SHF Holdings, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. References in this section to “we,” “us,” “our,” “SHF” or the “Company” refer to SHF Holdings, Inc. References to “management” refer to our officers and board of managers. The following discussion and analysis of our financial performance and results of operations should be read in conjunction with our consolidated financial statements and the notes to those financial statements included elsewhere in this Form 10-K This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. See “Cautionary Note Regarding Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements. Overview Founded in 2015 by Partner Colorado Credit Union (“PCCU”) (please see “Business Reorganization” below for a description of SHF’s organization), SHF’s mission is to provide access to reliable and compliant financial services for the legal cannabis industry. Through that mission and as an early leader with over nine years of experience, SHF is a leading provider of access to reliable and compliance driven banking, lending and other financial services to financial institutions desiring to provide those services to the cannabis industry. Through our proprietary platform and on a multi-state level, SHF provides access to the following banking related services through PCCU and other financial institutions: ● Business checking and savings accounts; ● Cash management accounts; ● Savings and investment options; ● Commercial lending; ● Courier services (via third-party relationships); ● Remote deposit services; ● Automated Clearing House (ACH) payments and origination; and ● Wire payments. Our services allow Cannabis Related Businesses (herein referred to as “CRBs”) to obtain services from financial institutions that allow them to run their business more efficiently and effectively with improved financial insight into their business and access to resources to help them grow. Due to limited availability of payment and other banking solutions for the cannabis industry, most businesses transact with high volumes of cash. Our fintech platform benefits CRBs and financial institutions by providing CRBs with access to financial institutions and financial institutions access to increased deposits with the comfort of knowing that those deposits have been compliantly monitored and validated. By facilitating the daily deposits of cash receipts between CRBs and financial institutions, the risks associated with high cash on hand are mitigated, creating a safer atmosphere for the CRB’s employees and the financial institutions at which the deposit accounts are held. Because the Company is not a financial institution, it does not hold customer deposits. All deposit accounts are held by the Company’s financial institution clients and all transmissions of funds to and from deposit accounts are handled directly by the financial institutions. In an industry with limited capital and financing options, we offer access to loan options at what we believe to be competitive rates, often with less punitive terms than the current industry average. Our financial institution clients offer loan options including senior secured debt and operating lines of debt. Collateral types include real estate, equipment, and other business assets. We also provide access to lending options for ancillary service providers serving the cannabis industry as these businesses also can have difficulty finding reliable financial services. To ensure access to consistent and dependable banking access to CRBs, we provide our compliance, validation and monitoring services to financial institutions in a compliance driven environment ensuring strict adherence to the Bank Secrecy Act/FinCEN guidance and related anti money laundering provisions. Since inception, the Company has assisted in the processing of more than $22 billion in cannabis related funds. Through its relationship with its financial institution clients, the Company has successfully navigated 16 state and federal banking exams. 20 Table of Contents In strategically selected geographic areas, the Company has licensed its proprietary software and Safe Harbor Program (the “Program”) to other financial institutions to provide compliance-related services to CRBs. As part of the Program, we provide the following to financial institutions interested in licensing the Program to assist in compliant cannabis banking: ● Initial customer due diligence – Know Your Customer; ● Customer application management; ● Program management support; ● Compliance monitoring; and ● Regulatory exam assistance. Business Reorganization SHF was formed by PCCU following the approval of the contribution of certain assets and operating activities associated with operations from both certain branches and Safe Harbor Services, a wholly-owned subsidiary of PCCU, to SHF Holding, Co., LLC. SHF Holding, Co., LLC then contributed the same assets and related operations to SHF, with PCCU’s investment in SHF maintained at the SHF Holding, Co., LLC level. The reorganization effectively occurred July 1, 2021. In conjunction with the reorganization, all of the employees engaged in the operations and certain PCCU employees were terminated from PCCU and hired as SHF employees. The relevant operations of the PCCU branches, and SHF, represent the “Carved-Out Operations.” After the reorganization, the entirety of the Carved-Out Operations were owned by SHF and the Pre-Public Company was dissolved. In addition, effective July 1, 2021, SHF entered into an Account Servicing Agreement and Support Services Agreement with PCCU, which memorialized the operational relationship between SHF and PCCU and which were subsequently amended and restated and are discussed in Note 10 to the Consolidated Financial Statements included elsewhere in this Form 10-K. On February 11, 2022, SHF and SHF Holding Co., LLC, the sole member of SHF, and PCCU, the sole member of SHF Holding, Co., LLC, entered into a definitive Unit Purchase Agreement (herein referred to as the “Business Combination”) with Northern Lights Acquisition Corp. (“NLIT”), a special purpose acquisition company, and its sponsor, 5AK, LLC. Subsequent to the completion of the transaction, NLIT changed its name to “SHF Holdings, Inc.” (herein referred to as the “Company”). On September 19, 2022, the parties entered into the First Amendment to the Unit Purchase Agreement to extend the date by which the closing had to occur from August 31, 2022 until September 28, 2022 and provide for the deferral of $30 million of the $70 million in cash due at the closing. On September 22, 2022, the parties entered into the second amendment to the Unit Purchase Agreement to provide for the deferral of a total of $50 million of the $70 million due at the closing. On September 28, 2022, the parties entered into the third amendment to the Unit Purchase Agreement to provide for the deferral of a total of $56,949,800 of the $70,000,000 due at the closing. Pursuant to the Unit Purchase Agreement, upon the closing of the transaction, NLIT purchased all of the issued and outstanding membership interests of SHF in exchange for an aggregate of $185,000,000, consisting of (i) 11,386,139 shares of the entity’s Class A common stock with an aggregate value equal to $115,000,000 and (ii) $70,000,000 in cash. At transaction close, 1,831,683 shares of the Class A Common Stock were deposited with an escrow agent to be held in escrow for a period of 12 months following the closing date to satisfy potential indemnification claims of the parties. In addition, $3,143,388 in cash and cash equivalents representing the amount of cash on hand at July 31, 2021, less