Canadian cannabis giant Tilray (NASDAQ:TLRY) announced its fiscal second quarter of 2022 results last week. The company reported net revenue of $155 million in Q2 which was an increase of 20% year over year. Tilray attributed these gains to its expansion in verticals that include alcohol as well as hemp-based wellness.
Despite an uptick in sales, Tilray’s gross margin reduced by 7% to $32.8 million as the Canadian cannabis market continues to wrestle with oversupply issues resulting in lower-priced products. Alternatively, Tilray claimed its cost-reduction program is running ahead of schedule and it expects to save $100 million by 2023, up from its earlier forecast of savings of $80 million.
Tilray reported a net income of $6 million in Q2, compared to a year-ago loss of $89 million. The fiscal second quarter was also the 11th consecutive quarter where Tilray reported an adjusted EBITDA. This figure stood at $13.8 million in Q2.
Tilray stock rose by 15% in the two trading days following its Q2 results.
What impacted Tilray in Q2 of fiscal 2022?
Tilray explained its Q2 results were solid as it has successfully built a cannabis and lifestyle brand. Further, the company continues to benefit from its scale, global distribution capabilities as well as operational excellence allowing it to increase sales and maintain profitability despite macro-economic headwinds.
The company enjoys strong brand recognition and is focused on ensuring an adept pricing environment. It also believes marketing adjustments will allow Tilray to aggressively capture market share going forward.
Germany is the largest medical cannabis market in Europe where Tilray has a 20% share. It’s well-positioned to capture the adult use cannabis market as well in Europe, if and when cannabis is legalized in this region.
Tilray, similar to most other producers aggressively acquired companies in the past. Its acquisition of the U.S.-based SweetWater Brewing and Manitoba Harvest provides it a foothold in the world’s largest cannabis market. These two companies have invested in product innovation to enhance awareness and distribution.
Further, SweetWater and Manitoba Harvest are profitable and provide Tilray an opportunity to launch THC-based products in the U.S. when pot is legalized at the federal level.
What next for TLRY stock?
During its earnings call, Tilray disclosed its new parent name called Tilray Brands. It reflects the company’s evolutions from a Canadian licensed producer to a global consumer packaged goods company with a leading portfolio of cannabis and lifestyle CPG brands.
Tilray aims to post annual sales of $4 billion by 2024 which is quite optimistic given analysts expect revenue to grow to $980 million in fiscal 2022 and $1.2 billion in fiscal 2023. In order for Tilray to reach its lofty goals, it will have to acquire other licensed producers resulting in shareholder dilution.
Germany is expected to legalize marijuana at the federal level, making it the largest country to do so in terms of population. Tilray already has an EU GMP-certified facility operating in Germany which can increase production capacity to accommodate demand from the adult use segment.
Bottom Line: Is Tilray Stock a Buy Post Fiscal Q2 Results?
While Tilray’s stock gained pace, following its Q2 results, investors should understand that it was estimated to report revenue of $171 million in the quarter. Despite the cost synergies enjoyed by Tilray, the adult-use market in Canada is crowded as well as highly fragmented and should consolidate in the upcoming years which will allow companies to improve the bottom line.
Tilray stock is valued at a market cap of $3.2 billion which suggests its forward price to sales multiple is over 3x. Unlike most cannabis producers in the U.S. Tilray continues to post an adjusted loss making it a high-risk bet at current multiples.
In a press release sent out today, Emerald Holding, Inc. announced they have completed their acquisition of MJBiz for $120 million.
Emerald Holding, Inc. is a large, publicly traded business-to-business events producer and content conglomerate with a number of publications and events in industries like design, equipment, retail, safety & security and technology. Founded in 2013, the company has become a leading operator of B2B trade shows in the US, with their largest shareholder being the Toronto-based investment group called Onex Corporation.
MJBiz, founded in 2011, is known in the cannabis industry for their content platform, MJBizDaily, as well as the world’s largest cannabis trade show, MJBizCon.
As part of the agreement to acquire MJBiz, Emerald Holding will retain senior management in the company for day-to-day operations. The agreement also includes the potential for future payments, depending on the company’s performance through the end of this year.
Hervé Sedky, President and CEO of Emerald Holding, says they have been big fans of the MJBiz brand for a long time. “We have long admired MJBiz’s sterling reputation for being the most trusted event and content producer serving the business side of the cannabis and hemp industries and their respective participants,” says Sedky. “This is a transformational acquisition for Emerald as it represents an important next step in the implementation of our strategic initiatives and underscores our commitment to evolve and grow our customers’ businesses 365 days a year.”
The two founders of MJBiz, Cassandra Farrington and Anne Holland, will stay on with the company in a consulting capacity. According to Farrington, who is also chair of the MJBiz Board, says they went with Emerald because they value the company’s uniqueness. “Our organization has experienced massive growth since its inception, initially as a how-to resource to help dispensary owners run their businesses better, into our position today as the leading commercial resource for the cannabis sector,” says Farrington. “Integrating with a larger organization provides the additional resources and channels to unlock the next phase of MJBiz’s growth and is the right next step in our evolution as a business.”
Investors looking to gain exposure to the cannabis space have several options given the increase in the number of cannabis producers in the past decade, the recent wave of legalization in the U.S. and a rapidly expanding addressable market. However, one undervalued cannabis stock with enticing growth prospects that remains a top buy today is Columbia Care (OTC: CCHWF). Let’s see why we are bullish on the large-cap multi-state operator right now.
What is Columbia Care?
Columbia Care is one of the largest cannabis producers in the world with 31 manufacturing and cultivation facilities. It has 99 dispensary locations in the U.S. with more than two million square feet of cultivation capacity and over 300 acres of outdoor cultivation capacity.
The company’s rapid expansion over the last few years has allowed Columbia Care to increase sales from $77.45 million in 2019 to $179 million in 2020. Wall Street expects sales to more than triple to $626 million this year and grow by another 55% to $970 million in 2022. In case Columbia Care manages to meet analyst estimates, the company would have grown its revenue at an annual rate of 132% between 2019 and 2022.
While several of Columbia Care’s peers, especially in Canada, are grappling with negative margins, this cannabis company is racing towards profitability. It has already narrowed its operating losses from $81 million in 2019 to $31.5 million in the last 12-months. Analysts expect its bottom-line to improve from a loss per share of $0.48 in 2020 to earnings of $0.27 per share in 2022.
Columbia Care has a strong presence in markets such as Virginia, Ohio and Pennsylvania that provide limited licenses to cannabis producers. This allows Columbia Care to improve customer engagement and ensure repeat purchases of its products.
In the second quarter of 2021, it increased revenue by 232% year over year to $110 million. Its adjusted EBITDA also rose to $16 million, compared to a loss of $4.7 million in the prior-year period.
Now, Columbia Care has shifted focus to larger cannabis markets including New York, Arizona, Columbia and New Jersey. In Q2, its sales in Arizona and Illinois rose by 23% and 15% respectively, on a sequential basis.
The cannabis heavyweight recently completed the acquisition of Medicine Man, a Colorado-based cannabis producer, for $42 million. Columbia Care explained the acquisition will be accretive to its bottom-line and is valued at 4.5x projected EBITDA for 2021.
Columbia Care has improved its gross margins to 42% in Q2, from 36% in the prior-year period. Its operating costs have also fallen from $61 million to $51 million in the last year, making it one of the best cannabis stocks on the market today.
Bottom Line: Why Should You Add Columbia Care to Your Cannabis Portfolio?
