With equity investors on the sidelines, cannabis operators have turned to direct loans
The investment that flowed into the cannabis industry as dozens of states legalized the drug in recent years has slowed to a trickle, pressuring some private lenders that have become the primary source of its financing.
U.S. cannabis cultivators and operators are facing an approaching wall of debt maturities at a time of slowing growth and little movement by the federal government in reclassifying cannabis as a less-dangerous drug. As private-equity and venture-capital firms have stepped back from marijuana that is legal at the state level, pot cultivators and retailers have turned to debt financing, which accounted for 92% of the roughly $1.2 billion in capital raised last year, said Frank Colombo, managing director for cannabis investment bank Viridian Capital Advisors.
Because federally insured banks are reluctant to finance cannabis operations that are illegal under federal law, private credit has stepped in to fill the gap. U.S. pot companies now owe more than $2.5 billion in debt that comes due before the end of 2026, said David Zubricki, managing director for investment bank Ducera Partners. Unless federal regulations loosen substantially, he doesn’t expect an infusion of new capital to help manage debt they took on when investor optimism was higher.
Some direct loans are already souring as heavy taxes, regulatory costs and a production glut combine to push prices down and hit profitability.
“We’re not lending to Apple and Google here,” said Daniel Neville, chief executive of Advanced Flower Capital. The West Palm Beach, Fla.-based company, through both private credit and a publicly traded commercial mortgage real estate investment trust, has made nearly $800 million in cannabis-related loans.
Another private lender, Pelorus Capital Group, shows how some direct loans in the cannabis space have deteriorated. Since 2018, Pelorus has made more than $545 million in real estate
loans in 73 deals with state-legal marijuana companies. In September, it sued StateHouse Holdings over $116 million in loan defaults, after which the company was placed into receivership in California and its assets put up for sale.
Pelorus also filed a lawsuit last year over $19 million in defaulted construction loans made to publicly traded Item 9 to develop sites in Arizona and Nevada. Last year, publicly traded Juva Life, to which Pelorus lent $11.8 million to buy a California facility, defaulted on its debt, which led to Juva being put into receivership. Pelorus declined to comment.
Back when equity financing accounted for a significant majority of cannabis operators’ capital, lenders had the peace of mind of knowing that shareholders were inherently subordinate to them in the capital cushion if a business went up in smoke. But with equity investments in cannabis drying up to absorb those initial financial hits, lenders are more selective and are doing stricter due diligence, Neville said.
“For the last two years when we’ve been underwriting, we’ve been assuming that the company is never able to raise another dollar of equity,” Neville said. Advanced Flower also has tried to strengthen its underwriting by focusing on lending to more creditworthy borrowers, tightening covenants and charging slightly higher rates, he said.
Marijuana-industry research firm Whitney Economics said in a survey released last year that roughly 27% of cannabis businesses are profitable, down from 42% in 2022. Nearly a third are unprofitable, with the rest breaking even. Whitney estimates next year’s debt maturity at roughly $6 billion, based on both public and private multistate operators.
Cannabis operators still vie for consumer dollars with illegal dealers who avoid taxes and regulatory costs. Competing products derived from hemp rather than marijuana and sold in convenience stores and gas stations fall into a legal gray area but also affect legal operators’ bottom line. Some states that have legalized marijuana don’t cap the number of licenses and have reduced criminal penalties for black-market players, contributing to oversaturation.
The U.S. Cannabis Spot Index, which tracks wholesale prices in 22 states, sits at $955 a pound after reaching a record low in early January of $888. That is down from its peak of $2,133 in September 2015, a few months after the index was launched by a team of former Standard & Poor’s commodities trackers.
Equity investors have noticed the glut. Cannabis investments by private-equity and venturecapital firms are at their lowest levels in years in both dollar values and deal counts. Last year, U.S. private-equity deals in the sector totaled $260 million, compared with $1.3 billion for all of 2018, deal tracker PitchBook said. Venture-capital deals were $410 million, compared with roughly $3.06 billion in 2019.
“In a lot of instances, with where we’re at in this cycle in cannabis, there ain’t any equity financing,’ said Seth Yakatan, partner at consulting firm Katan Associates.
Lance Boldrey, a cannabis lawyer at law firm Dykema, said he is seeing “the aftereffects of what was a lot of irrational exuberance, disconnected from the basic economics of supply and demand.”
“When the first licenses were issued, I can’t tell you how many prospective clients had the same story about how they had the best grower ever, and how they’d be at the premium end of the market getting $3,500 a pound out of the gate,” Boldrey said. “My reaction to clients was, ‘I hope you’re stress-testing your pro formas to $850,’ and a lot of people scoffed at that.”
Duane Morris cannabis lawyer Michael Schwamm said he is seeing an increasing rate of restructuring transactions and defaults. And “if you were to poll most equity investors, they would tell you they have significant losses in the cannabis investments.”
The number of U.S. cannabis licenses as of August was 39,032, down from a peak of 44,682 in early 2023.
“This is a sign of market correction, recognizing that some licenses were awarded and never activated, and a number of these other businesses failed, squeezing both equity and debt investors,” said Dotan Melech, chief executive and a founder of CTrust, a credit-rating firm for the cannabis industry.
Since cannabis is still federally illegal, pot businesses haven’t been allowed to seek protection from creditors in a U.S. bankruptcy court to restructure obligations in an orderly way. That doesn’t keep them from trying, however. Earlier this month, New York-based Empire Cannabis Clubs filed for bankruptcy. An earlier filing by the company last December had been dismissed, partly because it didn’t have a lawyer.
Pelorus, meanwhile, is trying its luck in a California state court to recoup its stake in StateHouse, which has been placed into receivership and listed its assets for sale. They include brands, roughly a dozen California retail dispensaries and farms that generate some $120 million a year in revenue. The preference has been to sell all the StateHouse assets together, but the receivership said it would consider offers for individual pieces.
The StateHouse sale has generated 72 offers, a “massive success,” said Drew Mathews, chief executive of San Diego-based cannabis brokerage Greenlife Business Group, which is conducting the process. He didn’t say how much the offers yielded in terms of dollars but said they were higher than expected.
“The industry needs to see the light at the end of the tunnel, and this sale can determine how outside investors and guys not in cannabis feel about entering the mysterious cannabis market,” he said.
Write to Becky Yerak at becky.yerak@wsj.com