An increasing number of states are legalizing marijuana use, either recreationally or for medical purposes. This has led to a burgeoning industry, including growing, manufacturing products, and selling those products to consumers. Construction companies are being asked to participate in these projects on a regular basis now – some businesses even cater exclusively to the industry. However, the nature of the business can make these projects more risky than traditional construction projects. Here’s what contractors need to understand before they jump into a cannabis construction project, to make sure they don’t walk away high and dry.
Cannabis construction can carry high risk of payment problems
It is important to mention that while more states are moving to legalize it, marijuana is still illegal under federal law.
This means projects in this industry are in a gray area – local laws permit the practice, but federal law prohibits it. As a result, protections afforded by the federal government, such as bank guarantees, do not apply in this industry.
As a result, funding comes from different sources than regular projects. Banks and federally backed financial institutions cannot provide funding, so locally run banks, credit unions, and private companies have stepped up.
While many of these organizations are stable, well-run businesses, some may be short-lived and have financial problems. This makes protecting your payment rights even more important than on regular jobs.
How project financing works in cannabis construction
When you’re considering a new construction job, whether in the cannabis industry or not, understanding the project’s financial status is critical. While it’s important to prequalify the general contractor, even the most honest and fair GC in the world can’t make payments on time if the property owner’s funding falls apart.
While legal in many states, marijuana is still classified as a schedule 1 substance under federal law. According to the US government, it’s in the same category as heroin, LSD and ecstasy.
Due to the legal nature of the product in question, most federally-insured banks and financial institutions will not get involved in these types of projects for fear of federal prosecution.
Many state credit unions and local banks are able to offer funding, along with private funding companies and investors. Some projects are financed through cash proceeds from the sale of products, leading to additional concerns.
Some projects are financed through the cash sales of products, meaning your customers may pay in cash. This could mean that contractors receive their payments, even large sums, in paper bills.
Payment is already slow in construction. Relying on paper processes for payment can delay the process even more. In addition, if you are working on such a project, you’ll need to institute some cash-handling protocols to ensure the safety of the funds.
Make sure that before you take on a cannabis project you ask for project funding information. If cash is the source, you’ll need to make sure you know where the cash is held and if there is enough on hand to complete the project. The safety and security of the storage site will also need to be discussed.
Crowdfunding is another popular source for funding these projects. Due to the nature of the business, campaigns are not listed on traditional sites. However, there are some specialty sites now set up for these types of investments.
It is important to ask specific questions about where the money is coming from, where it is being held, and how it will be dispersed. Request as much proof as the client is willing to give, to avoid problems getting paid.
One of the most popular funding options for cannabis projects is private funding companies. Some finance other types of projects, and others concentrate only on cannabis-related businesses. These companies focus on providing the funds for property purchase and development.
Because the funds are not backed by any regulatory body, these sources can be less reliable than federally insured banks. Even with a private $55 million loan, a cannabis project in Oakland, CA, allegedly missed $2.2 million in payments to contractors, and now faces mechanics lien claims on the property.
Controlling risk with title insurance
As with other cannabis project funding options, it is important to get as much information about the quantity and availability of funds as possible.
Socotra Capital is a private financing company in California that uses funds from retirement funds, employee investments, and other high-value clients to provide funding support for cannabis-related projects. They only finance project development, land purchase, and improvements. Once construction is complete borrowers find other funding sources for on-going costs and paying back their construction loans.
Matt Yu, Vice President of Socotra Capital, said that they use title insurance to protect their projects from liens. This insurance protects the property by covering any liens that are filed during the construction project. This can give construction businesses an added layer of payment protection.
Socotra relies on the borrower and general contractor to disperse the funds to the appropriate parties. They do check the general contractor’s background and financial standing and there are some checks on the borrower as well, such as financial statements.
Yu said Socotra only sees about one or two projects a year that go bad. When a project is not able to be finished, the finance company decides whether they will finish the project and sell it or sell it in its current state. The sale is used to recoup any funds lent on the transaction.
Reduce payment risk on cannabis construction projects
As far as lien rights go, cannabis projects are like any other construction project in the state they are located in. Contractors still have the statutory right to file a mechanics lien if the owner or funding company isn’t willing or able to pay. If the project has title insurance, that coverage will kick in and pay the amount owing to remove the lien.
Be sure to protect yourself by filing all the required notices to maintain your lien rights. States may require preliminary notices, or other documents to keep your lien rights on these projects. Make sure you meet all the deadlines and get your paperwork in order before the job starts.
If payment is slow in coming or there is a payment dispute, send an intent to lien notice and follow it up with a mechanics lien when necessary.
Asking your customer for proof of funding, and waiting to start work until that proof has been received, makes prudent business sense with these types of projects.
However, even with proof of funding, projects can still go south. So maintaining your payment rights is crucial in ensuring that you will be paid for the work you provide.