accrued but unpaid liabilities, were paid to PCCU at the final transaction close. The Company’s lending services program currently depends on PCCU as its largest funding source for new loans to CRBs. Under PCCU’s loan policy for loans to CRBs, PCCU’s board of directors has approved aggregate lending limits at the lessor of 1.3125 times PCCU’s net worth or 60% of total CRB deposits. Concentration limits for the deployment of loans are further categorized as (i) real estate secured, (ii) construction, (iii) unsecured and (iv) mixed collateral with each category limited to a percentage of PCCU’s net worth. In addition, loans to any one borrower or group of associated borrowers are limited by applicable National Credit Union Association regulations to the greater of $100,000 or 15% of PCCU’s net worth. On September 28, 2022, the parties consummated the Business Combination, resulting in NLIT, consistent with the aforementioned parameters, purchasing all of the issued and outstanding membership interests of SHF in exchange for an aggregate of $185,000,000, consisting of (i) 11,386,139 shares of the Company’s Class A Common Stock with an aggregate value equal to $115,000,000 and (ii) $70,000,000 in cash, $56,949,801 of which will be paid on a deferred basis. The purpose of the $56,949,800 deferral is to provide the Company with additional cash to support its post-closing activities. Pursuant to the third amendment to the Unit Purchase Agreement, the deferred consideration was to paid in one payment of $21,949,801 on or before December 15, 2022, and the $35,000,000 balance in six equal installments of $6,416,667, payable beginning on the first business day following April 1, 2023, and on the first business day of each of the following five fiscal quarters, for a total of $38,500,002, including interest of $3,500,002. Furthermore, PCCU agreed to defer $3,143,388, representing certain excess cash of SHF, LLC due to the Seller under the Definitive Unit Purchase Agreement, and the reimbursement of certain reimbursable expenses under the Definitive Unit Purchase Agreement. 21 Table of Contents Pursuant to the Unit Purchase Agreement, the Company entered into the Amended and Restated Support Services Agreement and the Amended and Restated Account Servicing Agreement under similar terms as the July 2021 agreements. In addition, in conjunction with the Unit Purchase Agreement, the Company and PCCU entered into a Loan Servicing Agreement. On March 29, 2023, the Company and PCCU entered into the Commercial Alliance Agreement that sets forth the terms and conditions of the lending-related and account-related services governing the relationship between the Company and PCCU and supersedes the Amended and Restated Support Services Agreement, the Amended and Restated Account Servicing Agreement, and the Loan Servicing Agreement. On October 26, 2022, the Company entered into a Forbearance Agreement (the “Forbearance Agreement”) with PCCU and Luminous Capital USA Inc. (“Luminous”). As per the terms of the agreement, PCCU has agreed to defer all payments owed pursuant to the Unit Purchase Agreement for a period of six (6) months from the date hereof while the Parties engage in good faith efforts to renegotiate the payment terms applicable to the Deferred Obligation (the “Forbearance Period”). On March 29, 2023, the Company and PCCU entered into a definitive transaction to settle and restructure the deferred obligations, including $56,949,800 into a five-year Senior Secured Promissory Note (the “Note”) in the principal amount of $14,500,000 bearing interest at the rate of 4.25%; a Security Agreement pursuant to which the Company has granted, as collateral for the Note, a first priority security interest in substantially all of the assets of the Company; and a Securities Issuance Agreement, pursuant to which the Company has issued 11,200,000 shares of the Company’s Class A Common Stock to PCCU. Purchase Agreement and Public Company Costs The Business Combination detailed above was accounted for as a reverse recapitalization, with no goodwill or other intangible assets recorded, in accordance with GAAP. Under this method of accounting, NLIT was treated as the acquired company for financial reporting purposes. Accordingly, for accounting purposes, the Business Combination is treated as the equivalent of SHF issuing shares for the net assets of NLIT, accompanied by a recapitalization. The net assets of NLIT are recognized at fair value (which is expected to be consistent with carrying value), with no goodwill or other intangible assets recorded. Other related events in connection with the Business Combination are summarized below: ● The 2,875,000 of Class B Common Stock converted at the closing to an equal number of shares of Class A Common stock. ● Upon closing of the Business Combination, 11,386,139 shares of Class A Common Stock were issued to PCCU as set forth in and pursuant to the terms of the Purchase Agreement. PCCU was due to receive a cash payment of $3.1 million at the consummation of the Business Combination, which represented the amount of SHF’s cash on hand at July 31, 2021, less accrued but unpaid liabilities. In addition, pursuant to the terms of the Purchase Agreement, the Company is responsible for reimbursing the Seller for its transaction expenses. ● Approximately $56.9 million of the $70 million of cash proceeds due to PCCU was deferred and is due to the Seller. Approximately $21.9 million of the amount was due to PCCU beginning December 15, 2022. The residual $35 million is due in six quarterly installments of $6.4 million thereafter. Interest accrues at an effective annual rate of approximately 4.71%. A sum of 1,200,000 shares of Class A Common Stock were escrowed until the amount is paid in full. ● The Parent-Entity Net Investment appearing in the balance sheet of the Company amounting to $9,124,297 on the date of business combination was transferred to additional paid in capital. ● Immediately prior to the Closing, 20,450 shares of Series A Convertible Preferred were purchased by the PIPE Investors pursuant to the PIPE Securities Purchase Agreements for an aggregate value of $20,450,000. The shares of Series A Convertible Preferred were converted into 2,045,000 shares of Class A Common Stock at a purchase price of $10.00 per share of Class A Common Stock. Twenty (20) percent of the aggregate value was deposited into a third party escrow account for purposes of paying the PIPE Investors any required Registration Delay Payments. Upon the filing of the registration statement 10 calendar days subsequent to closing, 17.5% of the escrow amount was released with the remaining amount once all securities were included in an effective registration statement. ● For tax purposes, the transaction is treated as a taxable asset acquisition, resulting in an estimated tax basis Goodwill balance of $43,198,800, creating a deferred tax asset reported as Additional Paid-in Capital in the equity section of the balance sheet as of the date of the business combination. There is not any goodwill for book reporting purposes as no goodwill or other intangible assets are to be recorded in accordance with GAAP. ● Preferred Stock: The Company is authorized to issue 1,250,000 preferred shares with a par value of $0.0001 per share with such designation rights and preferences as may be determined from time to time by the Company’s Board of Directors. As of December 31, 2023, there were 1101 preferred shares issued or outstanding and 14,616 preferred shares issued or outstanding on December 31, 2022. 