Navigating the Financial Landscape of the Cannabis Industry: The Harsh Reality

The cannabis industry presents a complex financial landscape for entrepreneurs launching and growing businesses across the spectrum, from the plant-touching operators (cultivators, processors, and dispensaries) to ancillary service providers such as technology platforms, packaging companies, and professional services firms such as CannabizMD. My experience bootstrapping three startups, including CannabizMD, and insights gained from industry experts highlight the significant challenges and strategies for success in this evolving sector. They emphasize that while plant-touching businesses face unique regulatory hurdles and higher capital requirements, ancillary businesses also navigate industry-specific obstacles in fundraising and scaling their operations.

The Harsh Reality of Cannabis Financing

Capital in the cannabis industry is significantly more challenging now than a few years ago. There’s a concerning rise in predatory practices, with some well-known funds offering egregious terms that could result in entrepreneurs losing control of their businesses.

High interest rates are prevalent in cannabis financing, ranging from 18% to 25%. These rates, combined with the unique tax consequences of IRS Rule 280E, prohibit cannabis businesses engaged in the trafficking of controlled substances from deducting ordinary business expenses from their gross income. 

This creates a complex and challenging environment even for businesses with substantial revenue.

The Three-Tier Classification System

The cannabis industry is often categorized into three tiers, a classification system developed to help financial institutions assess risk and create standard operating procedures for serving marijuana-related businesses (MRBs). Steven Kemmerling introduced this tiered approach in 2016, which was later updated in 2020.

Tier 1: Plant-touching entities directly involved in the cannabis supply chain. These businesses derive their actual or expected revenue from the cultivation, production, testing, or sale of cannabis products. Examples include cultivators, processors, testing laboratories, and dispensaries.

Tier 2: Ancillary businesses specifically focused on providing products and services to Tier 1 MRBs and the broader marijuana (cannabis) industry. While not directly handling cannabis, these companies are integral to the industry’s operations. Examples might include specialized equipment manufacturers, cannabis-specific software providers, or packaging companies designed for cannabis products.

Tier 3: Businesses that serve Tier 1 MRBs but are not exclusively focused on the cannabis industry. These companies may have some cannabis industry clients but also serve a broader market. Examples could include general office supply companies, HVAC service providers, or professional services firms that work with cannabis businesses, among other clients.

This tiered classification system aims to provide a framework for financial institutions to assess risk and potentially expand access to banking services for cannabis-related businesses. It recognizes the industry’s varying levels of involvement and associated risks.

The Importance of Strategic Planning and Professional Guidance

Strategic planning is crucial for long-term success in the cannabis industry. Entrepreneurs must consider immediate funding needs, future capital requirements, and potential exit strategies.

Engaging professionals early in the process is essential:

1. Legal Counsel:  An attorney should review all agreements, particularly operating agreements and partnership deals, to avoid hidden clauses that could be detrimental to the entrepreneur.
2. Financial Advisors: A CFO or financial advisor who understands the unique aspects of cannabis accounting is crucial, particularly regarding tax issues like 280E.
3. Insurance: Securing proper business and life insurance is important, emphasizing the need to work with agents familiar with the cannabis industry.

Funding Strategies and Considerations

Funding strategies in the cannabis industry include multifaceted approaches to securing capital for business operations, growth, and compliance in a uniquely challenging financial landscape. These strategies typically include a mix of strategies; each must be carefully tailored to navigate the industry’s regulatory complexities, limited access to traditional banking, and the need for substantial capital to cover high startup and operational costs.

Several funding strategies and considerations are worth noting:

1. Bootstrapping: While some entrepreneurs may attempt to bootstrap their operations, cannabis businesses are typically highly capital-intensive.
2. Equity Financing: Selling ownership stakes to investors. 
3. Debt Financing: Due to industry risk, loans are often at high interest rates. Debt financing may be challenging without substantial assets for collateral.
4. Creative Financing: Alternative financing methods such as equipment financing and energy credits can be explored.
5. Investor Relations Building relationships with investors is crucial, as “people fund people” rather than just ideas.

Regulatory Considerations

The cannabis industry operates in a dynamic regulatory environment, being federally illegal and with each state having its own set of laws and regulations for its cannabis program. Upcoming changes, such as the looming potential rescheduling of cannabis from Schedule I to III and the SAFER Banking Act, could significantly impact how businesses are funded and operated.

Conclusion

While the cannabis industry presents unique financial challenges, entrepreneurs can navigate these waters successfully with proper planning, professional guidance, and a realistic understanding of the landscape. As the industry continues to evolve, staying informed and adaptable will be key to long-term success and building a team of trusted experts with cannabis industry expertise. 

Author Jacquie Cohen Roth, MS, is the Founder/CEO of CannabizMD and its ESG The Tea Pad Foundation LTD. Watch and/or listen to CannabizMD Maryland Cannabis Industry Symposium: Financial Management + Investment for more on best practices in financial management and investment within the cannabis sector, including protections from predatory investors and partners.