In a policy notice effective April 3, the U.S. Small Business Administration (SBA) updated its standard operating procedures (SOP) to prohibit providing loans to both marijuana- and hemp- related businesses and businesses deriving any gross revenue from sales to marijuana related businesses (MRBs) including those providing lighting, hydroponic equipment or testing services (SBA policy notice).

Beyond failing to define what a hemp related business is and being nearly impossible to implement, the SBA Policy Notice will derail hundreds of cannabis-supporting- businesses and defeat the SBA's core objective of provide financing opportunitiesto those precluded from attaining mainstream financing including minorities and veterans.

What Is a Small Business Loan?

When seeking an SBA loan, the borrower is actually applying for a commercial loan structured pursuant to SBA requirements through an SBA-authorized lender. While not directly making the loan, the SBA provides a guarantee to the lending bank to repay a portion of the loan proceeds if the borrower defaults.

By alleviating risks associated with lending to those falling short of traditional loan underwriting criteria, SBA loans provide financing opportunities to thousands of entrepreneurs, startups, growing businesses, minorities and veterans incapable of attaining mainstream financing. In 2014, the SBA's flagship 7(a) loan program (the proceeds of which may be used for working capital, equipment purchases and refinance existing debt) approved 52,044 loans encompassing nearly $20 billion of loaned funds.

A 7(a) loan program subset, SBA express, is designed for financing needs of up to $350,000 and requires no collateral for loans up to $25,000.

Financing Woes

Few industries more greatly fail to satisfy “traditional lending criteria,” and more desperately need SBA loans, than legalized marijuana and industrial hemp.

First, because it is 100 percent violative of federal law, for “plant touching” MRBs obtaining a loan from a federally charted bank or credit union is almost impossible. Specifically, because the Comprehensive Drug Abuse Prevention and Control Act, 21 U.S.C. Sections 801, Et. Seq (1970) (CSA) prohibits “manufacture, distribution and dispensation” and any transfer or deposit of monies yielded from cannabis sale may be deemed “money laundering” in violation of the Currency and Foreign Transactions Reporting Act, 31 U.S.C. Section 5311-5330, most banks and credit unions refuse to provide marijuana growers, processors or dispensers with financial services.

Second, even if able to traverse the CSA obstacle, most MRBs and hemps concern lack sufficient assets to secure a loan. While all forms of security are subjective, like every other business a plant-touching MRBs worth can be best anchored by the value of its appraisable assets.

Liquid assets and cash flow are the easiest to value. How much cash does the MRB have in the bank and what other capitalization does it possess (e.g., investments, lines of credit, loans, etc.)?

If a grow or dispensary is operating—a leading valuation indicator is the MRBs “cash flow analysis”— i.e., an examination of its cash inflows and outflows during a specific period beginning with a starting balance and generating an ending balance after accounting for all cash receipts and expenses paid during the period.

However, because most plant-touching MRBs are not particularly cash rich, well funded, or capable of producing reliable historical cash flow information, liquidity is often lacking and any “cash flow analysis” will be based on “projected performance” rendering it more of an “estimation” than a “valuation.”

Ownership of real estate and hard, transferable production assets is also used to secure a loan to plant-touching MRB. For example, having the deed to, and equity in, real estate used to grow, process and sell marijuana both helps define and enhance an MRB's value. Beyond commercial real estate's sheer worth, any parcel that is “built out,” correctly zoned for, and capable of marijuana production and sales is distinctive, desirable and highly valued.

Another tangible asset is the value of the license based on the existing/estimated market. For example, Pennsylvania's Medical Marijuana Act authorizes 25 grow/processor—and 50 dispensary—licenses to serve its 12.8 million residents. Because estimates indicate that if only 1 percent of its population obtains medical marijuana cards Pennsylvania's market will yield between $100 and $150 million annually, each licensee may be presumably valued as a proportional fraction of this sum.

Further, as they may be grandfathered into, or receive most favored nations status regarding, adult use licensure, medical marijuana licenses may have a secondary or dormant value in developing markets.

Intellectual property ranging from branding, to ownership of a proprietary strain, to innovative cultivation or extraction methodologies also may secure an MRB's loan. For example, some dispensaries lock up exclusivity to sell celebrity strains like Marley Natural (promoting itself as the “official Bob Marley cannabis brand) or Charlotte's Web (reputed to being particularly successful in treating seizures).

Breakdown of SBA Policy Notice

The SBA policy notice amends “SOP 50 10 5(J), Lender and Development Company Loan Programs,” which became effective on Jan. 1, and provides that businesses engaged in any activity that is illegal under federal, state or local law are ineligible for SBA financial assistance.

