Why the Silicon Valley Bank Failure Is Bad News for Cannabis Stocks

Big banks are taking a closer look at who they lend money to in light of the Silicon Valley Bank crisis. And one thing that's already a big risk for them: getting involved with an illicit industry such as cannabis. Here's why the banking failure could hurt cannabis stocks.

Banks could further distance themselves from the industry

SVB Financial Group (OTC:SIVB.Q), the parent company of Silicon Valley Bank, is seeking bankruptcy protection. And a big reason things got so bad was the bank was willing to take on risk and help provide funding for start-ups and venture capitalists. In a rising-interest-rate environment, that can simply end up being too much risk to take on.

No bank wants to be the next SVB, and that means investors can expect financial institutions to exercise even more caution than before. That's not a good sign for the cannabis industry, where many companies already struggle to obtain banking services. While venture capital may be risky, cannabis companies in the U.S. operate in a risky and illegal industry. The banks that do business with cannabis have to file ongoing suspicious activity reports, and so it's an arduous process for the ones that already want to work with marijuana businesses. Giving banks an added incentive to avoid these types of companies could result in more of them shunning the illicit industry.

While no one expects the feds to come and shut down cannabis companies -- they've effectively allowed states to do what they want with respect to cannabis without formally stating that marijuana operations are OK -- the bigger issue is that due to a lack of federal legalization, there are hurdles such as not being able to transport pot across state lines that impact operations for cannabis producers. Although you might see marijuana companies post adjusted earnings profits, these are, for the most part, unprofitable businesses. Here's a look at how the top multi-state marijuana operators have done over the past few years:

CURLF Net Income (TTM) data by YCharts.

This is the type of industry banks may be more inclined to avoid if for no other reason than to alleviate any concerns investors may have about the risk they are taking on.

What does this mean for cannabis companies?

Cannabis companies already have difficulty finding banks to do business with. But now, if it's more difficult to do so, then that can result in additional expenses for companies, especially related to security, as they would need to hold more cash on their premises. A security system at a dispensary could cost just a few thousand dollars or as much as $250,000, depending on the complexity. And multi-state operators (MSOs) may need security systems at many locations. Trulieve Cannabis (OTC:TCNNF) and Curaleaf Holdings (OTC:CURLF), two of the largest MSOs in the country, have well over 300 locations combined.

Not only could costs go up, but this could also derail any potential the SAFE Banking Act had. The bill is designed to enable big banks to do business with the cannabis industry without fear of consequences from the federal government (since pot is illegal at the federal level). However, despite passing the House an incredible seven times, it never got voted on in the Senate. Even with Democrats controlling both the House and Senate, it has failed to come into law.

And now, with risk in the banking industry under the spotlight, it would be even more shocking for the bill to have any chance today. SAFE Banking was the one hope that the cannabis industry had that could at least make things easier for businesses, but even that looks like a long shot at this point. Meanwhile, overall, marijuana legalization could be years away from being a reality.

Other companies may also look to distance themselves from doing business with cannabis companies. Paychex, which provides payroll and human resources-related services to businesses, recently ceased offering services to cannabis companies. It noted in a memo that "Paychex has worked diligently to provide as many of our services as we can within the parameters established by our banking partners. Unfortunately, we can no longer provide you with some of the services you are currently receiving from Paychex."

The end result of this is that cannabis companies may end up having to be more self-sufficient, which can lead to greater inefficiencies and added costs, making profitability even more difficult to achieve.

Cannabis stocks could be riskier than ever

Cannabis stocks were always risky investments due to the federal ban on pot. But now, in light of the SVB failure, an even riskier era could be on the horizon for cannabis stocks, one where the prospects for any marijuana reform are dim. Unless you're comfortable holding onto these stocks for several years, you are better off avoiding pot stocks because conditions in the industry could very well be getting worse, not better.

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SVB Financial provides credit and banking services to The Motley Fool. David Jagielski has positions in Cresco Labs. The Motley Fool has positions in and recommends Cresco Labs, Green Thumb Industries, SVB Financial, and Trulieve Cannabis. The Motley Fool has a disclosure policy.