Marijuana startups are mostly shut out of the banking system

Marijuana
is a big business with a ton of challenges.
REUTERS/Leonhard Foeger

• 
  The USmarijuana
  industry is booming in a number of states, but the federal
  government considers marijuana an illegal, Schedule I
  drug.
• Because of that, most banks won’t touch the industry.
  And they won’t lend money either.
• That’s forced marijuana startups to come up with
  creative solutions to raise money, finance growth, file taxes,
  and pay employees.

Twice a
week, Emmett Reistroffer carefully
watches his array of security cameras. When the coast is clear,
an armed guard walks into his facility.

When the guard — a former law enforcement officer —
enters, Reistroffer sits down with an
accountant and the guard to count stacks of cash. 

Riestroffer is the Director of Compliance at Silver State
Wellness, a state-legal Nevada cannabis business.

The guard is a heavily armed cash courier, and this
highly-choreographed meetup is the reality of doing business in
Nevada’s cannabis industry. Riestroffer is just trying to pay
Silver State’s vendors on time — and everything has to be in
cash.

While marijuana is legal
in a number of states, the federal government still considers
it an illegal, Schedule I drug. Because of that, many marijuana
startups — though fully compliant with state law — are
shut out of the banking system. 

Marijuana companies that deal with the plant directly, like
cultivators, distributors, and dispensaries, are forced to come
up with creative solutions to do business on an all-cash basis.
That’s where the armored guards come in.

“The process is highly secure,” Riestroffer told Business
Insider. “We plan the cash drops when the facility is relatively
empty.”

Riestroffer said the word “cash” never appears in any of his text
messages or emails to the courier and vendors he needs to pay.

While Riestroffer wouldn’t say exactly how much cash he handles
on the twice-weekly drops, it’s upwards of $100,000. He said
other cannabis businesses he knows of are handling cash “into the
millions.” 

“We try and minimize as much as possible who needs to know, and
what the courier is coming to do at our facility,” he said.

Beyond the obvious public safety and theft issues of piles of
cash moving around Las Vegas in armored trucks, it’s “a huge
burden on my time,” Riestroffer said, adding that he has to
account for every single transaction purely in cash.

It’s also a problem for paying vendors, many of whom don’t want
or won’t accept cash payments, Riestroffer said.

A
man shops for marijuana at The Source dispensary, Saturday, July
1, 2017, in Las Vegas.
John
Locher/AP

No banks and no loans = lots of problems

The marijuana business is booming in the US. According to

a report from the investment bank Cowen, legal marijuana is
set to hit $75 billion in sales by 2030, putting it on par with
soda consumption. Marijuana cultivators are now
listed on the NASDAQ, have
former politicians on their board, and are backed
by heavyweight investors like Leon
Cooperman.

But for many big institutions, the risks of banking and lending
to the cannabis industry under the
current federal mandate just aren’t worth it, especially with
all the extra paperwork and scrutiny it can generate. 

“For cannabis businesses, this means that access to the
basic financial products like checking and savings accounts can
be elusive,” John Hudak, a senior fellow at the Brookings Institution who
studies issues pertaining to marijuana legalization, told
Business Insider. 

Tyler Beuerlein,
 a VP at Hypur, an Arizona-based fintech
startup that acts as a middleman between banks and cannabis
companies, told Business Insider that he believes there are “less
than 30” banks willing to do business with the booming cannabis
industry in the US.

That means the costs of doing business and remaining compliant
with the byzantine patchwork of state and federal laws guiding
the cannabis sector are much higher than in any other
industry. 

There’s also a higher risk of fraud in cash-only businesses,
according to Hudak. As a result, cannabis businesses have
had to resort to creative accounting in order to do the things
any normal business would, like paying employees and filing
taxes.

“The way it works in Nevada, the employees are actually
contractors of a parent organization,” Riestroffer said. “The
contractors work for the facility, but they’re really employed by
another entity.”

That system allows Silver State to pay employees regularly
through direct deposit, which Riestroffer said is “really lucky.”
Other companies are forced to pay employees in cash, which
creates its own obvious headaches for state regulators.

Because of a section of the federal tax code that doesn’t allow
cannabis companies to deduct business expenses, these startups
end up paying an effective tax rate “3.5 times higher
than their neighboring businesses,” Keegan Peterson, the CEO of
Wurk, a Colorado-based
payroll and compliance firm, told Business Insider. 

