All companies live and die by cash flow.
Companies that have managed to attract loyal customers and sell their products at a profit can still face collapse if the pace at which they collect cash does not out pace the outflows required to maintain their operations. When you are running a new company, you’ll often find that no one wants to give you credit and most of your customers will expect credit from you.
The result is that cash flows can become very stretched as you are forced to pay for your key supplies up front, while your customers may take months to pay you back for the goods and service you’ve provided. This challenge of cash flow management can be most acute for rapidly growing companies in emerging industries – and the cannabis industry is no exception.
Cannabis cultivators in Canada have already experienced severe cash flow challenges as the nebulous timing of Health Canada licensing forced companies to pay for their ongoing overheads without a clear timeline for when they could expect to collect cash from their first customers. Even when these companies first received their licenses, the gap between planting those first seeds or clones and getting paid by the end customers can be a very long road.
Growing a commercial cannabis crop for sale can take more than three months, while the provincial distributors who ultimately purchase the product, such as the Ontario Cannabis Store, may not send you the actual cash for your product for another two months. All the while, cultivators must make payroll, cover rent, keep the lights on, and start planting their next crop while incurring its associated and not insignificant growing costs. The result is that even if a cultivator is making a good margin on a high-quality product, there is a risk the company might not survive the cash crunch in between.
For cannabis companies facing this position, options can seem relatively limited as the capital market interest for equity in cannabis cultivators has cooled considerably and large commercial banks remain tepid about lending. Despite these challenges, options that cultivators facing this cash crunch can explore to provide short-term relief are invoice financing or invoice factoring.
The premise behind both concepts is relatively straightforward – cannabis companies that have provided a good or service to a (creditworthy) purchaser can receive an immediate cash injection from a financier in exchange for a chunk of the total invoice amount – an amount which will ultimately be paid to the financier when the customer pays the invoice. The amount of cash provided upfront as well as the size of the chunk the financier takes are based on several factors, however, a critical factor that is to the benefit of cannabis cultivators is the creditworthiness of the party that purchased the goods and services.
Financiers in these scenarios generally have a favourable approach when the customer is a government-owned entity or major corporation with a strong credit rating and established history. This means that cultivators who sell their product directly to provincial distributors or to established licensed producers are more likely to receive funding than if they had sold their product to another nascent company in the industry.
Invoice financing or factoring should definitely not be considered a long-term solution for cannabis companies looking to address their cash management challenges, as continually discounting the full value of their invoices will be detrimental in the long run. For emerging companies seeking short-term financial solutions however, doing this can be a very practical way to bridge the gap between the earliest growth stages and the establishment of a normalized cash cycle.
Any cannabis company considering this option should realize that relationships are critical in these types of financing arrangements, and that meeting with financiers who specialize in these services and telling them your story before you need the cash is an excellent way to expedite the process.