Shark Bait

shark bait

Cannabis businesses can avoid predatory lenders by steering clear of unsolicited offers and heeding key warning signs.

Modern-day loan sharks are circling the cannabis industry.

Predatory lending—a practice that gained special notoriety during the Great Recession—can cripple or sink a cannabis business owner who is launching or expanding a company.

Predatory loans typically involve a lender who relies on unfair or misleading tactics. The result: A borrower is spurred into accepting a loan with a sky-high interest rate or other terms that are good for the lender­—but bad for the borrower.

Cannabis businesses are especially vulnerable. Many banks and other traditional lenders are reluctant to serve marijuana companies because the plant is illegal under federal law. That, in turn, has spurred MJ business owners to seek out alternative forms of finance—including predatory lenders who charge interest rates of 20% or more.

“This has happened for quite some time in the industry,” said Evan Eneman, CEO of Ello, a Los Angeles financial, tax and advisory services firm serving MJ businesses.

Moreover, the practice shows no sign of going away.

“I think predatory lending will continue to be prevalent in the cannabis industry because of the federal illegality,” said Nick Kovacevich, CEO of KushCo Holdings, a diversified ancillary cannabis business in Garden Grove, California.

Below are expert tips for how to avoid predatory lenders. They range from being wary of overseas lenders to knowing the warning signs of a questionable operator.

 

Crippling Costs

While not necessarily illegal, predatory loans can cripple an upstart cannabis business desperate for money.

“How can you grow your business if you add a 30% loan to your costs? If you are paying 30% on a loan, you can’t afford to hire anyone or expand your business,” said Denver lawyer Donald Emmi, who represents marijuana and hemp clients.

Emmi has firsthand experience with predatory lenders. “I just killed a deal for one of my clients who was trying to get a loan,” he said.

In that case, a hemp business owner wanted to borrow $1.5 million from a California venture capital firm bankrolled by several billionaires.

“My client has $13 million in assets, and they wanted to charge him a 26% interest rate. That’s outrageous. I consider that a predatory loan,” said Emmi, who did not want to identify the client or the VC firm. “A well-managed marijuana operation should expect to pay an interest rate of 9% to 12%.”

 

Warning Signs

Given that predatory lenders target the marijuana industry, it’s important for cannabis business owners to be alert to the warning signs that signal such operators.

Predatory lenders, for starters, may try to scam cannabis companies by not being upfront, said Justin Moriconi, a partner in the law firm Moriconi Flowers in Elkins Park, Pennsylvania, outside Philadelphia.

Some “hard money” lenders, for example, will circumvent state usury limits by securing the loan through a company’s assets—such as office equipment, machinery and even lighting fixtures—rather than a borrower’s creditworthiness. In such cases, a borrower risks losing assets if he or she fails to make the loan payments.

Predatory lenders also may require an upfront fee in exchange for the loan. For example, one of lawyer Emmi’s Denver clients, a CBD extraction company, paid a $100,000 fee on a $950,000 loan, in addition to being charged a high interest rate.

“Some lenders go further and ask for a fee tied to the companies’ gross or net profit,” Moriconi said. In some cases, he said, those fees can continue—even after the loan is repaid.

Moriconi said another red flag is if the funding originates from outside the United States. Foreign investments in U.S. cannabis companies are “clearly on the rise,” he said.

The problem: It can be difficult to know exactly where the funding is coming from.

“A typical ‘bait-and-switch’ involves (the MJ business) performing all the due diligence on the loan, but then when it comes time to cut a check, the funds are coming from another entity or person,” Moriconi said.

“This is problematic since the cannabis company does not know who they are dealing with directly … and opens the (company) up to aggressive lenders who do not understand the cannabis business and the curve on an ROI (return on investment).”

 

Stranger Danger

An easy way to reduce the risk of being stung by a predatory lender is not to borrow from a person or group that you are not familiar with.

“When someone cold calls you, there is a 99% chance they are not looking to offer you a fair rate,” KushCo’s Kovacevich said. “Stick with referrals and sources you know.”

Experts agreed it is important to work only with professionals with a track record of making marijuana loans with reasonable terms.

Kovacevich suggested business owners “build out a strong network” of reputable capital sources.

In addition, lawyers, accountants and consultants who specialize in the cannabis sector can recommend reputable lenders.

 

Read the Fine Print

To avoid predatory loans, closely examine the payback terms in addition to the interest rate, Ello’s Eneman said.

“You may be facing excessive fees to close the loan,” he noted, “or be required to have additional penalties or possibly abusive and abnormal prepayment penalties.”

For confidentiality reasons, Eneman declined to cite “real-life examples” but said he has seen operators saddled with short-term fees up to 40%. “This can create a significant cash-flow crunch,” especially if inventory and accounts-receivable collections are “already tight,” he said.

In fact, it’s crucial when getting a loan to plan for possible cash-flow problems.

A cannabis business owner, for example, may have trouble paying back a loan if faced with inventory problems or unexpected expenses. These issues can lead to a temporary cash shortage.

And if a cannabis company is not generating enough money to keep current on loan payments, it could result in onerous penalties or force the business owner to accept a new loan with bad terms, according to Eneman.

“Cash-flow issues are usually what cause the most problems for operators,” Eneman said.

 

Just Say No

Despite the lack of traditional banking options, there is no shortage of lenders willing to make loans to MJ businesses. A Google search of “cannabis lenders” resulted in 848,000 hits.

The key is to steer clear of the questionable dealmakers. If you sense a lender may be questionable or simply trying to cash in on the multibillion-dollar MJ industry, trust your gut and take a pass.

“Don’t be afraid to say ‘no’ if the loan looks shady,” said Moriconi, the Pennsylvania attorney. In the short term, he added, that might mean adopting “lean business practices” and saving money at every opportunity until the right business partner or lender is secured.