Columbia Care expects its total addressable market in licensed U.S. states to reach approximately $31 billion by 2026. In the event that cannabis is legalized at the federal level, this figure will surge significantly higher. Additionally, Columbia Care is well poised to gain traction in the future and leverage existing expertise, as it already has wholesale distribution agreements in 13 operational markets.
Its capital expenditure investments continue to generate returns as the company continues to benefit from economies of scale and higher margins.
As a business owner, it is imperative to concentrate your time on only the most essential areas of your business. To focus more on revenue generation and growth strategy, outsourcing your accounting is one of the wisest decisions you can make for your cannabis business.
A great accountant will prepare financial statements, manage cash flow and ensure that you remain compliant with your state’s rules and regulations. Your best option is finding an accountant who possesses the required technical and business knowledge and has also navigated the cannabis industry and understands its nuances.
There are a lot of factors to consider when searching for the right accountant and it can be difficult to know what questions you should ask. We’ve put together this list with some important considerations that pertain to accountants in the cannabis industry.
1. Do you have a network of cannabis industry professionals?
One of the greatest perks of partnering with an accountant that’s already established in the cannabis space is that they typically have connections to other industry professionals that might be helpful in the future. For example, suppose you have questions about important legislation or what permits are required for certain operations. It’s beneficial to be connected with people that can answer these questions for you.
Similarly, an accountant well-versed in the industry can notify you of events, conferences and trade shows that may be beneficial to your business. A great indicator that an accountant is well established in the industry is that they’re members of well-known trade associations, for example, the National Cannabis Industry Association.
2. What formal certifications do you hold (enrolled agent, CPA)? Are you familiar with cannabis compliance?
A CPA (Certified Public Accountant) and an Enrolled Agent have passed the IRS’s testing and keep up with continuing education every year. Not only is it necessary that your accountant has all required licensing per Internal Revenue Services (IRS), but it is also crucial to make sure you’re operating in compliance with state laws for cannabis businesses.
Dispensaries and other cannabis businesses are subject to various tax laws across every state, making compliance challenging. The rules and regulations of each state are unique. There is no exact residency requirement for every state, and some states do not apply IRS code 280E.
While an accountant might hold the necessary certifications, they might not have the industry expertise to guide you through any compliance issues you might come across. It’s important that you choose someone who’s both properly certified and well versed in the cannabis space.
3. Are you currently representing cannabis companies? How long have you been in this industry?
There is nothing typical about the cannabis industry, and it operates differently from most other industries. Businesses that have operated in the cannabis space for several years and have a wide range of clients have more experience dealing with the challenges and obstacles that come with running a cannabis business.
Finding a cannabis accountant with experience is particularly important when it comes to compliance as the rules & regulations are constantly evolving. It’s often that compliance issues can lead to hefty fines from the IRS, so choosing someone familiar with the industry will save you from these penalties.
4. What are the advantages of outsourcing accounting rather than doing it myself?
While you can take a DIY approach and purchase software like QuickBooks, there is an inherent risk in tackling all of your accounting initiatives alone. As mentioned above, the industry has its own unique challenges that differ from businesses in other fields and failure to pay close attention to these things can result in serious financial and legal trouble. A great team of accountants has the knowledge to keep you informed on the ever-changing legislation and give you advice on how to avoid costly mistakes.
Similarly, outsourcing your accounting allows you more time to focus on the most critical aspects of your business. Running your own company is in many cases a 24/7 job, with entrepreneurs scrambling to find enough time to complete daily tasks and make efforts to grow their business. An accountant that keeps accurate records of your performance can give you the data needed to identify areas of improvement and increase overall productivity.
5. What are you expecting from me every month?
One of the main reasons why some clients are left dissatisfied by accounting firms is due to miscommunication surrounding each party’s expectations. A good accounting service will establish open communication around their own needs, goals, and objectives. Educating yourself on what an accountant expects from you will enable you to give them the information they need to provide accurate and efficient services.
On the other hand, it’s just as important that you understand what will be delivered by your accountant on a regular basis. Some firms operate on an annual basis and provide one-time bookkeeping or end-of-year tax preparation. Others take a more month-to-month approach, offering continuous business consulting and tailored services unique to your business. It’s helpful to have a checklist that both you and your accountant can reference that ensures you’re staying on the same page.
Why cannabis accountants are important
To meet the growing demand for cannabis, many dispensaries and other cannabis-related businesses are opening across the country.
A company in this sector has tremendous potential for success, but that success is not without risks, especially financial challenges. Throughout the cannabis industry, there is a need for financial professionals who can understand complex laws and regulations in order to make a legal profit from the industry.
Further, business owners require assistance in navigating complicated tax laws and managing primarily cash-based businesses without the support of traditional banks. It is advantageous to have an accounting team that is knowledgeable about all the traditional accounting functions, like financial reporting and bookkeeping.
Additionally, you should find someone who can help you make the right investments and manage the ongoing flow of money into and out of your cannabis business. A great accountant will guide you to the specific tax requirements applicable to your particular legal structure, how to pay taxes owed and if any tax deductions are available despite Internal Revenue Code (IRC) Section 280E.
Welcome to the Cannin Commentary Column. We’re happy to announce our partnership with Cannin Investment Group, a cannabis investment analysis firm. In this new column, we will provide readers with a taste of Cannin’s insights and analysis that they offer to their members. Throughout the new installments of this column, you’ll find articles that will touch on investment tips, trends, predictions, market updates and more.
Companies in the cannabis sector have the potential to increase your wealth at an enviable rate over the upcoming decade. But what are the 3 cannabis stocks that can gain over 50% according to analyst estimates?
The wave of cannabis legalization sweeping through the U.S. right now as well as the prospect of decriminalizing or even legalizing adult-use will be key drivers for licensed producers.
Here, we take a look at three cannabis stocks in Columbia Care, Green Thumb Industries and Cresco Labs that should be on your buying radar right now. Each of these stocks is also trading at a deep discount according to Wall Street estimates, allowing investors to derive market-beating gains in the next year.
U.S.-based multi-state operator, Columbia Care (OTC: CCHWF) is valued at a market cap of $1.12 billion. The company has already increased revenue from $77.4 million in 2019 to $179 million last year.
Now, Wall Street expects sales to more than triple year over year to $625 million in 2021 and surpass $970 million next year. These stellar growth rates in revenue should allow Columbia Care to improve its bottom-line from a loss per share of $0.48 in 2020 to earnings per share of $0.3.
Columbia Care has a presence in 18 jurisdictions across the U.S. and Europe where it operates 31 cultivation and manufacturing facilities.
The company generated $110 million in revenue in Q2 which was 232% higher than the prior-year period. Columbia Care has 73 active dispensaries and another 26 under development, enabling it to target a rapidly expanding addressable market that is forecast to touch $31.6 billion by 2026.
So, is Columbia Care a cannabis stock that can gain over 50%? Well, analysts tracking Columbia Care stock have a 12-month average price target of $9.38 for the stock which is more than 200% higher than its current trading price.
Green Thumb Industries
A cannabis giant trading 46% below its all-time high, Green Thumb Industries (OTC: GTBIF) is valued at a market cap of $4.4 billion. Headquartered in Illinois, Green Thumb Industries has 13 manufacturing facilities, licenses for 111 retail locations and currently operates in 14 domestic markets.
In the second quarter of 2021, the company’s revenue rose by 85% year over year to $222 million – driven by strong demand in Pennsylvania and Illinois. The Q2 of 2021 was also the fourth consecutive quarter where Green Thumb reported a profit, with a net income of $22 million compared to a loss of $13 million in the prior-year period.
