Over the last couple of years, the momentum in the marijuana industry has been virtually unstoppable. To our north, Canada has become the first industrialized country in the world to legalize recreational marijuana, opening the door to billions of dollars in added annual sales and, more importantly, providing validation to an industry that's been often touted as taboo by the business world.
To our south, Mexico legalized medical cannabis in 2017 and, following numerous Supreme Court rulings, is seriously considering moving forward with a recreational weed legalization plan.
In the U.S., two-thirds of all states have given the green light to medical pot in some capacity, with 10 of those states also allowing adult consumption. Further, two out of three Americans now favor legalizing marijuana, up from just a third of all Americans back in 2005, according to Gallup.
Things have been almost perfect for the legal cannabis industry...almost.
Marijuana's Schedule I classification is causing a host of problems
In the United States, which would easily be the world's largest market for cannabis on a nominal sales basis, marijuana remains a Schedule I drug at the federal level. In layman's terms, this means it's entirely illegal, prone to abuse, and not recognized as having any medical benefits based on its classification. Sure, the federal government has been relatively accommodative with state-level implementation, but this Schedule I status comes with a number of other negative impacts.
For instance, profitable cannabis-based businesses are subjected to Section 280E of the U.S. tax code. Implemented in 1982 to primarily stick it to cocaine and heroin drug dealers, it disallows businesses that sell a federally illicit substance from taking normal corporate business deductions, save for cost of goods sold. For pot companies, cost of goods sold tends to be a relatively small percentage of revenue, often leading to effective income tax rates that can approach 70% to 90%. In short, in makes hiring for and expanding a cannabis-based business very difficult.
Additionally, pot businesses in the U.S. have little or no access to basic banking services. Even though the Obama administration outlined a loose set of regulations that would allow banks to offer services such as loans and lines of credit to companies in the marijuana industry, the vast majority of banks have kept their distance. In some cases, this leaves cannabis companies entirely reliant on cash and unable to grow quickly due to financing issues.
On occasion, lawmakers have attempted to tackle marijuana banking reform but found an underwhelming reception from their colleagues. Sen. Cory Gardner (R-Colo.) has repeatedly tried attaching a marijuana banking reform amendment to a federal spending bill or criminal reform bill, only to either pull the amendment due to lack of support or have it outright excluded by Senate Majority Leader Mitch McConnell (R-Ky.). As a reminder, Republicans tend to have a less favorable view of cannabis than Democrats or Independents.
Cannabis banking reform legislation is (supposedly) on its way
However, the long string of failures in passing marijuana banking reform may soon come to an end. As reported by Politico on Monday, Feb. 4, the House Financial Services Committee was planning a hearing on cannabis banking reform that would, reportedly, be scheduled on Feb. 13. Note that Politico cited sources familiar with the matter, suggesting that nothing was officially set in stone as of yet.
Additionally, online publication Marijuana Moment reports that "preparations are now well under way for a full committee markup in the coming months on legislation to clear the way for cannabis businesses to gain access to banking services."
Should lawmakers pursue cannabis banking reform, it would be game changing for a number of reasons. First, with Democrats retaking the House for the first time in eight years and having much higher favorability for legalizing marijuana than Republicans, it would give their party a real opportunity to advance weed reform measures. It's unclear if a marijuana banking reform measure would have a chance to pass the Senate, with Mitch McConnell unsupportive of cannabis legalization, but it would nevertheless move banking reform legislation further along than ever before.
Secondly, it would be the first time that a cannabis banking reform measure was to be presented as a stand-alone bill rather than an amendment that was attached to a larger bill.
Third and finally, it could open the door to additional sources of revenue generation for U.S. banks while also providing ample nondilutive financing options for public and private cannabis businesses. This would, more than likely, help with order processing, business expansion, industry consolidation, and hiring.
This has big implications
We've already witnessed the possible implications of what opening the door to banks can do for this industry by looking north.
Although Canadian banks are still somewhat leery of lending to Canadian pot businesses, we have seen a few major convertible note financings, including a 600-million-Canadian-dollar offering by Canopy Growth (CGC -6.61%) in June. Understandably, Canopy Growth wound up netting itself an even bigger bounty in November when a $4 billion equity investment in the company from Constellation Brands was completed. But had this equity investment not come about, Canopy Growth's convertible note financing was going to serve as a means to expand internationally, diversify its product line into hemp, and help fund complementary acquisitions.
Check out the latest Canopy Growth earnings call transcript.
Something similar can be said of Aurora Cannabis (ACB -5.69%), which, last month, completed a CA$345 million senior convertible note offering due in 2024. Though convertible notes can be dilutive if converted, Aurora Cannabis' management team believes that it'll primarily be repaid with cash on hand, presumably from strong operating cash flow in due time. Since Aurora Cannabis still has plenty of work to do on the capacity-expansion front and has been an active acquirer since 2018 began, this injection of capital gives it even more breathing room to execute on its business strategy.
What happens next in the U.S. remains to be seen. But the pathway appears to be clear for banking reform measures to finally get the time of day from lawmakers on Capitol Hill.