22 Table of Contents ● Class A Common Stock: The Company is authorized to issue up to 130,000,000 shares of Class A Common Stock with a par value of $0.0001 per share. Holders of the Company’s Class A Common Stock are entitled to one vote for each share. As of December 31, 2023, and December 31, 2022, there were 54,563,371 and 20,815,912 shares, respectively, of Class A Common Stock issued or outstanding. As of December 31, 2023, and December 31, 2022, 3,667,377 Class A Common Stock are held by the purchasers under the Forward Purchase Agreement dated June 16, 2022, by and among the Company and such purchasers. ● Parent-Entity Net Investment: Parent-Entity Net Investment balance in the consolidated balance sheets represents PCCU’s historical net investment in the Carved-Out Operations. For purposes of these consolidated financial statements, investing requirements have been summarized as “Parent-Entity Net Investment” and represent equity as no cash settlement with PCCU is required. No separate equity accounts are maintained for SHS, SHF or the Branches. Key Metrics In addition to the measures presented in our consolidated financial statements, our management regularly monitors certain measures in the operation of our business. These key metrics are discussed below. Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) and Adjusted EBITDA To provide investors with additional information regarding our financial results, we have disclosed EBITDA and Adjusted EBITDA, both of which are non-GAAP financial measures that we calculate as net income before taxes and depreciation and amortization expense in the case of EBITDA and further adjusted to exclude non-cash, unusual and/or infrequent costs in the case of Adjusted EBITDA. Below we have provided a reconciliation of net income (the most directly comparable GAAP financial measure) to EBITDA and from EBITDA to Adjusted EBITDA. We present EBITDA and Adjusted EBITDA because these metrics are a key measure used by our management to evaluate our operating performance, generate future operating plans, and make strategic decisions regarding the allocation of investment capacity. Accordingly, we believe that EBITDA and Adjusted EBITDA provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management. EBITDA and Adjusted EBITDA have limitations as an analytical tool, and it should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are as follows: ● although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and both EBITDA and Adjusted EBITDA do not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; ● EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs; and ● EBITDA and Adjusted EBITDA do not reflect tax payments that may represent a reduction in cash available to us. Because of these limitations, you should consider EBITDA and Adjusted EBITDA alongside other financial performance measures, including net loss and our other GAAP results. A reconciliation of net income to non-GAAP EBITDA and Adjusted EBITDA is as follows: Year Ended December 31, 2023 2022 Net loss $ (17,279,847 ) $ (35,128,083 ) Interest expense 1,113,466 705,204 Depreciation and amortization 1,373,707 189,275 Taxes (1,829,701 ) (9,252,893 ) EBITDA (16,622,375 ) (43,486,497 ) Other adjustments – Provision for credit losses 290,857 506,212 Change in the fair value of warrants and forward purchase derivatives 1,853,920 8,058,091 Change in fair value of Forward Purchase Agreement - 33,322,248 Change in the fair value of deferred consideration (4,570,157 ) 97,593 Deferred loan origination fees and costs 27,271 (1,890 ) Stock based compensation 3,739,156 2,806,336 Goodwill and long-lived intangible assets impairment 18,907,739 - Adjusted EBITDA $ 3,626,411 $ 1,302,093 23 Table of Contents The increase in our income on both an EBITDA and Adjusted EBITDA basis for the fiscal year ending December 31, 2023, can be attributed to several key factors. These include a rise in deposits and activity income, which was significantly influenced by the growth in account numbers following the Abaca acquisition. Additionally, there was an increase in employee benefits and general and administrative expenses, coupled with a decrease in professional expenses, as detailed in the ‘Discussion of our Results of Operations’ section below. Other adjustments include estimated future credit losses not yet realized, including amounts indemnified to PCCU for loans funded by them, change in the fair value of warrants and forward purchase derivates, Change in fair value of Forward Purchase Agreement, Stock based compensation and Goodwill and long-lived intangible assets impairment. The Company had entered into a Loan Servicing Agreement with PCCU, pursuant to which the Company agreed to indemnify PCCU for claims associated with CRB activities including any loan default related losses for loans funded by PCCU; the Loan Servicing Agreement has since been superseded by the Commercial Alliance Agreement. Deferred loan origination fees and costs represent the change in net deferred loan origination fees and costs. When included with a new loan origination, we receive an upfront loan origination fee in conjunction with new loans funded by our financial institution partners and incur costs associated with originating a specific loan. For accounting purposes, the cash received for loan origination fees and costs is initially deferred and recognized as interest income utilizing the interest method. Other Metrics For our business operations, we monitor the following key metrics. Total account balances, number of accounts and average account balances Our lending capacity is dependent on the size of our managed deposit base and number of active accounts. In addition, fees are generated based on open accounts and account activity. We monitor account activity including deposits, withdrawals and ending account balance daily. Total account balances represent the balance of onboarded and monitored deposits on hand at financial institution clients at period end. Average account balance represents the total account balance divided by the number of accounts at the period end. Account fees per average active accounts managed Currently a significant amount of our fees is generated from account openings, active accounts and account activity. As a result, we monitor account openings and closings on a daily, weekly and monthly basis. We strive to meet the appropriate balance between depository balances and fees and therefore review account fees per average number of active accounts managed. Year Ended December 31, 2023 2022 Change ($) Change (%) Average monthly ending deposit balance (1) $ 204,923,090 208,155,596 (3,232,506 ) (1.55 )% Account fees (2) $ 7,735,582 5,951,337 1,784,245 29.98 % Average active accounts (3) 932 967 (35 ) (3.62 )% Average account balance (4) $ 219,835 215,259 4,576 2.13 % Average fees per account (4) $ 8,298 6,154 2,144 34.84 % (1) Represents the average of monthly ending account balances (2) Reported account activity fee revenue (3) Represents the average of monthly ending active accounts (4) Refer to the below section – Discussion of Results of our Operations for additional discussion of trends. For the year ending December 31, 2023, there was a decline in the average number of accounts compared to the previous year, primarily due to a decrease in clientele following the termination of an agreement with the Central Bank. Despite this, the average size and fees associated with accounts saw an increase, largely attributed to the acquisition of Abaca. We anticipate this pattern to persist as our lending program, which generally necessitates borrowers to make deposits at our affiliated financial institutions, remains a key