Managing Cash Flow Cycles

An old friend of mine is a successful Silicon Valley investor and venture capitalist. When I recently asked him what he expects of the companies he invests in, he was blunt: “Hire good people, and don’t run out of money. That’s all I ask.”

While running out of money seems like an obvious thing to avoid if you want to stay in business, it’s also one of the leading causes of business failure. For cannabis companies, running out of cash is an extremely dire situation because banks and other traditional lenders don’t offer short-term loans to companies dealing in Schedule I drugs.

Even for businesses that offer high-demand products, managing inventory, distribution, and invoices is an ongoing juggling act that can spell chaos for cash flow in cannabis. If the cash flow system fails and a company runs out of money, it can’t pay rent, utility bills, payroll…and the chief executive officer quickly moves from the catbird seat to the hot seat.

Going with the flow

As a legacy operator in California for fifteen years, Friendly Farms Chief Operating Officer Chaz Smith is an experienced cash-flow manager. With the company growing rapidly, managing money and business connections and hiring new staff are constant challenges, he said. Since the recreational market opened in 2017, Friendly Farms—a top-shelf extracts company specializing in live and cured resins—has churned through five distributors, in part because the distributors didn’t collect invoices from retailers on time. “It sucks when you push a million dollars of product out and you only get $400,000 back,” Smith said. “Retailers are good at paying if your product is valuable and they want to keep it on the shelves. They’re also good at paying if you have open communication with them.” In order to manage communication and invoices, Smith hired an internal accounts receivable team; he said the move made a big difference in maintaining steady cash flow.

In today’s market, as products make their way through the supply chain from distributors to retailers, only the most successful brands are able to negotiate cash-on-delivery payments. For others it’s a waiting game. In the early days of medicinal cannabis retailing on the West Coast, dispensary managers were notorious for rigging cash flow in their favor by waiting until products had been sold to pay the producer. Sometimes this meant weeks or months before cultivators saw even a penny for crops that took many months to grow and harvest. If the products didn’t sell—or the dispensary fell behind on its bills—producers and distributors heard excuses or “the check’s in the mail.”

Cash flow options

Bespoke Financial Chief Executive Officer George Mancheril is something of an expert on cannabis cash flow cycles. As one of the first licensed commercial lenders to work with cannabis companies in the U.S., Bespoke offers short-term lending options for businesses that want to grow or scale faster than their investment capital and cash flow might allow. Mancheril said invoice payments for Bespoke’s clients in 2019 ranged from 100 days to 110 days from the date of delivery. In 2021, that conversion time is closer to forty-five days to fifty days.

In a typical scenario, if a Bespoke client wants to borrow anywhere from $100,000 up to a few million dollars on a short-term deal, the lender will extend 75 percent to 100 percent of that amount to help the client cover day-to-day business costs until its distributor or retail client pays the invoice in full. The interest rate normally ranges from 3 percent to 4 percent, depending on the client’s credit rating and other variables.

“I think 90 percent of our borrowers right now are sitting with credit limits that are two or three times higher than they were initially approved for,” Mancheril said. “Once you go through underwriting and you start borrowing, we track your credit performance and we have ongoing surveillance. So, if you come to us in one to two quarters and say ‘my sales have doubled [and] I need more capital,’ it’s a very quick decision for us to say ‘yes, that makes sense.’”

Friendly Farms has been able to leverage a credit line from Bespoke to take advantage of unique business opportunities as well as scale its inventory and fast-track its business plans. Smith said his cash conversion window is forty days to fifty days, but because of his manufacturing process the actual return on investment might be as many as 100 days. “It may be fifty days from the time I sell our product to when I get paid, but it’s also another fifty days from the time I get product from a farm to when I have it in a package ready to sell. So when I spend $200,000 on farm-fresh frozen material, it’s about ninety days before I actually see the money come back on that cycle.”

Expanding the lender pool

Mancheril said he expects more lenders to offer similar services following passage of federal legislation (such as the proposed Secure and Fair Enforcement Banking Act) that protects lenders from prosecution, but Congress may take another three years to make such laws a reality. In the meantime, cannabis operators can only hope more lenders like Bespoke will be open to extending credit lines to companies that can check the right regulatory compliance boxes—licenses and bank accounts in order and a rock-solid, growing business with adults in charge.

“We got into this because we think it’s just a home run of an idea because you’re lending to an industry with strong fundamentals, great macro factors, and strong growth year over year,” Mancheril said. “So, it makes a lot of sense to us, and I expect it will make sense to other people too.”