The traditional business debt financing option is now fueling the future of cannabis, offering strategic returns for investors
More frequently than not, cannabis investors have typically been focused on equity investments. Early believers dove into the space, encouraged by wild speculation of future legalization. The rise of debt financing in the industry is just the latest opportunity to attract new investors to the space.
In today’s low-yield environment, investors are faced with a limited amount of attractive debt investment opportunities. Investors chasing yield have typically been forced to look at either distressed investment opportunities or illiquid markets. It comes as no surprise that investors have therefore begun exploring the cannabis industry to find higher yields without assuming the risk of distressed investments. For traditional debt investors, lending to the cannabis industry provides an opportunity to add exposure to a growing market with greater structural protections and diminished risk than traditional equity investments.
Unlike equity investments, if a business defaults on debt, there are means to recover investor capital. The borrower’s assets, which can be in the form of licenses, equipment and inventory, can be sold to recoup money owed to the investor. The result is an opportunity that can increase the odds of a return on investment in a short period of time on short-term loans with hard assets backing them up.
The recent surge in mergers and acquisitions in the cannabis industry has provided a growing and healthy supply of debt investment opportunities for investors. As more lenders open their checkbooks to debt capital for cannabis businesses, interest rates have begun to fall and the increasing appeal of these loans to the cannabis entrepreneurs has buoyed the faith of investors. Today, cannabis debt investment has become an exceedingly stable way for investors to enter the space, and more investors than ever are relying on them to add cannabis exposure to their portfolios with significantly lower volatility compared with equity investing.
The appeal of debt financing for cannabis businesses has also never been stronger, as more businesses consider it as a non-dilutive source of capital. Founders of cannabis companies are recognizing the potentially expansive value of their possible exit opportunities. These exits can be upwards of $100 million, meaning that every drop of equity has value. But to reach this potential, capital infusions are required for continued growth. Debt financing offers the solution to funding that growth, without sacrificing equity that can be worth millions of dollars down the line.
Despite the surge in cannabis debt issuance, there remains a deep pool of institutional investor demand which may further bolster the industry. Non-traditional forms of financing will continue to flourish as federal legalization meanders through the lengthy legislative process. Even once federal legalization occurs, larger financial institutions will likely still see cannabis as a high-risk space, keeping the cost of capital higher in this industry relative to other markets.
All this being said, federal legalization is just one of the many challenges investors face when working in the cannabis space. Banking limitations will continue to be a challenge as cannabis matures, and the complicated web of different state-specific and local regulations will continue to be a weight on the industry.
The rise of debt financing is absolutely an encouraging and important moment in the history of the industry and will enable businesses to scale and remain nimble without sacrificing growth opportunities. Debt capital is a tool that has been a mainstay of how traditional businesses operate and is finally widely available to cannabis businesses of all sizes.
George Mancheril is Chief Executive Officer for Bespoke Financial Inc., which was founded in 2018 as the first licensed commercial lender focused on the cannabis industry.