Investor Takeaway Cannabis Federal Legalization and Access to Capital – Part I

The bouncing ball that is the Secure and Fair Enforcement (SAFE) Banking Act is now back into deliberation by the Senate. It is intended to give protections to those financial institutions that provide traditional banking services to state-licensed cannabis-related businesses. How will it affect the much-needed access to capital that is still a hard to come by commodity in the cannabis space? We speculate that federal de-scheduling and the likelihood of the SAFE Banking Act passing will not come as early as this year. For substantiation, we turned to the comments of industry experts from sessions at the Benzinga Capital Conference last month for their insights. We found:

• The “Plumbing Problem” in the industry is still ready access to capital.
• Bipartisan support is growing on the Hill, The States Reform Act being an example.
• Yet, the best hope for progress by congress is a “Bare Bones” SAFE, addressing more manageable issues such as SARS.
• Whatever the future of federal legalization holds, however, investment in those operators that can scale into leadership positions is the soundest investment strategy.

The SAFE Banking Act and Access to Capital Cannabis Federal Legalization and Access to Capital – Part I

The bouncing ball that is the SAFE Banking Act is now back into deliberation by the Senate after having been killed toward the end of last year as an amendment to the 2022 National Defense Authorization Act and having been amended then withdrawn from Senator Chuck Schumer’s COMPETES Act. SAFE, as you recall from our previous coverage on the subject, is intended to give protections to those financial institutions that provide traditional banking services to state-licensed cannabis-related businesses.

The significance of SAFE, according to the National Organization for the Reform of Marijuana Laws (NORML), is the receptivity in the industry about the passage of cannabis banking legislation:

A recent survey by Whitney Economics of 396 licensed cannabis companies reported that over 70 per cent of respondents cited a “lack of access to banking or investment capital” as their top business challenge – ranking far above other challenges, such as onerous state regulations or competing with the unregulated market.

As the law firm of Brennan, Manna and Diamond (BMD LLC) summarizes it: “(The legislation) would provide expanded safe harbor protections for banks working with cannabis businesses. Re- or de-scheduling marijuana under federal criminal law could eliminate uncertainties such as the cannabis industry’s issues under Section 280E of the Internal Revenue Code and the current lack of access to the U.S. Bankruptcy Courts. There is also the aspect of protecting public safety. Verbiage in the Act states that opening financial services to legitimate cannabis businesses and service providers reduces the amount of cash at such businesses.”

Financial Regulation News points out that to mitigate the risk of lack of compliance with the myriad of federal financial crimes laws, banks doing business with the cannabis industry, and their bank regulators, draw on guidance issued by the Federal Crimes Enforcement Network (FinCEN) in 2014. The SAFE Banking Act would call for FinCEN to issue new guidance to incorporate the demand for increased bank services by traditional institutions in addition to the orientation of existing wording.

The FinCEN Guidance specifically incorporated content from a memorandum issued by the U.S. Department of Justice in 2013 by Deputy Attorney General James Cole (the “Cole Memo”), that essentially deprioritized prosecution of marijuana-related federal offenses so long as the actors were complying with state law. Among other things, the Cole Memo identified continuing priorities such as preventing distribution to minors, money flowing to criminal enterprises, and diversion of marijuana to states where it was still illegal.

Legalization on the Horizon? Cannabis Federal Legalization and Access to Capital – Part I

Adding to advocate expectations is the bilateral support for legalization, now in the form of yet another piece of legislation this time presented by Nancy Mace, GOP Representative from South Carolina. In November she introduced the first Republican-backed decriminalization bill, the States Reform Act. In essence the bill would remove cannabis from the Schedule 1 controlled substance list, while establishing a baseline of federal policies and imposing a three per cent federal excise tax on cannabis sales in each legal state. We will provide a more detailed analysis of the States Reform Act in an upcoming issue of The EDGE.

While the general consensus in the industry remains doubtful that SAFE will become law this year, we turned to industry experts on the subject at the recent Benzinga Capital Conference and summarized their thoughts from presentations and panel discussions.

Leonard Tannenbaum, CEO of Advanced Flower Capital (NASDAQ: AFCG), is one of those who feels SAFE is not likely to pass in this tumultuous year for the economy. He, like others in the industry, though, is hopeful for at least the passage of a lighter version, a “Bare Bones” version. While SAFE does not have a big impact on his business as a source of capital for the cannabis industry, he feels that one of the biggest obstacles for traditional institutional investors is the Suspicious Activities Reporting System, which under the FinCEN guidance requires information must be reported to this 5 agency Federal law enforcement network for potential criminal violations in transactions as small as $5,000. Transactions with cannabis companies until Federal de-scheduling fall under this scrutiny. Tannenbaum sees it as possible that a bare bones version of SAFE would simply lift this onerous requirement from potential sources of capital for the industry.

That sentiment was also expressed by Brady Cobb, Founder of Sunburn Cannabis and a Podcast commentator on the industry:

As an operator that is one of the biggest problems we have, what I call our ‘Plumbing Problem.’ It is not necessarily that we have bad fundamentals, it’s that we can’t access capital. Institutional capital has the inability to clear compliance.  The most overlooked thing about SAFE, It does not immediately fix anything.  What it requires is that FinCEN update its marijuana business guidance and their money laundering guidance to provide cover for everyone to do business in the sunshine. 

