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Creative Financing in the Cannabis Industry

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June 30, 2020

When you look around the cannabis industry, it is obvious that cash is king.  The bigger your war chest, the better your chances of coming out with some profit at the end.

With high up-front capital investments that will hopefully pay off later, cash management and stabilizing cash flow is a constant balancing act for cannabis business operators. 

Further, being a natural product and a crop that grows indoor and outdoor, it can sometimes feel like feast and famine or drought and surplus of product and cash! So ironing out these waves are also important.

Some operators raise more capital for confidence, some use current cash flow to grow, and others find creative ways to develop win-win partnerships with businesses upstream and downstream in their supply chain.  

For example, you might see a cannabis cultivation business taking a loan from distributors in cash to be repaid in flower.  With the cannabis industry incredibly fractured, a few solid JV deals or creative financing deals can go along way in helping you protect your market share.

Benefits of Creative Financing with Joint Ventures

Share access to helpful resources

Cannabis is best played as a team sport.  When you make a joint venture deal, you can share and leverage financial, technological and human resources to achieve your ultimate goals of success.  This also can give you the opportunity to turbo-boost your productivity and get to market faster.

Share Risks & Rewards

The cannabis industry is inherently risky for many reasons but also has tremendous upside potential, so having an ally in the industry can help spread that risk and reward out.  By entering into JV deals, you can help you align the incentives of two organizations and bring focus on an overarching goal.

As Formal As You Need

What’s nice about JV deals is that they can be as official as you want them to be.  Surely many of these JV deals will need to have proper written and signed contracts, but the terms can be as flexible as the deal deems necessary.  JV deals can be a temporary agreement or a long-term financial contract. But they allow for a bit of a test before it leads to something more formal and official such as a natural merger & acquisition after some initial success.

Create Cost Predictability

The seasonality of raw input costs and revenues is not for the weak at heart. So depending on the type of deal you enter into, potentially that initial example of a cultivator taking a cash loan from a distributor to be repaid in flower, the distributor can hedge against increased raw product costs and create consistency in supply.

Unlock Unseen Synergies

Many joint venture and creative financing deals allow space for the opportunity of economies of scale & specialization.  As you work more intimately with your partners, you begin to identify unpredictable opportunities that can have massive positive long-term effects that allow you to build bigger businesses together compared to you working separately. 

Considerations of Creative Financing Deals

Define a goal

Before entering into any type of agreement, you need to ask yourself, why are you doing this?  Is it for a long term partnership, access to distribution channels, or strictly about money/financing?  Define what success looks like by setting some mid-way milestones and goals of the partnership to make it easier to decide to renew agreements in the future.

Set and lock in as many terms possible

Having too much ambiguity in your contracts and being more trusting that necessary is an easy way to be taken advantage of as well as causing conflict.  Choose thoughtfully what those terms may need to be and have recourse if commitments are not kept by any party entering into the partnership.  Walkthrough as many scenarios with your team to see what questions come up and how can you preemptively solve for them by defining deal terms.

Define Financial Terms

Let’s continue with the example of the distributor financing a cannabis cultivator in cash and getting paid back in product.  Make sure that you obviously set the loan amount, interest rate, repayment frequency. In other deals, make sure you outline capital contributions, times when money is due to be put in, how to decide what it is used for, and who pays each type of tax if that’s applicable.

Assign Duties & Responsibilities

In business, you want to make the most revenue with the least effort, and sometimes that will lead to you pushing away duties that should be yours, but were never fully assigned.  To avoid this type of conflict, take time to outline background tasks such as who does the partnership accounting, who conducts delivery, and is responsible for the costs, who performs testing of products or handles the repayment cash of a loan.

Example of a Creative Financing Deal

Cannabis cultivator entering into a relationship with a distributor

Scenario: 

Distributor loans money to the cultivators and the cultivator pays the loan back, with interest, in flower.

Why this works for each party:

Cultivators have to put in a lot of cash before yielding, so this can help free up cash or give more to their expansion war chest. They also have a guaranteed buyer for their product

For Distributors, it locks in supply for them from a trusted source and potentially at a predetermined price.  This helps them hedge against the risk of drastic market price fluctuations.  This is similar to a futures contract but these parties do know each other so it 

Considerations

Biggest variable here is going to be the price of cannabis flower to convert the loan amount & interest to pounds of flower. This price creates a big exposure for both ends of the deal, so they could opt to fix the price or decide on a neutral data piece from where to draw price from BEFORE you have to pay.  For interest, you could set it as a flat cost per pound or use a fixed conversion rate.  That’s the beauty of these deals is that you can be as creative as you want.

Second is the variance in the quality of the final product. Getting 15% vs. 25% potency THC is a huge difference in value, so make sure to set parameters around testing and final product quality standards.  If the acceptable floor is 18%, then how much additional product does the cultivator have to ship if it tests at 15%?  Also, who covers the cost of the testing?

If you need help with developing a creative finance deal with one of your supply chain partners, then please reach out to us today.

Post Tags: Business, Finance, Accounting

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