Green Thumb currently has 65 retail stores and just opened a third store in the state of New Jersey which is a market that recently legalized cannabis for adult use. While retail sales in New Jersey are expected to begin next year, Green Thumb’s presence in the medical space will enable the company to gain traction in the highly competitive adult-use cannabis vertical as well.
So, is Green Thumb Industries a cannabis stock that can gain over 50%? Well, analysts expect Green Thumb stock to rise by 95% in the next 12-months given its average price target of $37.54.
The final stock on our list is Cresco Labs (OTC: CRLBF), another cannabis heavyweight valued at a market cap of $2.16 billion. A vertically integrated cannabis operator, Cresco Labs currently has 40 dispensaries in 10 states and has grown its sales from $43 million in 2018 to $476 million in 2020.
Most states have a limit on the licenses they are allowed to issue and this barrier to entry allows Cresco and peers to enjoy a competitive advantage in the markets they operate in. Cresco Labs reported revenue of $210 million in Q2, a rise of 123% year over year.
It reported a net profit of $2.7 million in Q2 compared to a loss of $41 million in the prior-year quarter. Cresco expects to generate $1 billion in sales by the end of 2021, making it among the first cannabis companies to reach the milestone.
We believe Cresco is certainly a cannabis stock that can gain 50%. Wall Street expects Cresco Labs stock to gain over 60% compared to its current trading price.
Federal regulations have made compliant credit processing in the cannabis industry difficult to achieve. As a result, most cannabis retailers operate a cash-only model, limiting their ability to upsell customers and placing a burden on customers who might rather use credit. While some dispensaries offer debit, credit or cashless ATM transactions, regulators and payment processors have recently been cracking down on these offerings as they are often non-compliant with regulations and policies.
KindTap Technologies, LLC operates a financial technology platform that offers credit and loyalty-enabled payment solutions for highly regulated industries typically driven by cash and ATM-based transactions. KindTap offers payment processing and related consumer applications for e-commerce and brick-and-mortar retailers. Founded in 2019, the company is backed by KreditForce LLC plus several strategic investors, with debt capital provided by U.S.-based institutions.
We interviewed Cathy Corby Iannuzzelli, co-founder and chief payments officer at KindTap Technologies. Cathy co-founded KindTap after a career in the banking and payments industries where she launched multiple financial and credit products.
Aaron Green: Cathy, thanks for taking the time today. How did you get involved in the cannabis industry?
Cathy Corby Iannuzzelli: I’ve been in the payments industry for a long time. I was doing some consulting a few years ago for a client in Colorado and that gave me exposure to the issues in cannabis like the fact that you couldn’t have real payments in cannabis. Then, a close family member with health issues turned to medical cannabis when nothing else seemed to work. I was amazed by the difference it made in her life. At that point, I put those two things together and I said, I need to focus on helping this industry get a real cannabis payments solution because I thought it was ridiculous that you had an industry of this size and importance that had been abandoned by the payments industry.
Aaron Green: Can you highlight some of your background prior to entering cannabis?
Corby Iannuzzelli: Throughout my career, I’ve been a banker, I’ve been a payment processing executive and I’ve been a consultant. So, I’ve kind of done it all in the payments and financial services space.
Aaron Green: Why is it that most dispensaries only take cash?
Corby Iannuzzelli: In the US, even though cannabis is legal in many states, it’s still illegal federally. There are big banks and card networks like Visa, MasterCard, etc., who are national, even global companies and frankly, the executives of those companies don’t want to end up in jail for violating national laws. So, they have put cannabis dispensaries on what’s called a “prohibited merchants” list. This means you cannot accept Visa, MasterCard, Discover, American Express, or similar payments as a cannabis business and so it’s forcing the industry to a cash-based solution.
About the only thing you’re seeing that’s not cash in dispensaries are ATMs. But if you think about it, ATMs are machines where the consumer goes and pulls cash out and pays upwards of $5 or more in fees for doing that. They then hand that cash back to the dispensary who then has the costs of having to deal with that cash. The industry is just stuck in a cash-based business until federal legislation changes.
Aaron Green: I’ve been to some dispensaries where they accept credit cards or debit cards. What is going on there?
Corby Iannuzzelli: I’ve heard reports of consumers who’ve been able to use a credit card or a debit card in a dispensary. Sometimes the processor who sold that solution to the dispensary says, “Oh, it’s compliant, I guarantee you it’s compliant.” But if you dig in, that’s not the case. And eventually, Visa or MasterCard figures it out and shuts it down. In some cases, it’s outright fraud where the processor who sold the payment terminal to the dispensary is misrepresenting it as say a doctor’s office rather than a dispensary. There’s no merchant category code in the payment networks that says this is for processing dispensary payments, so they pretend it’s something else until they get shut down.
When they do get shut down, I’ve heard of cases in Las Vegas where it was basically 100% Visa or MasterCard one day and 100% cash the next day. It completely disrupted the whole business. It’s not just the retail store, but the inventories and everything else throughout the business.
There have also been some cases where you’ll see something called a cashless ATM. In a store, they call it a debit card transaction. It’s really a cashless ATM where the consumer is making what looks to the ATM network like a cash withdrawal in $10 or $20 increments, but the consumer is getting a receipt instead of cash, and they’re turning around and handing that receipt back to the dispensary who then makes a change because the cashless ATM only dispensed in $10 or $20 increments.
Now ATM networks are looking at these cashless ATM transactions to see if they are compliant. Do consumers know the fees that they’re paying? Are these transactions coming in and looking to the network like real cash when it’s not? Cashless ATM transactions are probably the most common thing you see, but that’s being called into question after the Eaze incident where a large company was misrepresenting its terminals. The federal government stepped in and called it bank fraud and the individuals behind it, the executives, are in jail. Since then, the networks are looking at this and saying, what about these cashless ATMs? Are those transactions within our rules, or is there something funny going on here?
Aaron Green: So, to summarize here: you’ve got federal regulations at the national level that says that cannabis banking is not allowed so major institutions are not offering it. Yet you found a way through the regulations and compliance issues. I’m curious can you pull back the curtains a little bit and tell us how you came up with a solutionhere?
Corby Iannuzzelli: Well, we came up with the solution by stubbornly refusing to believe that cannabis payment processing could not be done in a compliant manner. We just said, “there is a compliant way to do this, let’s figure it out.” We took the same components that are out there for the financial services and payments industry and reassembled them in such a way that we do not violate any rules. We do not use any of the Visa, MasterCard, Discover or Amex rails, we built our own network. We have direct contracts with the merchants and direct contracts with the consumers. We control everything and all the funds flow through regulated financial institutions. So, we designed something that looks and acts to consumers and retailers the way Visa and MasterCard look and act when a consumer goes to make a purchase, but they run on a separate set of payment rails and in compliance with banking regulations and state regulations. When you’re looking at the problem from a different perspective, sometimes you can come up with a better answer.
Green: On the consumer side, what does that user experience look like?
Corby Iannuzzelli: Our product is completely digital. The consumer experience starts with integration at the online checkout. When it’s an e-commerce shopping cart and somebody is placing an order, they will see a button called “Pay with KindTap.” The first time they click that button they’re automatically brought to our integrated web app where they do a quick and easy application for our digital revolving line of credit product. If approved, they instantly go back to the checkout screen and their first purchase will just happen immediately, with flexible payment options over time. If the consumer decides they don’t want our KindTap credit and would rather have a pay now-product where we pull the funds from their bank account, then the consumer can do so. So, there is no physical card per se, it’s integrated like PayPal or Affirm at the point of checkout online. For the consumers who use KindTap credit, there is a mobile app where they can see their transactions, view statements, pay their bills, etc.