focus. We are focused on enhancing and growing our lending platform. Incremental lending key metrics will be monitored as this portion of our business grows in volume. Metrics will include average loan balance, average life to repayment, average effective interest rate and loan status, amongst others. Components of our Results of Operations Revenue The Company generates interest and fee income through providing a variety of services to PCCU and other financial institutions to facilitate its banking services to CRBs including, among other things, Bank Secrecy Act and other regulatory compliance and reporting, onboarding, responding to account inquiries, responding to customer service inquiries relating to CRB deposit accounts held at financial institution clients, and sourcing and originating loans. In addition, the Company provides these similar services and outsourced support to other financial institutions providing banking to the cannabis industry. These services are provided under the Safe Harbor Master Program Agreement. Operating expenses Operating expenses consist of compensation and benefits, professional services, rent expense, parent allocations, provisions for credit losses and other general and administrative expenses. 24 Table of Contents Compensation and benefits consist of employee wages and associated benefits while professional services consist of legal, general consulting and accounting fees. The Company reports a provision for credit losses both as it relates to loans funded internally and those carried by PCCU or other financial institutions. The Company indemnifies PCCU and other financial institutions for the losses on loans to borrowers sourced by the Company and funded by PCCU and other financial institutions. The Company anticipates comparable arrangements with other financial institutions that fund loans to borrowers sourced by the Company. Other general and administrative expenses consist of various miscellaneous items including account hosting fees, insurance expense, advertising and marketing, travel meals and entertainment and other office and operating expense. Discussion of our Results of Operations —2023 Compared to 2022 (Year Ended December 31) Revenue Year Ended December 31, 2023 2022 Change ($) Change (%) Deposit, activity, onboarding income $ 8,614,945 $ 6,063,939 $ 2,551,006 42.07 % Safe Harbor Program income 130,688 164,062 (33,374 ) (20.34 )% Investment income 5,844,836 2,120,640 3,724,196 175.62 % Loan interest income 2,972,434 1,130,178 1,842,256 163.01 % Total Revenue $ 17,562,903 $ 9,478,819 $ 8,084,084 85.29 % Account fee income consists of deposit account fees, activity fees and onboarding income. Historically, the Company has charged fees based on cannabis related deposit account activity. During 2023, we reduced our fee percentage for cannabis specific accounts in order to ensure we were competitive with the market and for many accounts implemented a flat fee structure for certain CRB accounts based on client specific activity levels. In addition, we receive a flat fee and lower rates for ancillary accounts, which are accounts provided to businesses servicing the cannabis industry in general but do not manufacture, possess, distribute or transport cannabis. The increase in deposit, activity and onboarding income was primarily attributable to the increase in the number of accounts related to the Abaca acquisition. In 2023, PCCU accounted for $5,150,397 of the revenue generated from deposits, activities, and client onboarding. Related to this revenue, the Company recognized $529,209 in account hosting expenses, in accordance with the Loan Servicing Agreement and the Commercial Alliance Agreement. In 2022, PCCU contributed $5,554,922 to the revenue from similar sources, with account hosting expenses amounting to $255,853 as per the Loan Servicing Agreement provisions. These expenses were categorized under “General and administrative expenses” in the Consolidated Statements of Operations. The Company provides similar account services and outsourced support to other financial institutions providing banking to the cannabis industry. These services are provided under the Safe Harbor Master Program Agreement. Revenue has decreased as we narrow the financial institutions and states we allow under this program and instead focus on servicing CRBs directly. The reduction in Safe Harbor Program income is a result of the reduction in the number of accounts. We have agreements with PCCU (related party) and Five Star Bank (FSB) where our financial institution clients pay us interest on the daily account balance as per the rates in the agreements. In fiscal 2022 and up to the third quarter of 2023, our investment earnings were solely from interest on deposits at the Federal Reserve Bank, capped at the earnings accrued by PCCU from its reserves. However, a strategic shift in the fourth quarter of 2023 led us to adopt Federal Reserve’s interest rates applied to the daily average balance of SHF customer deposits, with certain exclusions. This method, applied retroactively from the beginning of 2023, resulted in incremental revenue of $549,000 recognized in the fourth quarter. Under our Commercial Alliance Agreement, we pay 25% of the investment income as a hosting fee to PCCU based on this income. In 2023, the income derived from investment income associated with PCCU totaled $5,803,114. In relation to this income, the Company incurred $1,445,517 in investment hosting fees, consistent with the stipulations of the Loan Servicing Agreement and the Commercial Alliance Agreement. In 2022, PCCU’s contribution to investment income amounted to $2,110,572, against which the Company recorded investment hosting fees of $519,406, as governed by the terms of the Loan Servicing Agreement. These expenses were categorized under “General and administrative expenses” in the Consolidated Statements of Operations. We had a Loan Servicing Agreement with PCCU (related party) where our financial institution carries the loan balances on their financial statement; the Loan Servicing Agreement has since been superseded by the Commercial Alliance Agreement. The loan interest income reflects our share of loan interest on issued loans. We are obligated to pay 0.35% on the total outstanding principal of each loan that is funded and serviced by PCCU. Loan interest earned on the Company’s direct loans and the indemnified loans grew as the Company increased its focus on lending. For the year ended December 31, 2023, SHF serviced 22 loans, as compared to 11 loans in the year ended December 31, 2022. In 2023, the Company recognized $2,883,192 in loan interest income attributable to PCCU activities. Related expenses for this income included $81,577 in loan servicing fees, in compliance with both the Loan Servicing Agreement and the Commercial Alliance Agreement. In the preceding year, 2022, loan interest income from PCCU operations amounted to $989,642, with associated loan servicing fees totaling $26,088, pursuant to the same agreements. These expenses were categorized under “General and administrative expenses” in the Consolidated Statements of Operations. 