By Dan Roda, chief operating officer, Safe Harbor Financial
The cannabis industry is still grappling with legal complexities, stigma and evolving regulations, making traditional financing options more difficult to access. Banks and financial institutions often view cannabis businesses as high-risk due to the federal status of cannabis, despite its legalization in many states for medical and adult use. This perception creates significant hurdles for cannabis entrepreneurs seeking capital to expand their operations.
However, by following a strategic approach and adhering to proven best practices, cannabis businesses can improve their chances of obtaining the necessary funding to grow and thrive. A well-prepared and organized loan application, a strong business history, an understanding of alternative lending options and practical application tips can make a substantial difference in securing financing.
These steps not only demonstrate professionalism and reliability but also help build trust with potential lenders.
It’s important for cannabis businesses to recognize that navigating the complexities of cannabis financing requires diligence and preparation. Here are some essential tips for cannabis entrepreneurs looking to secure loans and grow their businesses:
1. Organize your documentation
The first step in preparing for a loan application is to ensure all your documentation is meticulously organized. This includes making sure your business formation documents, such as corporation or LLC paperwork, are complete and up-to-date and having your operating agreements or bylaws signed and readily available.
You should maintain accurate and comprehensive financial records, including balance sheets, income statements and cash flow statements, and be prepared to provide several years of tax returns to demonstrate your business’s financial history.
Additionally, keep all relevant state and local cannabis licenses and permits current and accessible, and document your compliance with state and federal regulations to showcase your commitment to legal operations.
2. Establish a strong business history and demonstrate financial health
Lenders typically look for a track record of business operations. To establish a strong business history, it’s essential to demonstrate consistent operations over a significant period, preferably two or more years.
Lenders typically look for a track record of steady or growing revenue streams, which should be supported by detailed sales reports and financial projections. Additionally, highlight the experience and expertise of your management team in the cannabis industry to further strengthen your business’s credibility and appeal to potential lenders.
It’s also critical that cannabis operators effectively demonstrate their financial health and stability to lenders.
One way to do so is by understanding and leveraging their Debt Service Coverage Ratio (DSCR). The DSCR, which is calculated by dividing net operating income by total debt service, including both principal and interest payments, measures available cash flow to meet current debt obligations. A higher DSCR indicates that a business has sufficient income to cover its debts, which is crucial for securing financing in an industry where traditional banking relationships are limited.
By demonstrating a strong DSCR, cannabis operators can show potential lenders that they are capable of managing their debt responsibly, thereby increasing their chances of obtaining necessary funding for growth and operations. This ratio not only helps in assessing the business’s financial performance but also plays a critical role in building trust and credibility in the financial market.
3. Understand how much you can borrow and explore alternative lending options
Collateral and loan-to-value ratio each play crucial roles in determining the size and terms of credit facilities. Collateral refers to assets pledged by a borrower to secure a loan, providing the lender with a form of protection against default. The loan-to-value ratio is the proportion of the loan amount to the value of the collateral.
When cannabis operators possess universally valuable collateral, such as prime real estate, they can often qualify for much larger credit facilities. High-value, easily liquidated collateral reduces the lender’s risk, allowing them to offer more substantial loans with potentially better terms.
For new or smaller cannabis businesses, especially those without collateral available to pledge, securing traditional loans can be challenging. These operators can explore alternative financing options that may provide the necessary capital for growth. Short-term bridge loans can help manage cash flow and bridge funding gaps until long-term financing is secured.
Equipment financing offers specialized loans for purchasing equipment, enabling production expansion without a significant upfront investment. Vendor financing from suppliers can assist in managing expenses for purchasing goods.
Additionally, Community Development Financial Institutions (CDFIs) often provide loans to businesses in underserved communities, including cannabis enterprises.
Additional advice for loan applications
To increase your chances of securing a loan, consider several practical tips.
First, prepare a polished loan application package, including a well-written business plan that outlines your business model, market analysis and growth strategy. Be honest and transparent about your business’s financial health and potential risks, as lenders appreciate candor and proactive risk management.
Building strong relationships with financial institutions experienced in the cannabis sector is crucial; a trusted advisor or financial partner can provide invaluable guidance. Additionally, highlight your commitment to compliance with all relevant regulations, demonstrating to lenders that you are a responsible and reliable operator and prospective borrower.
Finally, be prepared to answer detailed questions about your business operations, financials and compliance practices, as thorough preparation can set you apart from other applicants.
By following these best practices, cannabis businesses can position themselves for success and secure the funding needed to thrive in this dynamic industry. Navigating the complexities of cannabis financing requires diligence and preparation, but with the right approach, it is entirely achievable.
Dan Roda is the chief operating officer of Safe Harbor Financial, a leader in facilitating banking, payments and financial services to the regulated cannabis industry. A corporate attorney and serial entrepreneur with degrees from Tulane, Villanova, and the University of Alabama, Dan co-founded and operated Abaca, a cannabis-focused fintech that was acquired by Safe Harbor Financial in 2022.