For a cannabis venture looking to expand their operations, securing a location is the first step in getting a business off the ground. With BDS Analytics projecting global cannabis sales to reach $62.1 billion in 2026 at a compound annual growth rate of more than 15%, the sector has proven itself to be pandemic proof. The U.S. legal marijuana market alone is expected to pull in USD $24 billion in 2021, a 37% increase from the $17.5 billion in legal sales in 2020. Still, federal prohibitions on cannabis banking continue to make capital a scarce resource. Despite the consumer demand for cannabis products, several cities and towns remain opposed to allowing cannabis manufacturing or retail operations in their jurisdictions.
As a result, there are more cannabis entrepreneurs competing for the same pool of funding resources and space as they look to build new facilities and expand existing ones to take advantage of the growing market.
As the first dedicated lender to the cannabis industry, today, Pelorus Equity Group is the sector’s largest privately held value-add bridge lender. Having evaluated thousands of loan requests from every type of cannabis operator – from brand-name MSOs to startups – there are a few essential ingredients that separate the winners from the declines.
If you are a cannabis entrepreneur considering how to fund the next phase of your growth, knowledge is power. When you view the process through the eyes of a potential funder, you can clearly understand their expectations, and see where the dealbreakers lurk. Bottom line: be prepared. A proven track record and a solid plan are required to get these deals done.
Underwriting is all About Risk Mitigation
Underwriting is somewhat of an industry-agnostic process. It doesn’t matter whether you are building a cannabis operation, a data center, or any other specialty-use facility – determinations are based on risk. With that said, we only lend to currently operating businesses with a proven track record. Even then, our criteria are quite selective based on the strength of the financials, type of operation, and risk mitigants of the investment.
Whether or not you are in a growing industry like cannabis doesn’t matter – determining whether something gets funding or not lies squarely on the strength of your business and the risk your investment represents. How you present yourself and your data will certainly play a role in that final decision. If you are buttoned up, and you have a solid foundation and a solid plan, you are better positioned to make a deal happen than someone who hasn’t done their homework.
Of paramount importance is verifying your ability to grow. No, that doesn’t mean analyzing your crops. Funders will take a deep dive into the financial and operational underpinnings of your organization. So be prepared to open your books and share your data concerning the following aspects of your business:
- Company Financials: How much capital is on hand
- Company Proformas: How much revenue is (or expected to be) generated
- Sponsor’s Financials: Years in business and the relative health and reputation of your brand vis-a-vis the competitive set
In short, it’s imperative that you provide confirmation that your organization is experienced and ready to build out the next facility, and whether the company and sponsors are strong enough to support the expansion.
Additionally, lenders don’t just rely on the data and information you provide. Prepare for them to verify your information with third-party sources. When there are discrepancies, expect to be asked for clarification.
Assuming the underlying financials are solid, the process of assessing the overarching plan for the real estate investment begins. This is the stage where preparation is really key. As a borrower, you need to think through all the details and contingencies beforehand. If you’ve missed something unforeseeable, we’ll bring that to your attention and collaborate on a solution. However it’s important to note that any items missed due to a lack of thorough due diligence can begin to diminish your credibility.
What’s in a Plan?
Let’s start with the basics. Have you identified the property? What is the purchase price? What are the cost estimates, what licenses or approvals are required by the State and City municipality, plus contingencies and the timeline for the buildout? What amount of working capital will you need to sustain this new property, without any income, to carry the debt until you establish cash flow?
All this must be thought out in advance. We will review and revise with you, but we won’t do the homework for you.
A lender will also need to evaluate the guarantor for your loan. Is it an individual or a corporation? Is their net worth and cash flow sufficient from the lender’s perspective – not your perspective – to substantiate making this loan?
Once those parameters have been established, the lender is going to want to know that you can up to 50% of those costs at the outset. So for a $10 million project, you’re going to need to demonstrate how you’ll cover $5 million of equity contribution, plus financials to support until the facility is stabilized and generating revenue.
Risk and Reputation
Underwriting cannabis industry loans requires mitigating as much risk as possible. One part of that is working with clients with proven track records. Another is doing due diligence to ensure that all the underlying financials are solid. An important factor is also knowing from experience what it takes to build out a new facility, in addition to being a cannabis operating business.
Even the most experienced MSO might have completed 50 or 60 projects, the majority of which are probably leased dispensaries, not a full-scaled build-out of tenant improvements and equipment that’s required to operate the business. From our perspective, dispensaries are not build-outs, they are primarily shelves, countertops, and display cases, without any infrastructure. An indoor cultivation, distribution, co-packing center, or testing lab, where the cost for building the facility might exceed the purchase price is considered a true build-out.
We have evaluated thousands of buildout projects of this nature and understand the intricacies of these deals and the complexity of the buildout itself. From that perspective, as underwriters we can be a valuable resource. We will evaluate their buildout plans and budgets line-by-line to identify areas and costs that are out of alignment with our benchmarks.
For example, if you think you can get an HVAC system installed for $250,000, but our benchmark is $500,000, we are going to require that higher figure be reflected in your budget. If you can bring it in for less, that’s great – you’ll have additional contingency reserve or the opportunity to reduce the principal of your loan, or you can apply the extra capital to your payments once your project has been completed.
The collaborative nature of the process and the experience we bring to the table not only provides assurance to the lender, but also helps mitigate the potential for major surprises that could put you, your project, and potentially your entire business in jeopardy.
Seeing the Unseen
As a funder, our job is to work with you to help you navigate the very steep learning curve of building out a cannabis facility. We want to de-risk the situation as much as possible, for the lender and for you. That’s why we dig into the minutiae, ask all the questions, and evaluate every cost and timeline against our benchmarks. We’ve been there hundreds of times. We know where the challenges exist. Our job is not to just say no, our job is to see the unseen in order to help operators secure the funding they need to grow.
When your project is complete and your business grows, that’s a win-win for everyone.