25 Table of Contents Operating expenses Year Ended December 31, 2023 2022 Change ($) Change (%) Compensation and employee benefits $ 10,334,212 $ 6,695,319 $ 3,638,893 55.35 % General and administrative expenses 6,568,662 2,390,539 4,178,123 174.78 % Impairment of goodwill 13,208,276 - 13,208,276 100.00 % Impairment of long-lived intangible assets 5,699,463 - 5,699,463 100.00 % Professional services 1,858,137 1,985,343 (127,206 ) (6.41 )% Rent expense 315,615 99,246 216,369 218.01 % Provision for loan losses 290,857 506,212 (215,355 ) (42.54 )% Total Operating Expenses $ 38,275,222 $ 11,676,659 $ 26,598,563 227.79 % Compensation and employee benefits expenses rose due to an increase in stock-based compensation and a higher headcount, in anticipation of business expansion. General and administrative expenses increased across various categories including: i) $926,111 in investment hosting fees as a result of the increase in investment income, ii) $715,771 in increased bank sharing fees due to the increase in the number of accounts related to the Abaca acquisition, iii) $1,184,432 in amortization and depreciation, and iv) $343,187 in business insurance. Professional services expense reduced primarily due to the reduction in the legal fees and consulting fees associated with acquisition and SEC filing. Impairment of goodwill and finite-lived intangible assets arose from the annual impairment assessment conducted on December 31, 2023, and an interim impairment assessment on June 30, 2023, triggered by the termination of the Master Services and Revenue Sharing Agreement with the Central Bank. Under this agreement, the Company offered expertise and intellectual property to cannabis-related businesses primarily in Arkansas. Provision for credit losses has decreased due to the adoption of ASU 2016-13 as of January 1, 2023, utilizing the modified retrospective method. Financial Condition Cash and cash equivalents Cash, cash equivalents totaled $4,888,769 and $8,390,195 as of December 31, 2023 and 2022, respectively. Cash flows For the year ended December 31, 2023, the Company’s cash used in operations was $832,144 compared to cash provided by operations of $1,697,380, for the year ended December 31, 2022. This was mainly due to increase in the operating expenses and payments of the liabilities pertaining to the reverse acquisition along with an additional amount resulting from changes in working capital. See discussion under “Discussion of our Results of Operations” above for more information. Contract assets and liabilities Deferred revenue is primarily related to contract liabilities associated with the Company agreements. As of December 31, 2023, SHF reported a contract asset and liability of $0 and $21,922 respectively and on December 31, 2022, SHF reported a contract asset and liability of $21,170 and $996, respectively. Liquidity and going concern Liquidity refers to our capacity to fulfill anticipated cash demands, encompassing obligations to settle debt, sustain assets and operations, distribute earnings to shareholders, and cover other typical business expenditures. Our cash outflows predominantly settle towards repaying debt principal and interest, distributing dividends to shareholders, and financing our operational activities. The main contributors to our liquidity are the cash inflows from our operational performance. As of the end of the fiscal year on December 31, 2023, the Company reports no significant commitments to capital investments. As of December 31, 2023, the Company had $4,888,769 cash and net working capital deficit of $135,355. The Company has also incurred an operating loss of $20,712,319 for the year ended December 31, 2023, and cash flows used in operating activities of $832,144. Based upon these factors, management of the Company has determined that there is a risk of substantial doubt about the Company’s ability to continue as a going concern for a period of at least twelve months from the date these consolidated financial statements have been issued. If the Company is not able to sustain its present level of operations, it may be forced to make reductions in spending, extend payment terms with suppliers, liquidate assets where possible, or suspend or curtail planned expansion programs. Any of these actions could materially harm the Company’s business, results of operations and future prospects. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business, and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or amounts and classification of liabilities that may result should the Company not continue as a going concern as a result of this uncertainty. 26 Table of Contents Critical Accounting Estimates Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, as well as disclosure of contingent assets and liabilities. An appreciation of our critical accounting policies is necessary to understand our financial results. In some cases, we could reasonably use different accounting policies and estimates, and changes in our estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates, and our financial condition or results of operations could be affected. We base our estimates on our experience and other assumptions that we believe are reasonable, and we evaluate these estimates on an ongoing basis. We refer to the following accounting estimates as critical accounting estimates, based on their importance to the financial reporting and potential for changes in future periods: Revenue recognition The company records revenue when it meets its service obligations, which include various fees charged for financial services such as account maintenance and transaction fees, along with other miscellaneous fees. When determining transaction prices, the company considers potential variations in these fees, which may fluctuate based on customer usage and specific contract terms. This is in line with ASC 606 standards, which require the allocation of transaction prices to the specific services provided within a contract, such as setup and ongoing fees for certain programs. The company also earns revenue from interest on loans, which includes those directly issued and those backed by a partnership with PCCU under a commercial alliance agreement. Investment income consist of interest earned on the daily deposits balance with financial institution. A strategic change in the fourth quarter of 2023 saw the company adopt a new method for calculating interest on customer deposit balances, excluding certain amounts. This new approach, applied retroactively to the start of 2023, led to an additional $549,000 in revenue for that quarter. The company’s customer base mainly consists of financial institutions that serve cannabis-related businesses (CRBs), with revenue primarily generated in the United States. Under the terms of its Commercial Alliance Agreement with PCCU, the company is obligated to pay PCCU various fees, including a loan servicing fee of 0.35% of the current loan balance, and monthly service fees based on account balances, with rates varying for balances below and above $1 million. Additionally, the company must pass on 25% of its investment hosting fees to PCCU, which are calculated from the returns on PCCU-related deposits. Indemnity liability The indemnification component of the Loan Servicing Agreement is accounted for in accordance with ASC 460 Guarantees, which follows guidance in ASC 326 - Financial Instruments - Credit Losses (ASC Topic 326), for estimating expected credit losses under the current expected credit loss (“CECL”) methodology, presented in the liabilities section in the consolidated balance sheets as an “Indemnity liability”. The Company accounts for the indemnification component of the Commercial Alliance Agreement for claims related to cannabis-related businesses, with a particular emphasis on default-related credit losses. The Company’s indemnity is secondary to other recovery methods like foreclosure or guarantor recourse. Indemnity payments don’t absolve borrowers of their obligations, maintaining PCCU’s rights to recoveries. The indemnification is considered a general loss contingency under