Cannabis on Fire: How debt financing is hurting small to mid-sized cannabis companies

Editor’s Note: This editorial was contributed by Christine De La Rosa, co-founder and CEO of The People’s Ecosystem, a California-based, multi-state, equity-focused cannabis company.

No one will say it because no one really wants to acknowledge it: the cannabis industry is on fire. We are seeing massive downturns in many first mover jurisdictions due to a market downturn and of course over-taxation. However, we have known this for a long time and have understood the danger that overtaxation poses, especially for small and medium-sized companies. 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, blacks and immigrants who have no access to capital during this or any other recession.

It’s a three-alarm fire. What do we do?

We often say being in the cannabis industry means constantly putting out fires. What actionable things need to happen to put out the three-alarm fire we’re currently 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 significant tax cuts because states need the money. Despite the rhetoric, there is no state in the union that legalizes for the factory – they legalize for the money.

And taxation isn’t the only fire. Anyone currently raising capital for asset-touching operations knows that raising equity has become increasingly difficult in recent months. Investors used to look for unicorns to invest in. That has changed, and now companies are looking for financiers willing to make investments in small and medium-sized companies. These equity investors, well, they’ve become unicorns. To say that equity funding has dried up in recent months is an understatement, as the Viridian chart below demonstrates.

Equity financing dried up

The lower dark green bars in each chart represent equity offerings under $10 million in volume. They have always represented only a small fraction of the capital raised in the plant-touching business. This year this bar is gone. Small companies are being shut out of the market right before our eyes. The dark blue bars represent deals from $10 million to $25 million, which are disappearing for midsize companies. Do you see the lit area? This light blue area shows the leverage available to a select few in the industry. At the moment it is almost impossible to find equity if you are a small or medium-sized business. More than 90% of all equity financing that exists goes to incumbent multi-state operators that have already received and lost a lot of equity. Now the billions of dollars being raised are going to fund debt, and this is where the cannabis industry has set itself on fire.

The shift from equity financing to debt financing as the primary funding avenue for the cannabis industry is dire, especially given some of the debt structures on offer. These debt facilities are often complex and punishable by law, hello 28% interest or what we call payday loans.

creditworthiness in the crisis

But what kind of funding is needed? Before we can understand what kind of financial products we should be assembling for the cannabis industry, especially small and medium sized businesses and especially social participation businesses, we need to understand the failures of our financial institutions. In general, we need to understand the rubric currently used to determine who has credit worthiness for investment, equity, or debt, who would be most likely to succeed, and who has market share. That doesn’t work in the cannabis industry. It leaves many people getting initial licenses, which isn’t a problem in regular industries as there wasn’t a whole market before non-cannabis industries arose.

We need to start opening up to different ways of assessing the creditworthiness of cannabis companies run by people who have traditionally been considered creditworthy for nothing in this country’s existence. We must appreciate the power of their intellectual property over the past 80+ years, their ability to create and transform a marketplace for their companies, and the innovation they have brought and continue to bring to the industry. They have true value that is a bang on your investment budget.

If we’re looking at this in relation to upcoming recovery states, we need to look at New York.

What will New York do?

Using the credit rating rubric as it exists in the cannabis financing industry today means understanding that there is no such thing as equity (ideal) and debt (less than ideal) financing for the people who get the first licenses in New York. It certainly didn’t help those who got their first licenses in California. It also hasn’t helped the social justice people who came in later in Colorado and other states. We need new, creative financial products that are fairer without sacrificing 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 rubrics that funders, financial institutions and foundations use going forward to truly support this pioneering industry and provide financial products to people who are less likely to qualify but are more likely to succeed in the cannabis industry.

Though New York is starting out with a $200 million debt fund, it’s about real estate, not startups or the OPEX capital needed to actually open a retail store. Not including the cost of real estate, opening a cannabis retail store costs between $1 million and $2.5 million to open the doors. Then add 30% to that number for New York City.

Where will this capital come from and in what form? What are the options for low-cost startups and OPEX capital? And where do we start?

Financial literacy beyond Quickbooks

We begin by providing financial training on how to run a capital-intensive business that goes beyond using Quickbooks. The financial sector, which puts together equity deals, credit facilities and everything in between, needs to speak to ex-prisoners, BIPOC or women on a large scale to see what they want from their financial products. Financial products should solve a problem and not create a new one. What good is a golden ticket if you can never use it because you don’t have access to adequate capital, and the capital you have access to, you may not understand how to take full advantage of it, or it can be so damaging that you risk losing your business? Building up capital for every contingency is not taught to new founders entering this complex industry.

On the other hand, funders need to create compelling financial products that support the entire industry, not just a select few. And last but not least, governments — at the local, state, and federal levels — must prepare to create the low-interest loans and grants needed to build a new industry like they’ve done for electric cars, solar, energy, wind, steel, railroads, etc., but that’s my next comment.

Continuing to act as if the cannabis industry is like any other industry means continuing to fund an industry that is failing to reach its full potential. This will be reflected in the bottom line of your investment dollar. It is in the best interest of the industry and its investors that small, medium and large operators exist synergistically. We must all work together to move forward together, or we will remain a fragmented industry and marketplace that willingly contributes to an ongoing prison pipeline for the very people who built the industry.

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