The cannabis industry and its participants are caught up in a seemingly endless hunt for capital sources. The early days of the commercially regulated cannabis industry witnessed an abundance of equity investment. Often, this came in absurd amounts based on jaw-dropping valuations across the United States, our neighbors to the North, across LatAm, the European markets, and far beyond.
Never in history has such little due diligence been conducted in any cogent industry prior to the deployment of such substantial sums. Perhaps this was FOMO? Perhaps these investors wanted to capture the first mover advantage, which incidentally, does not seem to apply to the cannabis industry. Whatever the reason, markets have cooled substantially. The days of investors throwing money at cannabis companies have come and gone, at least in the form of equity.
Despite solid efforts to reduce cash burn, increase sales, and reduce the cost of goods sold (which is counterintuitive given the issues surrounding 280e), cannabis companies currently require significant capital infusion to grow, scale, and continue to compete. In many cases, this ultimately requires the completion of build-outs and strategic acquisitions.
As of today, the equity markets are virtually closed to cannabis businesses. Given these market forces and trends, it is likely the cannabis space is about to see a marked increase in the role of debt financing as the main, if not sole, funding source for months and years to come.
With the tightening access to capital markets, and the corresponding movement toward primarily debt financing, the role of credit scoring, rating, and analysis has become increasingly important for cannabis companies. Going forward, credit will become paramount to raising capital in the cannabis space.
Credit ratings for cannabis companies are essential because equity financing has become increasingly challenging to obtain. Correspondingly, tightening credit standards will likely cause debt to become more expensive or unavailable for poorly rated companies. Today, such credit ratings are not available for U.S. cannabis companies. Investors have only blind faith and their own diligence to lean on, and this lack of visibility often translates to insurmountable interest rates for the businesses that seek financing.
This is a problem. There needs to be a credit rating system that can assess risk factors in a standardized manner. Further, there needs to be a learned algorithm that underpins the essential elements of cannabis business health, or lack thereof, as a baseline. These parameters for standardized evaluation have yet to be developed by those who have performed substantial work in the cannabis industry, both domestically and abroad, in the fields of operations, supply chain, law, compliance, policy, finance, and technology.
Watch for this dire need to spur new near-term innovations to benefit cannabis businesses and investors alike.