ASC 460 due to uncertainties that could lead to losses, resolved by future events. The Company’s liability for indemnity is based on management’s estimation of probable credit losses at the balance sheet date, influenced by individual loan risk ratings and economic assumptions in the estimation model. These risk ratings are re-evaluated quarterly. The indemnity liability for the pooled component is derived from an estimate of expected credit losses primarily using an expected loss methodology that incorporates risk parameters such as probability of default (“PD”) and loss given default (“LGD”) which are derived from internally developed model estimation approaches for smaller homogenous loans. The PD is quantified by analyzing historical data to determine the rate at which loans have defaulted within the portfolio, relative to the total outstanding loans as of the end of the reporting period. This rate is expressed as a percentage and serves as a key indicator of the likelihood of default across the loan pool. LGD assessments are conducted to estimate the potential loss amount in the event of a default, considering the recoverable value from the collateral liquidation against the remaining loan balance. This involves a detailed analysis of two primary components: the loss on principal, which arises from the gap between the collateral’s liquidation value and the unpaid principal balance of the loan; and the loss associated with various ancillary costs to recover, including, but not limited to, foregone interest, transaction costs, legal and administrative fees, and expenses related to the maintenance and renovation of the property. Changes in the PD and LGD directly affect the estimated indemnity liability. An increase in PD, indicating a higher likelihood of defaults, necessitates a larger indemnity liability to cover potential losses, impacting the company’s financial reserves. Conversely, a decrease in PD would lower the required indemnity liability, reflecting a more favorable risk outlook. Similarly, a rise in LGD, due to reduced collateral values or higher recovery costs, increases the estimated loss per default, requiring a higher indemnity liability. Conversely, a reduction in LGD suggests more loss recoveries, allowing for a decrease in the indemnity liability. Stock-based compensation In conjunction with the 2022 Plan, as of December 31, 2023, the Company had granted stock options and restricted stock units which are described in more detail below: Stock options The Company awards stock options to incentivize employee ownership and performance, applying ASC 718 for equity-based payments. Options, with a 10-year term with their fair value determined at the grant date, considering either market price or the Black-Scholes model. This model factors in expected option term, stock price volatility (set at 100% due to significant price fluctuations since listing), risk-free interest rates (aligned with U.S. Treasury rates), and an assumed zero dividend yield, given the Company’s history of not paying dividends. The expected option term is derived using the simplified method, averaging the contractual term and vesting period. Compensation cost is recognized over the service period on a straight-line basis, with immediate recognition of forfeitures. Changes in valuation assumptions could significantly alter fair value estimates. 27 Table of Contents Restricted Stock Units / Restricted Stock Awards The Company values equity-based payments under ASC 718, using fair value at grant date for stock awards, recognizing expenses over the service period. Fair value is estimated via the market price or Black-Scholes model, considering variables like expected term, stock volatility, risk-free rates, and forfeiture rates. Given the stock’s limited listing period and significant price drop, volatility is presumed at 100%. Risk-free rates align with U.S. Treasury rates matching the awards’ lifespans. The options’ expected term merges the contractual and vesting durations. The Company assumes zero dividend, reflecting the Company’s history and future dividend outlook, impacting the valuation of stock-based compensation. Changes in valuation assumptions could significantly alter fair value estimates. Forward Purchase Agreement The Company, under a Forward Purchase Agreement (FPA) with Midtown East, which was later reassigned to Verdun and Vellar, involved complex transactions around Class A common stock. Initially, about 3.8 million shares were acquired from the market. Post-business combination, the Company disbursed $39.6 million for these shares and associated costs. The FPA allows for an early termination sale of shares by the assignees, with proceeds above the reset price going to them and the rest to the Company. The final settlement at the Maturity Date includes a cash or share payment based on the Forward Price and a Maturity Cash Consideration. In 2022, the reset price adjustment, influenced by the common stock’s trading value and preferred share conversions, significantly reduced the FPA receivable from $37.9 million to $4.6 million. No further transactions or value changes were noted in the year end December 31, 2023, maintaining the FPA receivable’s value. The value of the forward purchase agreement could diminish if the Company issues any securities at a price below the reset price of $1.25 per share before the agreement expires. Forward Purchase Derivative The Company records the forward purchase derivative from a business combination as per ASC 815, marking it as an asset or liability at fair value, adjusted each reporting period. Fair value adjustments are recognized in the consolidated statement of operations. The Monte-Carlo Simulation, applying Geometric Brownian Motion for stock price projections, was utilized for valuation in the year ended December 31, 2022. In 2022, the company fully accounted for the maximum contractual liability. Throughout 2023, there were no notable shifts in risk factors that would impact the values of FPA derivatives. As a result, the valuation established on December 31, 2022, was maintained for the year ended December 31, 2023. Impairment of Goodwill and Finite-lived intangible assets On November 15, 2022, the company finalized a significant acquisition for $30 million, resulting in the recognition of $19,266,276 in goodwill and $10,800,000 in amortizable intangible assets, which included market-related intangible assets valued at $2,100,000, customer relationships at $2,000,000, and developed technology at $6,700,000. According to ASC 350 and 360, the company is required to perform impairment assessments annually or more frequently if needed. An interim assessment conducted on June 30 utilized a hybrid approach, dividing emphasis between the income approach (one-third) and the market approach (two-thirds) for evaluating goodwill’s fair value. Additionally, specific methods were applied to the intangibles: the Royalty Method for market-related intangibles, the Discounted Cash Flow Method for customer relationships, and the Cost to Re-create Method for developed technologies. This interim evaluation led to a goodwill impairment of $13.2 million, a $1,865,668 impairment for market-related intangible assets, and a $1,814,795 impairment for customer relationships. The annual assessment on December 31, 2023, also adopted the hybrid approach for goodwill valuation and applied the Relief from Royalty Method for market-related intangibles and developed technologies, along with the Multi-Period Excess Earnings Method for customer relationships, resulting in a $2,019,000 impairment for developed technologies. The