De-scheduling.  Well, It’s Complicated. Cannabis Federal Legalization and Access to Capital – Part I

Speaking to the issue of “Big” legislation like the Marijuana Opportunity Reinvestment and Expungement (MORE) Act and SAFE, Representative David Joyce, (R-Ohio) is attempting to break these all-encompassing bills into smaller bite-size pieces of legislation in an effort to make incremental progress. In his role as co-chair of the Cannabis Coalition in the House he is the author of two bills attempting to accomplish this. One, the Harnessing Opportunities By Pursuing Expungement (HOPE) Act, is designed to first address the expungement issue. It would create a new grant program under the U.S. Department of Justice, the State Expungement Opportunity Grant Program, and authorize it to be funded up to $20 million over the span of Fiscal Years 2023-2032. The intent of the bill is to reduce the financial and administrative burden on States for the process of expungement for convictions of cannabis offenses.

Representative Joyce has also co-authored the Preparing Regulators Effectively for a Post-Prohibition Adult Use Regulated Environment (PREPARE) Act, a bipartisan bill designed to create a fair, honest and publicly transparent process for the federal government to establish effective regulation to be enacted upon termination of its 85-year prohibition of cannabis.

“With the major bills,” he says, “you get too many people in what I call the ‘off-ramp.’ It is easy to vote no, then go back to your district and say it was just the wrong thing. Getting people to vote yes, you have to make them feel comfortable, educate them.” In that education process people want to be convinced by seeing “the research.” He cites the examples of legislators wanting to see research on:

• The potential of product consistency across the country so that when people move from one state to another, they are going to be able to rely on a product producing the same effect as it did before.
• Consistent law enforcement across the states. Will it be treated the same way alcohol regulations are enforced?
• Consistent regulations on access to cannabis by minors.

So, the approach he is taking to advance the smaller bits of legislation is to get as many of the experts and affected parties in a room as possible to draw out what needs to be in or out of the final regulations. The irony he experiences is that the concerns of legislators and the White House are the same things the industry wants to contain. He sums up those concerns as: “That it is not being sold for something it isn’t. That people are getting it for all the right reasons, in all the right doses, using it the way they should.” His request of the cannabis industry to aid him in the process:

To build up the comfort level, show me the research you have been doing and what more you could do with given the opportunity so you can live out your corporate dream and help folks solve the problems that people have. Invite your representatives to your facility and let me know if they had an issue – to help us understand how we can take this the next step forward.

Nevertheless, the reality as we see it is that passage of even a banking bill like SAFE is not likely this year. The industry is still trying to come to grips with the productive impact of federal legalization. From a business standpoint, existing financing sources to the industry know that legalization means more competitors bringing with it reduced lending spreads compared to loans currently out in the sector.

Even from the standpoint of traditional banking institutions, passage of the Act is not a slam dunk. BMD LLC points out that unlike private lenders, banks are subject to regulation and examination, and are held to an overarching requirement of safety and soundness.

Banks need a degree of collateral certainty by way of timely and effective control of underlying assets, so that they can protect against further dissipation in value of the underlying assets and business. This will be difficult to achieve if they must go through some process of uncertain time or success to gain asset control from the defaulting borrower. 

Viridian Research, as reported by MJBiz Finance is another industry source that feels the SAFE Banking Act is still not likely to pass.  And even if it does, as noted above, it is likely to take time to “percolate through the market.”

From the standpoint of lenders currently active in the space, Leonard Tannenbaum sums up the eventuality of SAFE by saying, “We are going to help our borrowers either way.  If you can get bank financing cheaper, we’ll fall behind the banks. We want your cost of capital to go down, we want our cost of capital to go down, and continue to be a trusted partner in the industry.”

Making the Right Decision for Your Investment Portfolio Cannabis Federal Legalization and Access to Capital – Part I

So, whatever the future of federal legalization holds, investment in those operators that can scale into leadership positions is the soundest investment strategy. Then, when full legalization does occur those companies will have strong exit possibilities with valuations superior to their peers. However, especially in emerging markets, due diligence is key to identify the real players from the pretenders.

The approach we take with our clients for risk mitigation prior to presenting strategic cannabis investment opportunities: evaluating the prowess and the passion of the executive team, assessing the competitive advantage of the company and how quickly they can scale for growth, and determining how well they are ready for the regulatory regime in their home and target growth markets. We take these steps before presenting the company to our extensive network of pre-qualified investors.

How We Can Help 

At Highway 33 Capital, we see these challenges daily in our role as an investment banking intermediary as we arrange for the financing of growth companies in the cannabis and hemp markets. Finding the right fit for your strategic investment portfolio, or the proper way to appeal to a source for your growth funding requires transacting deals were the operators’ objectives and scalability are a strategic fit for investors’ portfolios.

We excel at structuring deals to meet client investment strategies in emerging opportunities with our core expertise in Cannabis along with other highly regulated markets in the fields of Pharma, Biotech, Healthcare, Agtech, Clean/ClimateTech, and CBD/hemp companies. We specialize in thoroughly vetted companies looking to drive growth and enterprise valuations through M&A, non-dilutive debt financing and/or capital investments ranging from $5M to $100M+.

Let’s talk about putting the power of this expertise to work for you as a Sell-side or Buy-side client.