Additionally, there is a loyalty program for all purchases – KindTap credit or through the consumer’s bank, because we feel very strongly that a lot of the reasons consumers choose to pay with one card over another is the points and the rewards that they get. So, we’re providing loyalty rewards with KindTap so that consumers can get rewarded for that spending with KindTap and it’s better for the retailers.
Green: On the retailer side, what does that experience look like and what is your business model?
Corby Iannuzzelli: We are not going store by store doing integrations, rather, we’re integrating with various software, delivery and e-commerce providers. That gives us broad reach and ability to expand rapidly in various state markets where cannabis is legal. Once a merchant says “yes, I want to be a member of the KindTap Merchant Network,” then we work to get them set up on our platform in a matter of days. The merchants receive continuous support from our success team, marketing co-investment and a depth of analytics reporting. We made the entire process and ongoing operations streamlined and frictionless for both merchants and consumers.
Aaron Green: What are the benefits of moving from cash to credit type of payments?
Corby Iannuzzelli: On the retail side, there are the obvious benefits of not having all the security, safety and theft issues associated with operating a physical cash business. Consumers very often don’t carry cash anymore, except when they’re making a cannabis purchase. There are a lot of hidden costs to retailers because payments are not just about moving money from the consumer to the business.
“I really am optimistic that with so many scientific breakthroughs we’ve had that we’re going to be able to figure this out.”Payment options – or lack thereof – can shape where people shop, how much they spend and what they buy. It’s a proven science how consumers make impulse purchases. If you’re a cash-based business in cannabis, and you’re trying to get somebody to make an impulse purchase, and they walked in with $100, then you can’t get them to spend more than $100, no matter how creative your marketing is! The consumer is limited by how much cash they have in their bank account or in their pocket at that point in time. So, it’s really about the upsell that comes with the bigger basket sizes that retailers experience when you move from a cash-based business to credit and suddenly, the merchant doesn’t have to deal with long lines of consumers on payday when the store was beyond slow two days before. Now the consumer can spread purchases with the thinking, “I’d rather not be the one standing in that line on payday. I’m going to go Wednesday [instead of Friday] because I have KindTap credit so I can budget and manage my cash flow throughout the month rather than around my paydays.”
So, we think that the lack of an efficient and effective payment system for cannabis is holding back sales. We all focus on how much the industry is growing. KindTap thinks about how much faster it could be growing if it was supported by a decent payment system.
Aaron Green: What are some other cash-only markets you are looking at?
Corby Iannuzzelli: We are laser-focused on the cannabis ecosystem and bringing a compliant credit and loyalty-based digital payments solution to cannabis merchants and customers and rewarding those stakeholders for accepting/using KindTap. Additionally, we are planning to extend the KindTap Merchant Network so that consumers can use/earn our loyalty points with other goods and services they’re purchasing that are adjacent to cannabis or that are important to the cannabis consumer. That’s the direction we’re going.
Aaron Green: Today people can receive gas points for spending with their credit card. Now with KindTap, you can spend to get cannabis points?
Corby Iannuzzelli: That’s exactly right.
Aaron Green: What in either cannabis or your personal life are you most interested in learning about?
Corby Iannuzzelli: Personally, I am most interested in seeing breakthrough technologies in climate change. We’re going to need to correct this situation and I’m reading about collecting carbon dioxide from the air and burying it in the earth and things like that. I really am optimistic that with so many scientific breakthroughs we’ve had that we’re going to be able to figure this out. Certainly, it’s going to take a lot of smart people and a lot of investment, but I really look forward to watching them do their stuff and hopefully taking us out of this nightmare situation that we’re heading into if we don’t make some changes.
Aaron Green: Thanks Cathy, that concludes the interview.
Few people will disagree that financial compliance isn’t the most exciting topic within the cannabis industry. But compliance is, and always will be, the engine grease to the legal cannabis market. Cannabis operators have the arduous task of dealing with multiple layers of compliance, both operational (maintaining and adhering to regulations enforced by the state licensing board) and financial. These compliance measures include managing everything from seed-to-sale systems for all plant-related activity to on-site requirements like facility access points and alarms systems to name a few.
With complex compliance requirements for the business, the last thing cannabis operators want to think about is financial compliance. We created Confia on this notion. Just as cannabis regulators impose the tracking of plants through the supply chain via a seed-to-sale system, we have developed a storyboard similarly designed to follow the money, which is the equivalent of a transaction-to-deposit system.
Having experience in regulatory technology, artificial intelligence and machine learning, we’ve been fortunate enough to work with some of the world’s largest banks across multiple countries. This experience has afforded us the luxury of working alongside regulators, chief compliance officers and chief risk officers, understanding how risk is perceived by financial institutions and how it ought to be mitigated. It was this access and knowledge that allowed us to effectively reform, enhance and improve the antiquated BSA programs with a technology-enabled process. Leveraging technology is a necessity, almost a requirement, for the cannabis industry as legalization nears and banking access begins to broaden.
Jamming cannabis requirements into an existing BSA program doesn’t scale well. BSA programs are very manual, descriptive and process oriented. So, we’ve taken our prior experience and success in banking to form Confia, distilling the complexities and simplifying the deliverables surrounding cannabis banking compliance. To best articulate cannabis banking requirements, I break it down into three pillars.
Pillar One: KYC-Enhanced Due Diligence
The first pillar is the client-onboarding bucket or KYC – Know Your Customer. In the complex world of cannabis banking, banks must know and understand their clients to great depths. It’s not enough to simply know that the client exists; you also have to understand whether or not that client could be a potential risk to the bank, and one step further, the financial system. Cannabis is a high-risk industry, so the KYC requirement is escalated to a deeper diligence and review, called Enhanced Due Diligence (EDD).
Banks need to know and understand their customers’ story, and all the key parties (officers, directors, and those with key decision-making powers or access to the bank accounts) within that organization. This includes reviewing personal, business, and legal history – not to mention watchlists and negative news presence. An initial onboarding review must then be followed with daily screening and monitoring of all watchlists and adverse media. Typically, banks do KYC refreshes every three years. In cannabis, a full refresh should be done annually with the daily monitoring systems in place.
The high-risk nature of the industry also requires a level of diligence on all parties to a transaction, even if one of the parties, whether a payer or recipient, is not a client of your bank. Unlike traditional banking sectors, reliance on other banks’ KYC programs is far less defensible in the cannabis industry.
Pillar Two: Transactional Monitoring & Detection
Tracking and monitoring the actual financial transactions comprises the second pillar required for cannabis banking. At Confia, we have focused on streamlining processes, so the cannabis operator can seamlessly support the compliance obligation for every transaction. A bank must demonstrate supporting documentation for every cannabis transaction, and gathering such information is a large undertaking in and of itself and can pose future issues if not done properly, see the pitfalls for lack of compliance. Banks are obligated to understand the nature and reason for each transaction, the source of funds, ensure cannabis licenses are in good standing for all parties, and collect evidence such as accounting records and seed-to-sale data.
Core to transaction monitoring in the traditional sense, is the overarching support through anomaly detection. Relying on information is important, but testing those inputs keeps everyone honest. It is important to evaluate transactions from a holistic point of view relative to peers and relative to the general contents of a transaction. This anomaly detection layer is your last line of defense, and as new information is collected, it continues to refine itself.
Pillar Three: Filing and Reporting Requirements
The third component to compliant cannabis banking is regulatory filing and reporting. Once a client is onboarded, the account requires an initial suspicious activity report or SAR-Initial within 30 days of that client being approved by the bank. Then, a report must be filed every 90 days after that for all the transactions of that cannabis operator. Banks must file the SAR-Initial and the Continuing-SAR reports for each cannabis client they have.