impairment determination process is inherently subjective, heavily reliant on assumptions about future conditions and events that might affect asset values. For impairment testing under ASC 350 and ASC 360 regarding goodwill and other intangibles, critical assumptions include future cash flow projections, appropriate discount rate determination reflective of asset-specific risks, the estimated useful lives of intangible assets, and customer attrition rates for assets tied to customer relationships. These assumptions are affected by wider market and economic factors, including interest rate fluctuations, inflation, and sector-specific developments. Due to these variables, impairment test outcomes can significantly shift over time with changes in the company’s operational performance, market dynamics, technological innovations, or strategic decisions like asset disposals or cessation of certain operations. This variability highlights the complex and judgment-based nature of impairment testing, emphasizing the potential for notable fluctuations in impairment charges across different periods. Warrants Liability The Company’s accounting for warrants, including Public, Private Placement, PIPE, and Abaca warrants, constitutes a critical accounting estimate due to the significant judgments and assumptions involved in their valuation and the potential impact on our financial statements. These warrants are recorded at fair value on a recurring basis, requiring the use of observable market data and valuation techniques that involve significant estimates and assumptions. For Public warrants, the Company utilizes Level 1 inputs, relying on exchange-traded prices which provide a transparent and observable market valuation. This approach minimizes the level of estimation uncertainty associated with these warrants. Private Placement and PIPE Warrants valuation, as of 2023, has transitioned from third-party reports to internal assessments by the Company, employing Level 3 inputs derived from unobservable inputs. This shift aims to enhance the precision of the valuation process, allowing for adjustments reflective of the unique characteristics of these warrants and prevailing market conditions. Key assumptions in this valuation include the expected volatility of our stock, the risk-free interest rate, the expected life of the warrants, and the dividend yield. Variability in these assumptions could significantly impact the fair value estimates of these warrants. For Abaca Warrants, the Company also utilizes an internal assessment approach with Level 3 inputs. The valuation assumptions include, but are not limited to, the exercise price, the fair market value of the underlying Class A Common Stock, the expected term of the warrants, and the risk-free interest rate. Future variations in these critical assumptions could arise from changes in market conditions, such as fluctuations in the volatility of the Company’s stock, alterations in the risk-free interest rate reflecting broader economic shifts, or adjustments in the expected life of the warrants due to changes in the holders’ exercise behavior. Additionally, regulatory changes or shifts in the market perception of the Company could also necessitate adjustments to these assumptions. Changes in these assumptions could lead to significant variations in the recorded fair value of the warrants, impacting the Company’s financial position and results of operations. The Company closely monitors these assumptions and market conditions to ensure that the warrant valuations accurately reflect their fair market value on reporting date. 28 Table of Contents Deferred consideration The Company’s accounting for the deferred consideration arising from the acquisition of Abaca represents a critical accounting estimate, consistent with ASC Topic 815, “Derivatives and Hedging” (“ASC 815 “). This consideration, due to its failure to meet the equity classification criteria under ASC 815, is accounted for as a derivative liability. This approach necessitates the recognition of this obligation on the balance sheet at its fair value, with subsequent adjustments to fair value reflected at each reporting period end. The determination of fair value involves significant judgments and assumptions, particularly in light of the complex terms outlined in the Abaca merger agreement and its amendments. The deferred consideration includes cash payments scheduled at various anniversaries of the merger closing, the issuance of common stock based on specified conditions, and the introduction of additional consideration and stock warrants as per the latest amendments to the agreement. The fair value assessment of these components is influenced by several factors, including the Company’s stock price, the volatility of the stock, the risk-free interest rate, and the specific terms of the deferred and stock considerations as amended. Future variations in the fair value of this derivative liability could arise from changes in the Company’s stock price, fluctuations in market volatility, alterations in the risk-free interest rate, or changes in the terms of the agreement as negotiated with the Abaca stockholders. Such changes could be prompted by evolving business strategies, market conditions, or regulatory environments that impact the financial and operational aspects of the agreement. These estimates and assumptions are subject to inherent uncertainties and the exercise of management’s judgment. Changes in these critical assumptions could lead to significant adjustments in the recorded fair value of the derivative liability associated with the Abaca acquisition’s deferred consideration. These adjustments could materially impact the Company’s financial position and results of operations, emphasizing the importance of the estimates and assumptions used in the valuation of this complex financial instrument. The Company closely monitors related developments and market conditions to ensure the derivative liability is accurately valued, providing transparency and reliability on the reporting date . Emerging Growth Company Status SHF is an emerging growth company (“EGC”), as defined in the JOBS Act. Under the JOBS Act, EGCs can delay adopting new or revised accounting standards issued until such time as those standards apply to private companies. In electing this relief, the JOBS Act does not preclude an EGC from adopting a new or revised accounting standard earlier than the time that such standard applies to private companies. SHF has elected to use this relief and will do so until the earlier of the date that it (a) is no longer an emerging growth company or (b) affirmatively and irrevocably opts out of the extended transition period provided in the JOBS Act. As a result of the elected JOBS Act relief, these combined and consolidated financial statements may not be comparable to companies that do not elect JOBS Act relief or choose to early adopt different accounting pronouncements than SHF. Internal Control Over Financial Reporting In connection with our management assessment of internal control over financial reporting as of and for the year ended December 31, 2023, the Company has identified three (3) material weaknesses within our internal controls associated with Revenue Recognition, Complex Financial Instrument and Credit losses. Refer to Item 9A of this document for additional details. Related Party Relationships Account Servicing Agreement The Company had an Account Servicing Agreement with PCCU. SHF provides services as per the agreement to CRB accounts at PCCU. In addition to providing the services, SHF assumed the costs associated with