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Alerts and Updates

A Budding Market: Financing for Cannabis Businesses

October 15, 2020

A Budding Market: Financing for Cannabis Businesses

October 15, 2020

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Fund financing is an umbrella term covering numerous types of credit facilities that meet various financing needs of investment funds, their affiliates and principals.

Many cannabis businesses have struggled to find a bank willing to provide depositary services or sources of financing to meet their financial needs. However, cannabis businesses may now have a new option available to meet their financial needs: fund financing.

Cannabis businesses within the U.S. operate within a legal gray area. Currently, 33 states have legalized cannabis for medical use; of those states, 11 have legalized cannabis for adult use. However, there remains a conflict between those states’ laws and federal law. In particular, under the Controlled Substances Act, cannabis is listed as a Schedule I narcotic, which is the strictest category reserved for drugs that have “no currently accepted medical use in the United States, a lack of accepted safety for use under medical supervision, and a high potential for abuse.” As a result of this conflict between state and federal law―and the potential exposure for the banking industry given that they operate, at least in part, pursuant to regulations promulgated by federal agencies―many banks have declined to offer depositary or other financial services to cannabis businesses. The American Bankers Association has recognized that “[l]eaving the cannabis industry unbanked is not a viable option―sales totaled almost $12 billion in 2018 and are conservatively estimated to reach $31 billion by 2025.” Accordingly, most cannabis businesses have, out of necessity, had to transact in cash, leaving those businesses and their staff “ripe targets for violent crime.” Unless cannabis is legalized under federal law, cannabis businesses will likely continue to face legal uncertainty and challenges to meeting their financial needs. 

Fortunately, cannabis businesses may now have a new way to meet some of their financial needs: fund financing. Fund financing is an umbrella term covering numerous types of credit facilities that meet various financing needs of investment funds, their affiliates and principals. These products include so-called subscription credit facilities secured by the agreements of investors in a fund to contribute capital to make investments (e.g., investments in cannabis businesses), related contract rights and any bank account into which capital contributions are made. Stated simply, fund financing consists of money pooled together from numerous investors into a fund, which then can invest directly into businesses, including businesses involved in the cannabis space.

Fund financing may provide a solution to meet some of the financial needs of cannabis businesses because some banks view lending to funds that invest in cannabis businesses differently (from a legal perspective) from lending directly to the cannabis businesses. In fund financings, the bank accepts capital from investors, who contribute capital to a fund that invests in cannabis businesses, and the bank then lends to that fund. There is no direct monetary link between the bank and any cannabis business. This lack of a direct monetary link gives some banks greater comfort about lending to cannabis businesses in a legal gray area. 

We are aware of multiple lenders, including private lenders as well as traditional depository banks, who either currently provide financing to cannabis businesses or funds that invest in them or are considering doing so. While most funds that take advantage of fund financing are private investment funds, we are also aware of at least one SEC-registered, exchange-listed fund that was formed to invest in exchange-traded equity securities of legal cannabis-related businesses. Thus, there are multiple potential sources of financing for funds that invest in cannabis businesses.

Cannabis businesses would be well served to consult with counsel experienced with the cannabis industry as well as fund financing, formation and related regulatory matters regarding potential ways to meet financial needs and structure transactions. Experienced counsel can help negotiate the legal gray area that currently encompasses the cannabis industry, obtain desirable terms to meet business objectives, minimize legal risks and ensure maximum efficiency from transaction inception to completion. Businesses in the cannabis industry face many challenges, but fund financing may provide a means to address at least some of them, in a way that works for the cannabis business, its investors and lenders. 

For More Information

If you have any questions about this Alert, please contact Tracy Gallegos, Anastasia Kaup, any of the attorneys in our Cannabis Industry Group or the attorney in the firm with whom you are regularly in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.