Solutions like Confia automate the filing process and support the filing with transactional data evidenced on our distributed ledger of record. This provides immutable audibility and simplifies the process for all parties involved.
Compliance Requirements After US Legalization
The anticipation of federal legalization and banking reform bills has many operators hoping for easier banking. Yet, in my opinion, regulatory oversight and audits will likely increase after such reform or legalization. As other financial institutions start to support cannabis, it will inadvertently create greater opportunity and expose the financial system to nefarious or illegitimate transaction activity. This is why cannabis banking will be carefully monitored by regulators, and more so, why banks will be slow and pragmatic in standing up their internal cannabis banking programs. Some banks may forever avoid the cannabis industry due to the known pitfalls of an industry specific program, while others may simply mitigate the possible exposure to reputational risk.
Choose Wisely: Pitfalls for Lack of Compliance
Financial compliance is the responsibility and duty of the banks, but the real losers and result of non-compliance always fall on the cannabis operators. Regulatory action against an institution may result in the bank shutting down its cannabis program or may require them to complete a remediation of all their cannabis transactions for a certain period from its clients. At the end of the day, regardless of action, the cannabis operator is the one being punished. Operators either lose their bank account and have business massively disrupted, or they are asked to provide all the compliance docs for a historic period, which is a huge undertaking and operational distraction, ultimately impacting business and productivity. So, choose your banking partner wisely.
Summarizing Key Banking Requirements
In summary, banking in the cannabis industry will undoubtedly remain a high-risk industry, with or without legalization. Although banking opportunities may expand as US policies change, there will be continued compliance and regulatory requirements for the foreseeable future.
Onboarding and ongoing screening are critical
Evidence for every transaction is a significant portion of compliance and must not be dismissed
Evaluating activity with broader strokes is essential in mitigating against money laundering
Managing the staggered filing timelines and due dates for each client
Compliance is the most crucial factor in cannabis banking at this point. It cannot be overlooked or taken for granted. Cannabis operators must take an active role in evaluating the compliance programs of their financial providers. To open a bank account is one thing, but the consideration and effort that goes into keeping a bank account is the difference that will protect your business in the long run.
Cannabis is still federally illegal and is included on Schedule 1 of the Controlled Substances Act (CSA), along with such other substances as heroin, fentanyl and methamphetamines.1 It is a federal crime to grow, possess or sell cannabis.
Despite being federally illegal, 36 U.S. states and the District of Columbia have legalized the sale and use of cannabis for medical and/or adult use purposes,2 and both direct and indirect cannabis-related businesses (CRBs) are growing at a rapid rate. Revenue from medical and adult use cannabis sales in the US in 2019 is estimated to have reached $10.6B-$13B and is on track to reach nearly $37B in 2024.3
Because the sale of cannabis is federally illegal, financial institutions face a dilemma when deciding to provide services to CRBs. Should they take a significant legal risk or stay out of the market and miss out on a significant revenue opportunity? So far, the vast majority of financial institutions have been unwilling to take the risk, resulting in a dearth of options for CRB’s. Until recently, cannabis business operators had few options for financial services, but times are changing.
This piece will discuss current trends in banking for cannabis-related businesses. We will cover differences in legality at state and federal levels, complexities in dealing in cash versus digital currencies, Congressional actions impacting banking and CRBs and how banking is changing. The explosion of state legalization of cannabis over the past several years has had a strong ripple effect across the US economy, touching many industries both directly and indirectly. Understanding the implications of doing business with a CRB is both challenging and necessary.
Feds Versus States
Money laundering is the process used to conceal the existence, illegal source or illegal application of funds.4 In 1986 Congress enacted the Money Laundering Control Act (MLCA), which makes it a federal crime to engage in certain financial and monetary transactions with the proceeds of “specified unlawful activity.”5 Therefore, CRB transactions are technically illegal transactions under the MLCA.
Financial institutions therefore face a risk of violating the MLCA if they choose to do business with CRBs, even in states where cannabis operations are permitted. In addition, financial institutions could also face criminal liability under the Bank Secrecy Act (BSA) for failing to identify or report financial transactions that involve the proceeds of cannabis businesses operating legally under state law.6
In short, because cannabis is illegal at the federal level, processing funds derived from CRBs could be considered aiding and abetting criminal activity or money laundering. States, however, began legalizing cannabis in 1996, and by 2009, thirteen states had laws allowing cannabis possession and use.7 Despite this legislation, federal authorities continued to aggressively enforce federal cannabis laws.8 That changed under the Obama administration when, shortly after being elected, President Obama stated that his administration would not target legal CRB’s who were abiding by state laws. In an attempt to provide clarity in this murky environment, beginning in 2009, the Department of Justice (DOJ) issued three memos designed to guide federal prosecutors in this area. However, none of the DOJ memos issued from 2009 through 2013 addressed potential financial crime related to the legal sale or distribution of cannabis in states allowing the use of medicinal or recreational cannabis.
To assist financial institutions in navigating potential financial crime implications of banking CRBs, the Financial Crimes Enforcement Network (FinCen) issued guidance in 2014 that clarified how financial institutions could conduct business with CRBs and maintain compliance with their Bank Secrecy Act requirements (2014 Guidance).9 According to the 2014 Guidance, financial institutions may choose to interact with CRBs based on factors specific to each institution, including the institution’s business objectives, the evaluated risks associated with offering such services, and its ability to manage those risks effectively.
The 2014 Guidance requires those who choose to provide services to CRBs to design and implement a thorough customer due diligence review that includes, in part, analyzing the licensing of the entity, developing an understanding of the business operations of the entity, and ongoing monitoring of the entity.9 In addition, financial institutions are required to file a Suspicious Activity Report (SAR) for every transaction they process for a CRB, should they choose to accept the business.
Although the 2014 Guidance does outline a path for financial institutions to engage with CRBs, it does not change federal law and, therefore, does not eliminate the legal risk to financial institutions.10 By its very nature, the 2014 Guidance was a temporary fix, subject to changing views of different administrations, evidenced by the fact that all three of the DOJ guidance documents noted above were rescinded by then Attorney General Jeff Sessions on January 4, 2018.12 The DOJ enforcement posture could change once again in a Biden administration. Biden is on record as favoring decriminalization, and Attorney General candidate Merrick Garland has stated that if confirmed he will deprioritize enforcement of low-level cannabis crimes. Garland also believes using limited government resources to pursue prosecution of cannabis crimes states where cannabis is legal does not make sense.12
Because of the uncertainty and high risk, most banks remain unwilling to serve CRBs. Those that do serve CRBs charge exorbitant fees (fees of $750-$1,000 or more per account per month are not uncommon), pricing many smaller operators out of the financial services market.
Cash is King – Or Is It?
Cannabis operators have discovered the old adage “cash is king” is not necessarily true when it comes to the cannabis space. Bank-less CRBs are forced to utilize cash to pay business expenses, which can be particularly difficult. Utility companies, payroll companies, and taxing authorities are just some of the providers that are difficult, if not impossible, to pay in cash. For example, cannabis operators have been turned away from IRS offices when attempting to pay large federal tax obligations in cash. Likewise, cannabis operators have been unable to utilize payroll processing companies to administer payroll and benefits for their businesses because the processors won’t take cash. CRBs can’t use Amazon or other online retailers because online providers cannot accept cash.
