A small change in U.S. Small Business Administration rules could have a big impact on legal weed.
The agency has tightened its lending rules to prohibit banks from using SBA-backed loans to finance any business that has direct interaction with the marijuana industry.
The change was quietly published in a Policy Notice, which went into effect April 3, and is an interesting new approach to policing an industry that is now legal in the majority of U.S. states.
The use of medical marijuana is legal in 29 states while recreational use is legal in nine states. The cannabis industry is also becoming more economically significant — an Arcview Market Research report forecasts the legal marijuana industry will generate $24.5 billion in revenues by 2021.
SBA rules already precluded lending to any business directly involved in the industry — “a business that grows, produces, processes, distributes, or sells marijuana or marijuana products, edibles, or derivatives, regardless of the amount of such activity.
This applies to personal use and medical use even if the business is legal under local or state law.” Regulators have long recommended banks avoid providing any services to businesses directly involved in the trade, so this is nothing new.
“The stricter rules come as the Trump administration’s Justice Department seeks to make life hard for the marijuana trade even as public support for it grows. “
The new SBA rule goes much further, however. SBA now also precludes lending to any firm that is even indirectly doing business with a marijuana-related operation, significantly expanding the number of businesses no longer eligible for SBA-backed loans.
The rule defines such a business as one that “derived any of its gross revenue for the previous year (or, if a start-up, projects to derive any of its gross revenue for the next year) from sales to Direct Marijuana Businesses of products or services that could reasonably be determined to support the use, growth, enhancement or other development of marijuana.”
For most law-abiding citizens, that may seem like a very reasonable extension of the rule that prohibits offering SBA loans to a business involved in illegal trade, but it is significantly more difficult to follow in practice.
In a state like Colorado, where marijuana is a substantial part of the economy, many otherwise legal businesses may now be ineligible for SBA loans, because they derive some small part of their revenues from direct marijuana businesses.
It’s not just bong manufacturers
It may be obvious that a bong manufacturing business that caters directly to the trade should also be ineligible for government financing, but consider a garden supply company that sells bagged dirt, hydroponic equipment, potting supplies, fertilizer, or grow lights primarily to garden and home centers, but received even one purchase order from a local marijuana business. Is it now ineligible since its products could be used to help grow the product?
Similarly, consider companies like contractors, architects, or engineers that help build a grow facility, or online marketing and website development services that help market a retail marijuana business.
These businesses are providing a service that can be viewed as helping the marijuana business grow, and if their products and services are publicly available in a market that has legalized marijuana, it is very likely that they have some revenues that come from direct marijuana businesses.
This notice comes at a time when some private equity and individual investors have made bets on the so-called “picks and shovels” trade. This play involves investing in the suppliers to the industry as a way of gaining the benefit of the growth of legal weed while avoiding the risks associated with the fact that marijuana is still illegal on a national basis.
The SBA notice also bans lending to any business growing, producing, processing, distributing or selling hemp products unless the business can demonstrate that its business and products are legal under federal and state law.
The stricter rules come as the Trump administration’s Justice Department seeks to make life hard for the marijuana trade even as public support for it grows — a recent Gallup poll finds 64 percent of Americans favor federal legalization, including a majority of Republicans.
Banks offering SBA-backed loans will now have to require borrowers to attest that they are not engaging directly in the marijuana trade, and that they do not derive any revenue from the marijuana industry to be clearly eligible. But SBA recommends that banks also complete additional due diligence including website reviews to investigate how these firms market themselves and to review accounts receivable reports for red flags.
Architects, engineers and gardeners
With SBA-backed lending unavailable, businesses directly tied to the marijuana industry have always had to be inventive to get funds, relying on home equity lines of credit, personal credit cards, selling equity to friends and family, or by engaging with the few venture capital and investment funds that are working with the industry.
Under the new rules, even architects, engineers, and your local garden supply company may have to go to alternative sources to get their funding. Alternatively, they may have to turn away a ready source of revenues for providing an otherwise legal service or product to a willing buyer in order to comply and gain access to SBA financing.
It just got harder to comply with the new SBA regulations. Perhaps future guidance from SBA will soften the language to allow some de minimus amount of revenue to come from direct marijuana businesses without making an otherwise legal business ineligible. For now, business owners beware.
By: Mark Abell, senior vice president and SBA division director at NBH Bank (CNBC)