Commercial Factor Q&A: Joshua Reynolds Discusses Building Trust in Working Capital Financing for Cannabis Companies

The cannabis industry is one ripe with opportunities for working capital providers, including factors. In an exclusive Q&A, Joshua Reynolds, president of CapitalNow Cannabis, discusses the ins and outs of factoring in the cannabis industry in Canada as well as how things may evolve in the next few years, especially as legalization spreads more widely in other countries.  

How has the licensed cannabis market evolved in recent years in Canada and how did that lead to a need for working capital solutions for this industry?

Joshua Reynolds: The amount of personal cannabis consumption in Canada was greatly overestimated, and now there is a substantial oversupply of flower (cannabis biomass) in the market currently available. This has helped lower prices on a wholesale level but also created some difficulties in the sector. For example, M&As are happening weekly; C-suite turnover is occurring, with CFOs being the first on the chopping block; banks that had supported early teams have dropped their clients due to massive losses; private placements with aggressive dilution are a new bragging point; and EBITAs are a benchmark that are not showing the whole picture. 

The good news is, fluctuations in demand and retail prices have found a new level. The upstream supply chain, though it will take time to balance out, will eventually create predictability. New and exciting products are coming to market. In the end, consumer demand will dictate how fast the rest of the balancing out happens.

So, with the wild speculation, overconfidence and hyper-optimization all starting to subside, regularly accepted business practices like accounts receivable financing will help the industry become rational. Working capital is the lifeblood of these changes, and those who have it will weather whatever comes next.

What is your perspective on markets outside of Canada?

Reynolds: CapitalNow Cannabis has been solely focused on Canada, for now. The regulatory aspects and the very high barrier to entry make our process of verification and funding cleaner. We know exactly who we are doing business with at all times. The community, in general, has not liked the regulatory aspect of Canadian cannabis legalization, but from a financial side, it has been a benefit.

We feel strongly that when other countries around the world start to adopt legalization, we will be well-positioned to enter those markets with minimal bumps in the road. How and, let's be really honest, when America rolls out legalization will dictate if CapitalNow Cannabis enters the biggest market in the world.

Why might factoring be a particularly effective financing tool for cannabis producers/suppliers/distributors?

Reynolds: This question was the crux of our initial business model. We had to take the assuming and guessing right out; we committed to talking to everyone we could in the legal cannabis space. After spending over 18 months and hundreds of hours listening to these brave and pioneering entrepreneurs, a few things became evident.

Personal savings, friends and family, non-accredited and accredited investors have done the heavy lifting, thinking that schedule one banks would eventually treat everyone fairly and lend with reasonable terms and would take them the rest of the way. For the overwhelming majority, this did not happen! Yes, some did get forms of banking from a limited number of big banks and credit unions, or they managed to dilute themselves aggressively to attract big funds or went the PubCo way. Still, the bottom line is that the cannabis supply chain had nowhere to go.

What happened next was what we found most interesting. The cannabis community, though competitors, knew they couldn't go it alone and survive.  The joint ventures and royalty agreements between these parties created much-needed terms to get the product to market with minimal deposits, transitioning away from the historical "legacy" cash on-demand model of the past. This simple set of terms created an opportunity for factoring and us to help each client to know one another better.

What are some unique challenges a factoring company must deal with when working with a cannabis producer/supplier/distributor?

Reynolds: CapitalNow Cannabis adheres to The Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), "which is Canada's financial intelligence unit. Its mandate is to facilitate the detection, prevention and deterrence of money laundering and the financing of terrorist activities while ensuring the protection of personal information under its control." Canadian FINTRAC guidelines can be found here.

One aspect of these guidelines is the Know Your Customer Rule, "which essentially states that it is a requirement to know and keep records on the essential facts of each customer, as well as identify each person who has authority to act on the customer's behalf." 

We spend a lot of time understanding and verifying ownership structures, relationships within and the parties they are transacting with. Health Canada provides some information with the publication of each valid corporate license holder, but from there, we are on our own. CapitalNow Cannabis has gathered robust information over the last two years that connects the dots to efficient validation, verification and then funding. 

The real challenge for us was the acceptance by the community. Listening, being available when they are, providing complementary background information or introductions when asked, setting realistic expectations and having a deep purchasing fund all helped with acceptance. This is not a normalized business yet, and some of the "legacy" trust issues are still very real.

In March, the IFA accepted CapitalNow Cannabis as the first cannabis working capital company in its membership. What did this milestone mean for the company and what does it mean for the greater working capital industry around the cannabis industry?

Reynolds: We are very proud to be a member of the IFA. As exclusive cannabis and hemp working capital providers, acceptance was our indicator that we built out the right standards and team, signaling to our clients that we are here to stay and to support them in all business cycles. This industry is exciting on many levels. Technically, it is still in the startup phase, with the issuance of new licenses every Friday from Health Canada. It has and continues to have areas of rapid growth, and for some, turnaround needs are already a requirement. These companies and their needs rapidly evolve. 

What will membership mean for our clients? In a word, trust. The legal cannabis industry in Canada still suffers from many layers of trust issues, and we felt strongly that being admitted into the IFA would be a great bridge for the cannabis supply chain and CapitalNow Cannabis. Acknowledging and adhering to the IFA code of ethics will create a benchmark of expectations for our clients while seeking working capital.

How do you expect the demand for working capital solutions in the cannabis industry to change as the legalization of cannabis continues to spread, particularly in the U.S.?

Reynolds: Demand is and will continue to be strong. The money on the sidelines ready to get into this market is abundant; the need for solid solutions like factoring will always have a place in the legal cannabis business.

Terms generally run 15 to 90 days, invoice amounts range depending on the licensing and JV agreements, banking does not know how to securitize the product and the various business acumen levels of the clients make for a strong market for our services.

The Canadian and American markets will be very different. Our federal and provincial legal structures will have different nuances than the United States’ federal government and what each state will have. I would even go as far as to say that Canada is currently much more conservative in its approach to cannabis legalization than what the USA will eventually roll out.