As a New York-based cannabis finance company, Canna Business Resources is a definitive resource for cannabis operators in the United States, having provided over $100 million in funding in 2021 to operators in nearly every state and of all verticals and on track to eclipse that amount this year.
We were delighted to sponsor this year’s Benzinga Capital Cannabis Conference and have yet to encounter such an enthusiastic and exciting set of new opportunities presented to virtually everyone in our great industry.
Consumer and patient buying habits have been instrumental in increasing investor interest in plant-based companies. Annual cannabis sales figures continue to break records year after year, with global sales in 2022 expected to reach more than $35 billion, according to BDS Analytics. Despite difficult economic conditions, most cannabis operators are doing quite well, especially compared to other industries. Big players in the tobacco, alcohol and pharmaceutical industries have bought into the cannabis industry in recent years. All of this activity is precisely what hesitant investors have been waiting to see before seizing plant investment opportunities.
A Brief History of Cannabis Finance
Since bank funding is largely unavailable, many entrepreneurs in the cannabis industry have sought funding from angel investors or venture capital and private equity funds. Several major private equity funds have been launched and have continued to capitalize cannabis operators of all types, but the reality is that there simply isn’t enough equity to support the industry’s growth in the world. over the next five years. We are currently seeing this in the funding market for closed, entrepreneurial and publicly traded organizations.
In the early years, equity was essentially the only source of funding, accounting for 81% of total capital raised in 2018-2019. This made sense given the nascent nature of the industry, the lack of public awareness of the business, and the fact that most players in the industry had strongly negative cash flows and little cash flow to bear the debt.
But the fall in stock prices in the second half of 2019 changed the landscape in a lasting way.
Between the first and fourth quarters of 2019, cannabis stock prices fell nearly 52%, leading to a sharp decline in stock issuance.
By the end of that year, public company equity issues had essentially been squeezed out of the market.
Debt accounted for 74.5% of total capital raised in 2020, the first year in cannabis history that debt exceeded equity in capital raised.
That year also marked the beginning of the trend towards debt without conversion features or warrants, led by issues from Curaleaf and Cresco.
Newfound optimism as 2020 turned into 2021 regarding the prospects of federal legalization produced a 120% surge in cannabis stock prices, sparking the second major wave of cannabis stock issuance.
According to Viridian, public companies issued $1.2 billion in equity in the first quarter of 2021, a record at the time.
From the third quarter of 2021 to the first quarter of 2022, debt accounted for 93% of total funding, with private companies raising a record 10% of that total.
This trend of debt financing is expected to continue for the foreseeable future. In the current environment, public companies are reluctant to raise equity for two reasons:
- Prices are well below perceived intrinsic values.
- The hope of legalization reform that could allow uplisting is freezing the market.
Whether we like it or not, the financing trends of publicly traded issuers are favorable to closely held companies. And over the past six to eight months, the major MSOs have all issued funding that is now trading below the issue price. Returns (read: risk ratings) have all increased across the market as risk perception has increased across the board. Rising interest rates in recent months have been a significant driver of the cost of capital, especially for cannabis companies.
Deferral of financing on public markets
If publicly traded MSOs – generally speaking, companies with the most liquid equity and debt markets and those with diversified revenue streams – choose not to raise equity and/or cannot raise equity and therefore raise debt capital, it is inevitable that the same funding trend is likely to dominate closely held markets as well.
We were fortunate to meet hundreds of operators at the Benzinga conference and were grateful to hear first hand about the challenges even the best operators face in raising equity. For the Canna Business Resources team, this is not a big surprise. We speak with thousands of potential borrowing clients each year and have unique insight into the forces driving canna business financing in nearly every US market.
What are the main financing options for operators?
Sale and leaseback transactions
Sale-leaseback (SLB) transactions allow companies to release cash from their balance sheets without diluting the operating company. We have seen an increase in these types of real estate financings as cannabis companies increasingly sell their cultivation, processing and storage facilities and rent them out immediately to raise operating or growth capital instantly. The potential downside is that an SLB locks the asset seller into a longer-term commitment than other direct debt alternatives.
It should be noted, however, that in common unsecured debt transactions, lenders are looking for more than just a promise of repayment. It is increasingly common for lenders today to require a corporate or personal guarantee or some type of seniority in the capital structure – often referred to as “senior debt”. Senior debt often has a fixed duration but has many structural flexibilities that SLBs do not have, which makes it more attractive in many cases.
Asset based lending
Based on the valuation of real estate assets and equipment, a cannabis company can typically borrow between 40% and 75% of the value of the assets. In the case of development projects, the loan is usually based on project costs. At Canna Business Resources, we have a long history of providing tens of millions in asset-based financing and have a team of highly experienced underwriters in this vertical.
Working Capital – Cash Flow Based Loans
One of our main products at Canna Business Resources is cash flow based lending. In other words, we assess an operator’s historical and pro forma cash flows and suggest a suitable form and size of financing for each individual operator. A relatively bespoke process, this underwriting and offering requires a collaborative approach to understanding an operator’s business, market and growth prospects. These characteristics are equally important for other forms of debt. However, cash flow-based borrowing is essential to help operators meet working capital needs.
Until now, most cannabis company debt financing has been in convertible note options with low conversion premiums, which essentially delays equity dilution. The company creates a note that converts into shares, often preferred shares, at a future date based on a future valuation method. These notes, similar to promissory notes with interest payable on or before a maturity date, gave investors the security that they would be repaid before shareholders if something went wrong. For both the investor and the business, this note structure helps address the question of future valuation while providing the capital needed for the business and a safer instrument for investors.
To meet these new challenges in our great industry, Canna Business Resources has expanded its presence to provide more robust lending alternatives and top-notch services to our borrowing clients. We take a hands-on approach to the funding process. We have the ability to create flexible structures and will spend all the time needed to customize a solution for our borrowing clients. In this challenging environment, we encourage operators of all sizes to reach out so we can deliver growth-oriented solutions.
For more information, you can contact CannaBusiness Resources at [email protected]
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