Because dealing in cash is so difficult, CRB operators look for workarounds such as using personal credit/debit cards to purchase business equipment and supplies. This doesn’t eliminate the cash problem, however, because the credit card holder will likely have to accept cash as reimbursement. Such transactions could be considered an attempt to hide the source of the cash, which is, by definition, money laundering.
Some bank-less CRBs try to skirt the system by obtaining bank accounts in the name of management companies or other entities one step removed from the actual business. While operators often choose this route in an effort to streamline business and operate out of the shadows, it again runs afoul of banking laws. Transferring cannabis related financial transactions to another entity is actually the very definition of money laundering – which, as noted above, is defined as the process used to conceal the existence or source of “illegal” funds.
In addition to the difficulties in making payments or purchasing business supplies, operating in a cash-heavy environment poses significant safety risks for cannabis operators. CRBs often have large sums of money onsite and transport large sums of cash when purchasing product or paying bills, making them a target for robbery. In 2017, there was a spate of dispensary robberies across the Phoenix Metro area, including one at Bloom Dispensary that took place during operating hours.13
Managing all that cash increases the cost of doing business as well, in the form of increased labor, insurance, and security costs. Cash must be counted and double counted, which can be time consuming for staff, not to mention the time it takes to deliver physical cash payments to hither and yon. Ironically, lack of banking significantly decreases transparency and clouds the waters of compliance, as operating strictly in cash makes it easier to manipulate reported financial results.
Potential Congressional Solutions
In recent years Congress has undertaken several efforts to pass legislation designed to address the state/federal divide on cannabis, which would likely clear the way for financial institutions to provide services to CRBs, including:
R. 1595 – Secure and Fair Enforcement Banking Act of 2019 (“SAFE Act”);
1028 & H.R. 2093 – Strengthening the Tenth Amendment Through Entrusting States Act (STATES Act); and
2227 – Marijuana Opportunity Reinvestment and Expungement Act of 2019 (MORE Act).
The climate in Washington DC, however, did not allow any of these initiatives to pass both houses of congress. Had any been sent to the White House, President Trump was unlikely to sign them into law.
The cannabis industry has new reason to believe reform is on the horizon with shift in political leadership in the White House and Senate. Newly anointed Senate Majority Leader Chuck Schumer recently committed to making federal cannabis reform a priority, and President Biden appears committed to decriminalization, reviving the hope of passage of one of these pieces of legislation.
The Changing Banking Landscape
Even though there is little in the way of formal protections for financial institutions, and with the timeline for a legislative fix unknown, an increasing number of banks are working with cannabis operators.
According to FinCen statistics, there were approximately 695 financial institutions actively involved with CRBs as of June 30, 2020. It is important to note that these statistics are based on SAR filings, which banks are required to file when an account or transaction is suspected of being affiliated with a cannabis business. However, some of these SARs may have been generated on genuine suspicious activity rather than on a transaction with a known cannabis customer.
There are arguably more banking institutions offering services to CRBs than ever before. The challenges for CRBs are (1) finding an institution that is willing to offer services; (2) building/maintaining a compliance regime that will be acceptable to that institution; and (3) cost, given the high fees associated with these types of accounts.
How CRBs Get Accepted by Banks
The gap between CRBs’ need for banking and the financial services providers’ sparse and expensive offerings to the sector has created an opportunity for third-party firms to intervene and provide a compliance structure that will satisfy the needs of the financial institutions, making it easier for the CRB to find a bank.
These third-party firms perform extensive BSA-compliant due diligence on applicants to ensure potential customers are following FinCen guidance required to receive banking services. After the completion of due diligence, they connect the CRBs with financial institutions that are willing to do business with CRBs and provide checking/savings accounts, check writing capability, and merchant processor accounts. These firms often provide additional services such as armored car and cash vaulting services. Some of these firms also offer vendor screening, pre-approving vendors before any payments can be made.
One such firm, Safe Harbor Private Banking, started as a project implemented by the CEO of Partners Credit Union in Denver, Colorado, who set out to design a cannabis banking program that would allow Partners to do business with Colorado CRBs.15 The program was successful and has since expanded into other states who have legalized cannabis. Other operators include Dama Financial and NaturePay.
While these services offer hope for many CRBs, the downside is cost. These services perform the operations necessary to find, open, and maintain a compliant bank account; however, the costs of compliance are still high, pricing some small operators out of the market.
Is Digital Currency an Answer?
Digital currency is also making its way into the cannabis world. Digital currency, or cryptocurrency, is a medium of exchange that utilizes a decentralized ledger to record transactions, otherwise known as a blockchain. One of the largest benefits of blockchain is that it is a secure, incorruptible digital ledger used for, among other things, financial transactions.16 Blockchain technology offers CRBs a transparent and immutable audit trail for business and financial transactions. Several cannabis-specific cryptocurrencies have sprung up in the past several years, including PotCoin, CannabisCoin, and DopeCoin, to name a few.
In July 2019, Arizona approved cryptocurrency startup ALTA to offer services to the state’s medical cannabis operators.17 ALTA describes itself as a “digital payment club where cash-intensive businesses pay each other using digital tokens instead of cash.”18 ALTA members purchase digital tokens that are used to pay other members using a proprietary blockchain based system. The tokens are redeemable for US dollars at a stable rate of 1:1, and CRBs do not need a bank account to participate in the ALTA program.
ALTA proposes to pick up members’ cash and exchanges it for tokens, which are then used to pay other members for goods and services. Tokens may be redeemed for cash at any time.18 The company has been approved by the Arizona State Attorney General, and one of the first members they hope to enlist is the Arizona Department of Revenue (ADOR). Enlisting ADOR into the program would allow dispensary members to pay state taxes digitally rather than hauling large amounts of cash to ADOR offices.
Similarly, Nevada recently contracted with Multichain Ventures to supply a digital currency solution to the Nevada cannabis industry. Nevada Assembly Bill 466 requires the state create a pilot program to design a “closed loop” system like Venmo in an effort to reduce cash transactions in the cannabis sector. Like ALTA, Nevada’s proposed system will convert cash to tokens which can then be transacted between system participants.19
While both proposals are promising for Arizona and Nevada CRBs, the timeline as to when, or if, these offerings will come online is unknown. Action on cannabis reform at the federal level may render these options moot.
Looking to the Future
Although states are legalizing cannabis in one form or another in growing numbers, the fact that cannabis is still federally illegal poses a significant barrier to accessing the financial services market for CRBs. While most banks are still reluctant to offer services to this rapidly growing industry, there are more banks than ever before willing to participate in the cannabis industry. Recent changes in leadership in Washington DC offer a positive outlook for cannabis reform at the federal level.
As the “green rush” continues to envelop the country, financial services options available to CRBs are slowly growing. Many new options are now available to help CRBs find a bank, develop compliance programs, and manage the cash related problems encountered by most CRBs. However, these solutions may be out of reach for the budget-conscious small operator. Also, there are a number of cryptocurrency solutions designed specifically for CRBs; however, when, or if, these solutions will gain significant traction is still unknown.
Controlled Substances Act, 21 U.S.C., Subchapter I, Part B, §812.
“State Marijuana Laws”; National Conference of State Legislatures, February 19, 2021.
“Exclusive: US Retail Marijuana Sales On Pace to Rise 40% in 2020, near $37B by 2024”. Marijuana Business Daily, June 30, 2020.
Kaufman, Irving. “The Cash Connection: Organized Crime, Financial Institutions, and Money Laundering”. Interim Report to the President, October 1984.
S. Code § 1956 – Laundering of Monetary Instruments.
Rowe, Robert. “Compliance and the Cannabis Conundrum.” ABA Banking Journal, September 11, 2016.