The SBA policy notice provides that because the CSA prohibits marijuana's sale and distribution, financial transactions involving an MRB “would generally involve funds derived from illegal activity” and businesses deriving revenue from marijuana-related activities or that support marijuana's end-use” are also SBA financial assistance ineligible.

Specifically, the SOP policy notice provides that “business's specific operations” determines “SBA financial assistance eligibility” and deems “direct marijuana business,” “indirect marijuana business” and “hemp-related business” as ineligible.

Direct marijuana business is defined as a business growing, producing, processing, distributing, or selling the marijuana flower, products, edibles or derivatives, regardless of the amount of such activity, whether for personal or medical use, or whether business is legal under loan applicant's state or local law.

Indirect marijuana business is defined as one deriving any of its existing or projected gross revenue from sales to direct marijuana businesses of products or services that could reasonably be determined to support marijuana's “use, growth, enhancement or other development” including testing services, grow lights or hydroponic equipment.

Hemp-related business is defined as a grower, producer, processor, distributor or seller of products made from hemp unless loan applicant can demonstrate that “its business activities and products are legal under federal and state law.”

Further, although the SOP already bars leasing space to a tenant engaged in any activity violative of federal, state or local law, because SBA loan payments may be deemed as “derived from illegal activity” and thereby subjecting the loan collateral to seizure, the SBA policy notice prohibits a borrower from leasing space to a direct marijuana business, indirect marijuana business or hemp-related business during an SBA-guaranteed loan's life, Leasing Part of a Building Acquired with Loan Proceeds (13 CFR Section 120.131). Chapter 2, Paragraph V.F.1.g) (page 131).

SBA Policy Notice's Ruinous and Prejudicial Impact

Nearly impossible to implement and derailing to hundreds of indirect marijuana businesses, the SOP policy notice defeats the SBA's core objective to provide financing opportunities to those precluded from attaining mainstream financing.

First, although banning lending to hemp growers, processors or sellers unless the borrower can demonstrate the legality of its business and products, hemp is already 100 percent legal under Section 7606 of the Agricultural Act of 2014 (Farm Bill). Specifically, the Farm Bill defines “industrial hemp” as a variety of cannabis sativa L. containing less than 0.3 percent THC that is legal to cultivate, transport, process, sell and use. Section 7606 pre-empts both the CSA and Drug Enforcement Agency's authority and confirms that where the Farm Bill applies, it supersedes or overrides any conflict with the CSA, as in Hemp Industries Association v. Drug Enforcement Agency, Case No. 17-70162 (9th Circuit April 30).

In enacting the Farm Bill, Congress' intent was to confirm that industrial hemp, or cannabinoids derived from industrial hemp, are not to be treated as controlled substances, see amicus brief of members of U.S. Congress in support of petitioners with consent of all parties at 3, 26.

Contrary to how controlled substances are treated, the Farm Bill sought to specifically allow for many industrial hemp activities including product development, exploring hemp-derived cannabinoids products' economic impact, and creating a retail marketplace.

Further, not only does the CSA not prohibit the entire cannabis plant, it's “marihuana” definition only includes certain plant portions and excludes “industrial hemp” pursuant to the Farm Bill, and the exempted stalk, stem, fiber and nonviable seeds of the plant which are still lawful even if containing naturally occurring cannabinoids such as THC.

Second, hundreds of business presently providing goods and services to MRBs in robust legalized marijuana states will be decimated regardless of what portion of their enterprise supports cannabis.

For example, in states where marijuana is a substantial part of the economy like Colorado, Washington, California and Nevada, many otherwise legal businesses may now be SBA loan ineligible because they derive direct marijuana business revenue.

Thus, a garden supply company selling bagged dirt, hydroponic equipment, potting supplies, fertilizer, or grow lights primarily to garden and home centers and MRBs will get defrocked. Similarly, contractors, architects or engineers that help build a grow facility, or online marketing and website development services to market MRBs are now rendered financially distressed due to SBA loan ineligibility.

Beyond imperiling prospective and existing businesses, the SBA policy notice defeats SBA's core objective to provide financing opportunities to those precluded from attaining mainstream financing. Stated another way, because legalized marijuana programs seek to empower and provide licensure to minority- and veteran-owned enterprises (whom are also among those who may not meet traditional loan underwriting criteria), the SBA policy notice will impair those whom the SBA is tasked with assisting.

Steven Schain practices marijuana law through national cannabis law firm Hoban Law Group. With 14 offices and 42 lawyers, Hoban Law Group's practice is 100 percent devoted to cannabis and hemp law. Admitted to practice in Pennsylvania and New Jersey, Schain represents entities, governments and individuals in choosing a structure, preparing and submitting license application, regulation, compliance and litigation, and drafting legislation. Contact him at [email protected].