The traditional option of corporate debt financing is now fueling the future of cannabis, delivering strategic returns for investors
Most often, cannabis investors have generally focused on equity investments. Early believers plunged into space, spurred on by wild speculation about future legalization. The rise of debt financing in the industry is just the latest opportunity to lure new investors into the space.
In the current low yield environment, investors face a limited number of attractive debt investment opportunities. Investors looking for yield have typically been forced to seek out distressed investment opportunities or illiquid markets. It’s no surprise that investors have therefore started exploring the cannabis industry to find higher returns without taking on the risk of distressed investments. For traditional debt investors, cannabis industry loans offer an opportunity to add exposure to a growing market with greater structural protections and reduced risk compared to traditional equity investments.
Unlike equity investments, if a company defaults on its debt, there are ways to recover capital from investors. The borrower’s assets, which can be in the form of licenses, equipment and inventory, can be sold to recover the money owed to the investor. The result is an opportunity that can increase the chances of a return on investment in a short period of time on short-term loans with durable assets.
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 loan capital for cannabis businesses, interest rates have started to drop and the growing appeal of these loans to cannabis entrepreneurs has boosted investor confidence. . Today, cannabis debt investing has become an extremely 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 a significantly lower volatility than equity investments.
The appeal of debt financing for cannabis businesses has never been stronger, as more businesses view it as a non-dilutive source of capital. Cannabis company founders recognize the potentially expansive value of their potential exit opportunities. These outflows can reach over $100 million, which means that every drop of capital has value. But to reach this potential, capital injections are needed for continued growth. Debt financing offers the solution to fund this growth, without sacrificing equity that can be worth millions of dollars down the line.
Despite the surge in cannabis debt issuance, there remains a significant pool of demand from institutional investors that could further bolster the industry. Non-traditional forms of financing will continue to thrive as federal legalization winds through the lengthy legislative process. Even after federal legalization occurs, major financial institutions will likely continue to view cannabis as a high-risk space, which will keep the cost of capital higher in this industry relative to other markets.
That 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 complex web of different state and local regulations will continue to burden the industry.
The rise of debt financing is an absolutely encouraging and significant moment in the history of the industry and will allow businesses to grow and stay nimble without sacrificing growth opportunities. Loan capital is a tool that has been a mainstay in the operation of traditional businesses and is finally widely available to cannabis businesses of all sizes.
George Mancheril is Managing Director of Custom Financial Inc., which was founded in 2018 as the first licensed commercial lender focused on the cannabis industry.