Capital raises in the U.S. marijuana industry are down nearly 65% this year versus 2021, but lower stock prices and more creditworthy cannabis companies mean debt financing is now the preferred method to raise funds for the first time in years.

Equity financing had dominated cannabis capital raises since at least 2018.

But so far this year, debt funding has dominated, according to data collected by New York-based cannabis capital, M&A and strategic advisory firm Viridian Capital Advisors.

To be sure, debt financing in the U.S. marijuana industry is down by 39.9% compared to last year from January to October, according to Viridian data.

But year-to-date, debt now makes up 93% of capital raised by U.S. cultivation and retail companies and 55.7% in the U.S. industry overall.

The shift comes as more companies have spruced up their balance sheets and are better positioned to repay loans.

Looking ahead, debt financing will continue to be the main means of raising capital until economic conditions change, according to analysts – think lower interest rates, higher stock prices, federal marijuana reform or some combination.

And despite this year’s shift in funding patterns, securing debt financing isn’t easy.

After bootstrapping ExtractionTek Stainless since 2011, Chief Marketing Officer Sean Winfield and his team at the Colorado-based company are at a crossroads.

The past two years of the COVID-19 pandemic have been tough, highlighted by supply-chain difficulties as well as added health and safety protocols at the extraction machinery company’s 30,000 square-foot manufacturing facility in Denver.

Now, ExtractionTek and its marijuana industry partners are battling lower cannabis prices at a time when the general economy is confronting raging inflation.

With expansion opportunities in emerging domestic markets and in Europe as well as his company’s plans to expand its training facility, Winfield is evaluating how best to secure investment of approximately $5 million for operating and growth capital.

What about debt financing?

Winfield winces at the word “debt” – something ExtractionTek has avoided taking on thus far.

“We don’t understand the implications of debt financing, necessarily,” Winfield said. “We need some further education, to find the right partners to really give us options that make sense and to educate us.”

Rising interest rates 

Most debt-financing deals are made between private companies.

But two recent deals made by public companies demonstrate some of the intricacies involved, most notably how interest rates and other terms are pegged to overall interest rates as well as risk spreads – such as the ICE BofA US High Yield Index Option-Adjusted Spread.

(The spread measures the difference between an index of corporate bonds and rates on government-backed U.S. Treasury securities.)

Which is to say that debt financing is getting more expensive.

Earlier this month, the Maryland and New Jersey subsidiaries of Toronto-headquartered cannabis operator TerrAscend – which has operations in five states and Canada – closed a nondilutive, senior secured loan for $45.5 million from Pelorus Equity Group.

Pelorus lends against the hard and soft costs of the real estate owned by a company, said Travis Goad, the financier’s managing partner.

“We’re also collateralized by the operating company and a license as well, so that if something were to ever go wrong or there was an issue, we could sell a functioning cannabis facility or lease it to somebody else,” he explained.

“So we spend a lot of time underwriting on a per-square-foot basis what they should be able to produce in this market.”

The $45.5 million comes at a 12.77% floating interest rate, which Frank Colombo, director of data analytics at Viridian, predicts will likely appear in more cannabis debt-financing deals to come.

He cited the Federal Reserve’s recent interest rate increases to fight inflation as well as expectations of further rates hikes.

“Is that potentially risky for cannabis companies? Yes,” Colombo said. “Because it’s 12.77% now; by the time the Fed finishes raising rates, what will it be?

“It could be another 100 basis points up from that.”

Equity-linked debt financing on the rise

In August, California-based Lowell Farms raised a total of $6.4 million through two rounds of debt financing to be used for “working capital purposes, automation, investments and expansion into new markets,” according to a news release announcing the deal.

“We are grateful for investor support as a testimony to the strategy we have employed to differentiate ourselves,” Lowell Farms Chair George Allen said in a statement.

“This financing allows Lowell to bring capabilities to market that have been in development for years.”

Lowell secured a 5.5% interest rate, but the debentures are convertible and include exercisable warrants for shares of its subsidiary Indus Holding Co. at $0.2613 and a 42-month term from the date of issuance.

According to Viridian data, equity-linked debt deals dropped off earlier this year but have bounced back to account for about 50% of debt-financing deals in the U.S.

The difference this time around is that equity-linked deals are more expensive.

In 2021, larger multistate operators with good credit could finance debt for around 8%, according to Viridian data. In the case of Lowell, Colombo estimates the cost at around 30%.

“I think Lowell had a liquidity problem, and they needed to raise cash,” Colombo said. “It’s likely not a financing of opportunity but a financing of need.”

Lowell did not immediately return an MJBizDaily request for comment.

Private deals

Michigan-based retailer Noxx closed a $15 million debt-financing deal with Altmore Capital in August. The terms weren’t disclosed.

Noxx CEO Tommy Nafso said he pitched to about a half-dozen potential capital partners and received an array of offers before striking a deal with Altmore.

Nafso said he focused on clearly articulating:

• The market opportunities for the three retail licenses the company holds in Grand Rapids.
• The executive team’s experience working at companies such as Amazon, Ralph Lauren and Domino’s Pizza.
• Noxx’s customer-focused goals, future expansion plans and how well-positioned the company would be should market conditions change.

Since securing the funding, Noxx has opened its first store while investing in e-commerce, delivery services and ensuring the store design was as close to the renderings as possible.

“It feels like you’re in a different universe in our store,” Nafso gushed.

Last week, Noxx announced its latest phase of its growth plan: a partnership with Cookies, the California-based cannabis brand, to open a 3,000 square-foot Cookies location in Grand Rapids.

Watch for prepayment provisions

Colombo anticipates debt financing to continue to be the main means of raising capital until economic conditions change, with lower interest rates, stronger markets, legislative changes or a combination of the above.

But he warns borrowers to look beyond interest rates and closely at prepayment provisions.

If banking reform legislation passes – which would boost marijuana stock prices – or interest rates decrease, agreeing to a provision requiring a premium on a prepayment or a minimum number of earned interest could mean losing out on less expensive borrowing conditions in the future.

“That’s one of the reasons why debt is not as down as much (as equity),” Colombo said.

“If you have to raise money because you have a liquidity issue or maybe you have a really great opportunity that you have to come up with the cash for, the only way you’re going to really want to do it is with debt.”

Source: https://mjbizdaily.com/debt-financing-eclipses-equity-in-us-cannabis-cultivation-and-retail-fundings/