The cannabis landscape in Kentucky is about to experience a significant shift as the Commonwealth’s long-awaited medical cannabis license lottery moves into its final stages. For those selected, a crucial next step for many will be securing the necessary financing to bring their cannabis operations to life. In this blog post, we explore the key financing options for lottery winners, as well as potential regulatory challenges and how operators can prepare for success.
Financing Options
While securing a Kentucky medical cannabis license offers a tremendous business opportunity, it also requires significant investment to turn that opportunity into a thriving operation. For winners of the lottery, building out a physical location, obtaining the right equipment, and hiring employees are essential early steps. However, these activities often require substantial capital, and many new license holders may not have the resources on hand to cover these expenses.
Without sufficient financing, businesses may find themselves unable to move forward, potentially risking the loss of their licenses if they fail to meet certain milestones. While the Kentucky cannabis license application process required applicants to demonstrate a threshold level of capital for the applicant’s category of license in order for the application to be entered into the lottery/approved, this was a minimum requirement, and most businesses will need more funding to actually prepare for and commence operations.
Not all capital is the same, and securing cumbersome capital or partnering with the wrong team could impede the business in the future and cause strained relationships between founders and financing partners. As a result, obtaining the right financing is critical to ensuring long-term success.
For new cannabis businesses, the two primary avenues for financing are debt and equity. Each has its own advantages and potential pitfalls, particularly in a highly regulated industry like cannabis.
Equity financing can be an appealing option for cannabis startups, as it does not inhibit cash flow that can be hard to generate in a company’s early days. Like debt, equity financing can have various features, including preferred returns, warrant coverage, and management rights. For cannabis businesses, equity financing can come from a variety of sources, including many of the same players who participate in cannabis debt markets. The key issues for equity financing will concern valuation, balancing capital needs vs. equity dilution, control of the business, and finding synergistic partners who understand the growth trajectory and challenges of cannabis companies.
Debt financing comes in many varieties, with structures that have variable or fixed interest rates, security interests, convertibility features, warrant coverage, management rights, etc. In the cannabis industry, however, access to traditional bank loans and other institutional debt is be limited due to the ongoing federal illegality of most cannabis. As a result of the more limited universe of lenders, business owners can usually expect debt to be more expensive than in other industries.
That being said, there are alternative lenders who specialize in cannabis-related loans, including private equity firms, venture capitalists, certain traditional financial institutions, and even specialized cannabis financing companies. Businesses also often turn to friends and family for early funding. Debt financing can be an attractive option because it allows companies to retain ownership of their business while accessing the capital they need. However, because interest rates can be higher than traditional loans, businesses must be realistic about their short term projections and ensure that they do not over leverage at the outset.
For both debt and equity financing, license winners in Kentucky must also be cognizant of regulations and ensuring proper and timely disclosures to, and/or securing pre-approvals from, the Cabinet for Health and Family Services, as applicable. Operators also need to ensure that all documentation is proper and thorough, as cutting corners in the early days of a business almost always leads to problems in the future. Dentons has significant experience counseling operators and financing partners throughout the life cycle of companies and can assist clients with structuring that will avoid common pitfalls.
How We Can Help
At Dentons, we specialize in helping cannabis businesses navigate the complex legal and regulatory landscape associated with financing, real estate, M&A, regulations, and other cannabis activity. Whether you are looking to secure debt or equity financing, structure a joint venture, or explore the possibility of selling your business, our team of experienced attorneys can provide the guidance and support you need to succeed. We have a deep understanding of Kentucky’s medical cannabis regulations and are committed to helping you avoid potential legal pitfalls while positioning your business for long-term success.