Eron
Silverstein, 51, (R) shops for marijuana at the MedMen store in
West Hollywood, California U.S. January 2,
2018.
Lucy
Nicholson/Reuters

California is a little further along than Nevada 

While California is a little further along in terms of cannabis
banking access than Nevada (and most other states that have
legalized marijuana), similar issues remain.

John Cochran, the CEO of Loudpack, a marijuana distribution and
cultivation company based in the Golden State, said there are a
number of credit unions willing to bank his business.

But in the “old days,” which in
the marijuana industry means two or three years ago, “I’m sure
there were lots of people that paid their employees in cash in
some form,” he said.

While credit unions will open basic checking accounts for
California cannabis businesses, institutional banks still won’t
lend to the cannabis industry, which hurts entrepreneurs across
the board.

It’s a question of “whether the juice is worth the squeeze” for
the big banks, Cochran said. Banks don’t want to invite the
scrutiny that lending to a federally illegal industry would
bring. 

Cannabis industry entrepreneurs have one option to finance
growth 

Borrowing money is almost impossible in the cannabis industry.
Just as with employees’ payments, cannabis operators are forced
to come up with creative solutions to finance growth.

To finance a new business, firms usually have two basic
options: they can use debt, by taking a loan and negotiating an
interest rate with a bank, or they can trade equity by hitting up
a venture firm — a process known as dilution.

Instead of going to banks and underwriting a loan backed by
whatever assets a company has, most cannabis companies raise
money from wealthy
individuals who are willing to take risks that banks
won’t.

But in order to protect their capital in what amounts to a
risky investment, these wealthy individuals — much like angel
investors or seed-stage venture capital firms — want something
for their money. That something usually amounts to a huge equity
stake, Kris Krane, the president of 4Front Ventures, a firm that
invests and manages a network of marijuana dispensaries across
the US told Business Insider.

For example, 4Front was recently granted a license to open
a dispensary in Western Massachusetts. 

But 4Front can’t get a loan to build in the state, so it’s
forced to hit up private investors. “We basically have to take
dilution and sell pieces of the company we otherwise wouldn’t
have,” Krane said.

For a firm like 4Front, which seeks to purchase many
licenses in states with legal marijuana to build a network of
dispensaries, each new license means more equity dilution,
according to Krane.

“We all own less of our company then we would have owned if
we had access to traditional banking and lending,” Krane
said.

For well-connected and well-capitalized companies like
4Front — which is composed of Wall Street veterans — this is a
surmountable problem.

Big
institutions aren’t lending to the marijuana industry —
yet.
Spencer Platt/Getty
Images

A lack of institutional lending hurts small business owners
the most

Where it really hurts, according to Krane, is with the
“mom-and-pops” and small businesses.

In states like Massachusetts, which allocate a certain
percentage of their dispensary licenses to “equity
applicants,”  who are below certain income thresholds or who
may have a past drug conviction, the lack of access to lending
puts these license holders at a disadvantage.

“They’re going to wind up owning substantially less than
their well-capitalized counterparts,” Krane said. Like 4Front,
these applicants will be forced to rely on private investors to
finance their dispensary, instead of banks.

These applicants, who may not have relevant management
experience and who may be less connected to networks of
high-net-worth investors, can get taken advantage of by private
investors.

It puts equity applicants and small business owners in a position
where “it’s almost impossible for them to keep majority control
of their company,” Krane said, “because they don’t have that
access to institutional lending where they could just get a loan
and do this on their own and keep a larger chunk of that
business.”

Hudak agrees. “For those without access to liquid
capital, they are forced to recruit more investors than a
traditional business would need,” which means they’ll end up
losing more control of their operation. 

Institutions ‘want to be at the table’

Right now, the only way for cannabis companies to get
institutional money is to
tap into public markets in Canada, where marijuana is set to
be legalized federally in October. But US institutions want the
“upside” of what’s going on in Canada, Cochran said — especially
as bigger public cannabis companies in Canada see their
valuations soar as they go on
acquisition sprees. 

“There’s a lot of institutional money in the state that wants to
be at the table,” Cochran, the CEO of Loudpack said.

Senators Cory Gardner and Elizabeth Warren have introduced the
bipartisan STATES Act, which would essentially provide an
exception from the Controlled Substances Act for states that
choose to legalize marijuana, allowing banks to lend to the
industry. 

President Donald Trump indicated that
he’d support the legislation if it crossed its desk. 

“The STATES ACT could theoretically solve the banking issue,”
Krane, of 4Front said. “But it won’t solve all of our problems.”

Until then, the cannabis industry will have to remain adaptable —
and creative. 

Read more of Business Insider’s marijuana industry coverage: