What You Need to Know Before Lending To a Cannabis Business

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Although marijuana is legal in some form in over 25 states, it is still designated as a Schedule 1 drug at the federal level.  This federal designation makes it extremely hard for cannabis businesses to borrow money.  Most banks refuse to lend to cannabis businesses regardless of the legal status in the state they operate.  Therefore, cannabis businesses rely on various forms of non-traditional lending to get the capital they need.

Many cannabis businesses fund their operations with debt.  When they need a loan, they either turn to family members, hard-money lenders, or private investors who are seeking to take advantage of a billion-dollar industry with limited competition.  If done correctly, cannabis lending can be very rewarding.  However, you should keep a few things in mind before lending in the cannabis space.

Learn the Industry

While marijuana cultivation has been around for thousands of years, the cannabis industry is relatively new.  Find out all you can about the market, including the legal and regulatory issues surrounding cannabis businesses.  One of the unique traits to the cannabis industry is that it is not only regulated on the state level but also by counties and local municipalities.  Therefore, it is crucial to learn the state rules, along with local regulations that cannabis businesses must comply with in your market, and consider these restrictions when vetting out prospective borrowers and their current situation.  As this space continues to grow and evolve, it is crucial to keep abreast of regulatory developments to ensure continued compliance by the borrower and by you.

Perform Diligence on the Business

While due diligence is a critical factor in any loan valuation, cannabis businesses require a different level of review.  Cannabis businesses need a higher level of scrutiny because the industry is new and because marijuana businesses have a shorter operational history, limited financial and tax documentation, possible temporary or restrictive licensing, and financial projections that may be a bit more speculative than other markets.

Because of these and other areas of concern unique to this industry, it is essential to vet the business and all of its owners properly.  Your due diligence should, at a minimum, include scrutinizing financials to look for irregularities, reviewing the income, assets, and credit rating of the borrowers, and asking for personal references.  For the business and the property, you should review agreements, including leasing and licensing to ensure compliance with state and local laws, and closely examine any partnership or equity agreements that may be in place.

Prepare for Scrutiny

Most states that have legalized marijuana also have laws in place to scrutinize those involved in the business, and this includes financiers.  If you decide to invest in cannabis businesses, be prepared to provide financial information and documentation to state regulators.  Even if you are only lending money to the company, state licensing boards will likely look into your finances as part of their vetting and oversight process.

Secure the Loan

With all of the regulations and politics surrounding cannabis businesses, you never know when or how the industry will change.  For this reason alone, you need to demand security for your loan.  This security may include unencumbered land, equipment, cars, and personal property of the borrower.  You may also wish to have the borrower execute an assignment of any permits and licenses that have been granted to the borrower with respect to the use of the property (to the extent such permits and licenses are assignable) and obtain a personal guarantee from any principals of the borrower (if the borrower is an entity) and/or any other third parties to provide additional protections for your investment.

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