparation demonstrates commitment!
4. Shop around for the best terms
Compare offers and review rates, terms, and collateral requirements to find the best fit for you. Join Green Check Connect to explore and compare dozens of lenders (it’s also great for other cannabis-related services; you won’t be sorry!)
5. Review compliance documents and history
Ensure you’re up-to-date and compliant with all relevant regulations, including cannabis reporting and taxation at both the state and federal levels.
6. Submit your application
Your lender will proceed with due diligence. Be prepared to provide documentation to support your application.
7. Build good banking relationships
After obtaining your loan, stick to the repayment terms to establish a good reputation with your lender. Strong banking relationships can lead to better terms in the future.
The Bottom Line on Cannabis Debt Financing
Successful debt financing for cannabis businesses requires strategy—but there’s no substitute for preparedness and good business practices. Understanding your risk, knowing your CTrust score, finding a reputable lender, and being aware of what to expect from different types of loans can help you secure the capital you need to grow without sacrificing a stake in your company.
Be proactive and start by getting your financials in order. If you need help with this, speak to the cannabis accounting and tax specialists at Growise today.