“History of Marijuana as a Medicine – 2900 BC to Present”. ProCon.org, December 4, 2020.
Truble, Sarah and Kasai, Nathan. “The Past – and Future – of Federal Marijuana Enforcement”. org, May 12, 2017.
Bespoke Financial was the first licensed FinTech lender focused on the legal cannabis industry. Founded in June of 2018, Bespoke offers four types of lending products: Invoice financing, inventory financing, purchase money financing and a general line of credit. With just over two years of originating loans to clients, they have benefitted from being a first mover in the cannabis lending space.
George Mancheril is the founder and CEO of Bespoke Financial. He has over fourteen years of experience in finance, with a special focus on asset-based lending, off balance sheet financing of commercial assets and structured credit. Following a stint with Goldman Sachs, he worked at Guggenheim Partners Investment Management’s Structured Credit Group in Los Angeles where he worked on structuring esoteric asset financing for a variety of commercial assets including airplanes, container leases and receivables.
Since 2018, Mancheril and his team at Bespoke Financial have deployed over $120 million in principal advances without any defaults and across eleven states. We sat down with Mancheril and asked him about the history of his business, how it’s been received so far and how the past few years of financial activity in the cannabis sector might shape the future.
Cannabis Industry Journal: What is Bespoke Financial in a nutshell?
George Mancheril: Bespoke Financial is the first licensed FinTech lender focused on the legal cannabis industry. Bespoke offers legal cannabis businesses revolving lines of credit that address the top problem in the industry – lack of access to non-dilutive, scalable financing to capitalize on growth opportunities and improve profitability. Due to the federal illegality of cannabis, traditional banking institutions cannot work with our clients even though these operators are working within the legal regulatory framework of their state. Bespoke solves this problem for businesses across the cannabis supply chain along with ancillary companies affected by the lack of access to traditional capital markets.
CIJ: How does your company help cannabis businesses?
Mancheril: Bespoke Financial offers 4 lending products – all are structured as a revolving line of credit but each allows our clients to access capital in a unique way based on their specific needs. Our Invoice Financing product, allows businesses to borrow capital against their Accounts Receivables in order to manage general business expenses, particularly if the borrower’s business growth is slowed due to a long cashflow conversion cycle. Inventory Financing and Purchase Money Financing allow our clients to finance payments to their vendors, which helps our clients achieve economies of scale by increasing their purchasing power. Lastly our general Line of Credit allows for the most flexibility for our clients to utilize our financing by either financing payments made directly to vendors or drawing funds into the client’s bank account to manage business expenses.
CIJ: I know the company is only a few years old, but can you tell me about your company’s success so far?
Mancheril: [Clarification, Bespoke was founded in June 2018 so we’ve been around for 3 years but we now have over 2 years of originating loans to clients.] Bespoke Financial has benefitted by being a first mover in the cannabis lending space as the first licensed lender specifically addressing the financing needs of cannabis operators, starting in early 2019. Over the past 2 years we have developed and refined our proprietary underwriting model to identify over 50 active clients spanning the entire cannabis supply chain. Since inception, Bespoke has deployed over $120 million in principal advances without any defaults to date and expanded our geographic footprint across 11 states. Our growth and success highlights our company’s expertise in structuring financing solutions which address the unique capital needs of cannabis companies.
CIJ: Can you discuss how the recent M&A activity, current and recent market trends, as well as the pandemic has affected your company’s growth?
Mancheril: The cannabis industry overcame a variety of challenges presented by the COVID-19 pandemic, ending the year with record sales in both new and existing markets. The support from state and local governments, evidenced by the industry’s essential business designation and the easing of regulations, coupled with increasing consumer adoption of cannabis combined to increase the industry’s demand for capital throughout the pandemic. Bespoke was well positioned to partner with cannabis companies across the supply chain and was proud to help our clients thrive during this pivotal period.
Coming into 2021, the cannabis industry and investors shared a very positive outlook for the future based on the previous year’s experience and expectations of material easing of federal regulation. While M&A activity in the industry has increased over the past 6 months, the overall consensus has been that both the frequency of exit opportunities and the corresponding valuations will continue to increase as federal decriminalization opens new sources of capital and materially changes investors’ valuation assumptions. In general, we’ve seen cannabis companies focused on both capitalizing on the increasing opportunity presented by the industry’s organic growth and maximizing the benefits of future regulation changes by utilizing the resources and capital currently available to increase revenue, expand into new markets, and work towards profitability. All of these factors have further compounded the industry’s demand for financing and we expect to see continued growth in our lending activity in line with the industry’s growth.
CIJ: Who has been your most successful client?
Mancheril: We have a handful of cases studies and client success stories here on our website. One of the most exciting growth stories we have seen has been our client DreamFields whose in-house brand, Jeeter, is now the #1 pre-roll brand in the state of California. Prior to working with Bespoke, the brand was not ranked in the top 25 but was able to grow sales over 1,000% within the first year of working with us and achieve the #1 spot in their product category.
The cannabis industry in the United States represents about a $50 billion asset class making it one of the largest new asset classes in the country. Commercial real estate lending is a key enabler for companies seeking to expand and scale. Pelorus Equity Group is one of the largest commercial lenders in cannabis with over $170 million deployed since its first cannabis transaction in 2016.
Since 1991, Pelorus principals have participated in more than $1 billion of real estate investment transactions using both debt and equity solutions. Pelorus offers a range of transactional solutions addressing the diverse needs of cannabis related business operators. While most cannabis private equity lenders focus on real estate acquisition and refinancing, Pelorus has leveraged its experience in more than 5,000 transactions of varying size and complexity to offer value-add loans, a rarity in the industry.
We spoke with Rob Sechrist, president of Pelorus Equity Group and manager of the Pelorus Fund. Rob joined Pelorus in 2010 after several years in the California real estate market. In 2018, Pelorus launched the Pelorus Fund where Rob is currently the manager. The Fund converted to an REIT in 2020.
Aaron Green: How did you get involved in the cannabis industry?
Rob Sechrist: Pelorus is a value-add bridge lender. We’ve been lending for a long time, originally in the non-cannabis space. We’ve done 5000 transactions for over a billion dollars – more than a lot of banks.
In 2014, our local congressman Dana Rohrabacher passed the Rohrabacher-Blumenauer Amendment that defunded the Department of Justice from prosecuting any cannabis related business in a medically licensed state. We were a supporter of that legislation and once that passed, we took a serious look at utilizing our expertise in being a value-add lender and applying it to the largest asset class of real estate that is newly coming about today. That cannabis related asset class is about $50 billion.
We decided that we had the expertise to move into this space and to build these facilities out for our borrowers so that the cannabis use tenants would have a fully stabilized facility and make it operate. After the amendment passed in 2014, by 2016 we had originated our first transaction. Since that time, we’ve originated 51 transactions in the cannabis space for over $177 million so far. It wasn’t that big of a pivot when you’re just providing the value-add loan.
“Value-add” in the loan business means that a portion of the loan amount, let’s just say is a million dollars, maybe 250,000 of that, is a pre-approved budget to go back into the property. In cannabis property those are typically tenant improvements and/or equipment to fully stabilize that tenant. So, we’re the first fully dedicated lender in the nation exclusively to cannabis and we’ve done more transactions than anybody else in the nation.
Green: What are some challenges of cannabis lending compared to traditional lending?