the CRB accounts. These costs include employees to manage account onboarding, monitoring and compliance, rent and office expense, insurance and other operating expenses necessary to service these accounts. Under the agreement, PCCU agreed to pay SHF all revenue generated from CRB accounts. Amounts due to SHF were due monthly in arrears and upon receipt of invoice. This agreement was replaced and superseded in its entirety by Commercial Alliance Agreement entered on March 29, 2023, between PCCU and the Company. Support Services Agreement On July 1, 2021, SHF entered into a Support Services Agreement with PCCU. In connection with PCCU hosting the depository accounts and the related loans and providing certain infrastructure support, PCCU receives (and SHF pays) a monthly fee per depository account. In addition, 25% of any investment income associated with CRB deposits is paid to PCCU. This agreement was replaced and superseded in its entirety by Commercial Alliance Agreement entered on March 29, 2023, between PCCU and the Company. Loan Servicing Agreement Effective February 11, 2022, SHF entered into a Loan Servicing Agreement with PCCU. The agreement sets forth the application, underwriting and approval process for loans from PCCU to CRB customers and the loan servicing and monitoring responsibilities provided by both PCCU and SHF. PCCU receives a monthly servicing fee at the annual rate of 0.25% of the then-outstanding principal balance of each loan funded and serviced by PCCU. For the loans that are subject to this agreement, SHF originates the loans and performs all compliance analysis, credit analysis of the potential borrower, due diligence and underwriting and all administration, including hiring and incurring the costs of all related personnel or third-party vendors necessary to perform these services. Under the Loan Servicing Agreement, SHF has agreed to indemnify PCCU from all claims related to default-related credit losses as defined in the Loan Servicing Agreement. This agreement was replaced and superseded in its entirety by Commercial Alliance Agreement entered on March 29, 2023, between PCCU and the Company. 29 Table of Contents Commercial Alliance Agreement On March 29, 2023, the Company and PCCU entered into the Commercial Alliance Agreement. This Agreement sets forth the terms and conditions of the lending and account-related services, governing the relationship between the Company and PCCU. The Commercial Alliance Agreement replaces and supersedes, in their entirety, the following agreements entered into between the aforementioned parties: the Amended and Restated Loan Servicing Agreement (the “Loan Servicing Agreement”, dated September 21, 2022); the Second Amended and Restated Account Servicing Agreement (“the “Account Servicing Agreement,” dated May 23, 2022, effective February 11, 2022) and the Second Amended and Restated Support Services Agreement (the “Support Agreement,” dated May 23, 2022, effective February 11, 2022). The Commercial Alliance Agreement sets forth the application, underwriting, loan approval, and foreclosure process for loans from PCCU to borrowers that are cannabis-related businesses and the loan servicing and monitoring responsibilities provided by the Company and PCCU. In particular, the Commercial Alliance Agreement provides for procedures to be followed upon the default of a loan to ensure that neither the Company nor PCCU will take title to or possession of any cannabis-related assets, including real property, that may be collateral for a loan funded by PCCU pursuant to the Commercial Alliance Agreement. Under the Commercial Alliance agreement, the PCCU has the right to receive monthly fees for managing loans. For SHF-serviced loans, which are CRB loans provided by the PCCU but primarily handled by SHF, a yearly fee of 0.25% of the remaining loan balance is applied. On the other hand, loans both financed and serviced by the PCCU are charged a yearly fee of 0.35% on their outstanding balance. These fees are calculated using the average daily balance of each loan for the preceding month. In addition, the Company’s is obligated by the Commercial Alliance Agreement to indemnify PCCU from certain default-related loan losses (as fully defined in the Commercial Alliance Agreement). In addition, the Commercial Alliance Agreement provides for certain fees to be paid to the Company for certain identified account related services to include: all cannabis-related income, including all lending-related income (such as loan origination fees, interest income on CRB-related loans, participation fees and servicing fees), investment income, interest income, account activity fees, processing fees, flat fees, and other revenue generated from cannabis and multi-state hemp accounts that are hosted on PCCU’s core system for a monthly fee equal to $30.96 per account in 2022, $25.32-$27.85 per account in 2023, and $26.08-$28.69 in 2024. In addition, as it pertains to CRB deposits held at PCCU, investment and interest income earned on these deposits (excluding interest income on loans funded by PCCU) will be shared 25% to PCCU and 75% to the Company. Finally, under the Commercial Alliance Agreement, PCCU will continue to allow its ratio of CRB-related deposits to total assets to equal at least 60% unless otherwise dictated by regulatory, regulator or policy requirements. The initial term of the Commercial Alliance Agreement is for a period of two years, with a one-year automatic renewal unless a party provides one hundred twenty days’ written notice prior to the end of the term. In fiscal 2022 and up to the third quarter of 2023, our investment earnings were solely from interest on deposits at the Federal Reserve Bank, capped at the earnings accrued by PCCU from its reserves. However, a strategic shift in the fourth quarter of 2023 led us to adopt Federal Reserve’s interest rates applied to the daily average balance of SHF customer deposits, with certain exclusions. This method, applied retroactively from the beginning of 2023, resulted in incremental revenue of $549,000 recognized in the fourth quarter. Under our Commercial Alliance Agreement, we are obligated to remit 25% of the investment hosting fees to PCCU based on this income. The below schedule demonstrates the ratio of CRB related loans funded by PCCU to the relative lending limits at December 31, 2023 and December 31, 2022. December 31, 2023 December 31, 2022 CRB related deposits $ 129,350,998 $ 161,138,975 Capacity at 60% 77,610,599 96,683,385 PCCU net worth 81,087,746 133,231,565 Capacity at 1.3125 106,670,306 174,866,429 Limiting capacity 77,610,599 174,866,429 PCCU loans funded 55,660,039 18,898,042 Amounts available under lines of credit 525,000 996,958 Incremental capacity $ 21,425,560 $ 154,971,429 The revenue from operation on the statement of operations consists of the following agreement mentioned above for the year ended December 31, 2023, and December 31, 2022: Year ended December 31, 2023 Year ended December 31, 2022 Account Servicing Agreement $ 3,075,458 $ 8,823,608 Commercial Alliance Agreement 10,761,245 - Total $ 13,836,703 $ 8,823,608 30 Table of Contents The operating expense on the statement of operations consists of the following agreement mentioned above for the year ended December 31, 2023, and December 31, 2022: Year ended December 31, 2023 Year ended December 31, 2022 Support Services Agreement $ 378,730 $ 775,259 Loan Servicing Agreement 11,929 26,088 Commercial Alliance Agreement 1,665,644 - Total $ 2,056,303 $ 801,347 Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information otherwise required with respect to market risk.