Sechrist: The number one challenge in cannabis is that you must disclose to your investors that you’re originating the loans to cannabis use tenants. Many people have concerns that lending indirectly might be federally illegal. If you did not disclose that to your investors when you form that capital stack to fund these transactions, you’re going to run into issues. So, you would need to create a vehicle where you disclose to your investors that you’re intending to lend into cannabis and it’s still federally illegal. Doing one-off stand-alone transactions deal by deal is not sustainable if you’re going to be a large lender.
There are other challenges. Because cannabis is still federally illegal, it gives insurers and other third parties the ability to deny a claim, or certain lender protections. Some examples include errors and omissions insurance, title insurance, property insurance, etc. and all of them say in those policies that if you’re doing something federally illegal, then the policy is null and void. So, you must think your way through very carefully all the things that could potentially be an issue. You also have to disclose to those third parties and find a way to get them to acknowledge it to make sure you have the coverage if you ever have to make a claim. That’s a very difficult process.
Green: How has the investor profile in cannabis lending changed over time?
Sechrist: Our fund was structured to allow for institutional capital from the inception. We were able to do that because we are completely non-plant touching. Our fund only lends to the owners of commercial real estate. We do not lend to any cannabis licensed operator directly whatsoever. Our borrowers – the owners of the properties – would then have a lease agreement with the cannabis use tenant. Even if it’s an owner-operator, those are separate entities. That’s how we’ve distinguished ourselves.
Regarding the investor profile, the first $100 million plus we raised was primarily from retail investors who were individuals writing checks up to a million dollars. Once we had three years of audited track record and our fund was $100 million, we then pivoted over to family offices and institutional investors and pension funds. We’re now working primarily with those types of investors.
The reason that we started with retail investors is that it’s very easy for me to explain our model to a single decision maker and answer their questions. Once I move into family offices or institutional investors, the opportunity goes to a credit committee where I’m relying on some other party to educate the investor about our investment. It’s enormously challenging at that point if it’s not me doing the talking. I know the answers, but I’m having to rely on somebody else to answer questions. We’ve tried to educate everybody we speak with and craft our documentation in such a way that even when it’s not myself answering the questions directly, people can understand how we thread the needle through some of the legal hurdles.
Green: How do you prioritize deal flow, and what are the qualities of a successful loan applicant?
Sechrist: We typically maintain a pipeline of around $150 million in transactions at any one time.
Applicants must have real estate. We’re not doing business loans or operator loans directly to tenants or business operations. So, that’s the starting point. We want a real estate piece of collateral where we feel more than comfortable with the loan-to-value and ratios and the loan to cost and other figures, that we feel that this transaction is going to be a success for our borrower and ultimately the tenant.
Next, we will only work with very experienced operators who have a proven track record where this is not their first transaction. Ideally, we are working someone who is looking to expand their operations and who is ready to either move from being a tenant of their previous facility and buying their next facility.
The next aspect that we’re looking for is the strength of the borrower’s guarantor. They must be able to qualify to support that transaction. Many of our transactions are millions or 10s of millions of dollars. You must have a sponsor that can support that size of a transaction.
Green: What sort of value-adds should a cannabis property owner look for in their lender?
Sechrist: Most people that are looking for loans are only familiar with getting loans for themselves on their owner-occupied house. Most loans have points, they have a rate and a term, loan-to-value and things like that.
“We wanted to make sure that when we underwrite the transaction, that every single piece of capital is necessary to get that facility all the way to where that tenant can start generating their first crops and make their lease payments.”When you move into construction loans or value-add lending, there are other elements that are more important than the pricing of the loan. The number one thing is to get that property fully stabilized and built as quickly as possible. Cannabis tenants are generating 10 to 15 times more revenue per month than non-cannabis tenants.
If you go to a bank and borrow money it may be a third of what it costs to borrow from us, but they process draws maybe once a month. So, if you’re having to advance the money for improvements of the property, and then the bank reimburses once a month, at a certain point you’re not going to be able to advance any more money until you get reimbursed. The project comes to a stop. So, in your mind, you might have saved an enormous amount on the pricing of the rate, but it’s costing you dearly in revenue and opportunity costs. We typically process 50 to 100 draws post-closing on transactions, and we get that facility built and the money reimbursed to all the contractors on a multiple-times-a-week basis. It’s happening in real flow all the time.
A typical problem for a tenant is that the tenant improvements are orders of magnitude higher than a non-cannabis tenant – anywhere from $150 to $250 per square foot. In addition, the equipment is often enormously expensive as well. It’s tough to put money into a buildout for a building that you may not own. Our vision at Pelorus was, let’s not force these tenants – the cannabis operators – to raise equity at the worst possible time when they’re not generating revenue through the facility. Let’s shift that capital balance for those tenant improvements and equipment from the from the tenant to the owner of the building, which is where it’s secured and adds value to that building anyway. Our vision was to shift that money from the balance sheet of the tenant over to the owner of the real estate so the tenant didn’t have to sell equity to come up with that money. Then the tenant is paying for the improvements in the lease rate and the borrower is paying for improvements in the note rate. And so we’ve shifted tenant improvements from being an equity component to now it’s just priced in the debt. This way you know what the terms are and you know what your total exposure is there.
We wanted to make sure that when we underwrite the transaction, that every single piece of capital is necessary to get that facility all the way to where that tenant can start generating their first crops and make their lease payments. Most of our peers in the space don’t look at it that way. They just do the acquisition or the refinance. They don’t do anything for the tenant improvements. They don’t do anything for the equipment. The tenant is left out there to either raise that equity or the borrower – the owner of the real estate – is having to come up with that additional capital on their own. We think you’re set up for failure in that circumstance. So, we blend all that into one capital stack. It’s important that the tenants can get all the way up to being able to cash flow and support that facility and be fully stabilized so they can refinance into a lower cost bank or credit union transaction.
Green: What federal policies and trends are you monitoring?
Sechrist: First, I think that it’s important to remind people that the Rohrabacher-Blumenauer Amendment has protected everybody from any prosecution. So, there’s no jeopardy out there that exists. The second thing I like to tell people is there are 695 banks on FinCEN’s website of cannabis Tier 1 depositors, and of those, we’re tracking numerous FDIC insured state banks and credit unions that are lending directly. We’ve been paid off by banks.
So, there’s this massive misconception that there’s no banking at all and that everything is happening by cash. The only cash buildup that happens is at the retail dispensary level because credit cards aren’t allowed for retail sales at the dispensaries. Out of the 2,000 transactions that we’ve either processed or reviewed, not one has ever not had banking set up. So, it is a big misnomer that there’s no depositor relations for Tier 1 banking, which is plant touching.
Tier 2/3 depositors are ancillary, which is what we are at Pelorus. There are 100 private lenders and dozens and dozens of state and federal credit unions or state banks and credit unions, not federal, that are FDIC insured and lending. Those banks are difficult to get loans from because they only want to do urban environments. They want to do fully stabilized companies and they want to use alternative views and the facility has to have seasoning for cash flow. It’s difficult to qualify for them. So, banking and lending exists out there, and most people are not aware of that.
Green: What are you most interested in learning about? This could be either in cannabis or in your personal life.
Sechrist: My two passions are snowboarding and racetrack driving. I just came back from the Mille Miglia race in Italy, and I do a lot of driving on the racetracks. I’m always looking to learn from those experiences.
In the cannabis sector, social equity programs are happening across the nation and cannabis licenses are being issued to operators. We would like to help participate in some system of educating these applicants that win the awards. Lending to an owner of a property who just won a license but has no experience is going to be problematic. Somebody needs to be thinking that out and making sure that these people that win have enough experience and education to set them up for success. Cannabis is one of the most complicated businesses ever, and they’ve got this license as their ticket, but they need to know how to make sure they’re going to be successful.
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