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Cannabis Federal Legalization and Access to Capital – Part II

May 27, 2022
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Investor Takeaway

In Part I of this two-part series, we reviewed the bouncing ball that is the Secure and Fair Enforcement (SAFE) Banking Act which is now back into deliberation by the Senate. We found in sessions and panel discussions conducted at the recent Benzinga Capital Conference that federal de-scheduling and the likelihood of the “Big legislation,” such as SAFE and MORE, passing will not come as early as this year.

  • Legislation coming now from the Republican side, with the States Reform Act, attempts to get consensus on the basic issues to achieve bipartisan support.
  • South Carolina Republican Representative, Mace, has included a regulatory framework in her bill and keeps federal excise taxes at 3%.
  • For the alphabet list of bills – SAR, ACOA, HOPE, PREPARE, MORE and SAFE, none of the efforts around the legislation are ripe enough in Congress to pass.
  • For strategic investors understanding the legislative landscape at all levels and looking for operators that can scale into leadership positions is the soundest investment strategy for when de-scheduling does occur.

Roll Call of Proposed Legislation

In Part I of this two-part series, we reviewed the bouncing ball that is the Secure and Fair Enforcement (SAFE) Banking Act which is now back into deliberation by the Senate. We found in sessions and panel discussions conducted at the recent Benzinga Capital Conference that federal de-scheduling and the likelihood of the SAFE Banking Act passing will not come as early as this year. And we found these other insights:

  • The “Plumbing Problem” in the industry is still ready access to capital.
  • Bipartisan support is growing on the Hill, The States Reform Act being an example.
  • Yet, the best hope for progress by Congress is a “Bare Bones” SAFE, addressing more manageable issues such as SARS.

This issue of the EDGE Briefing delves deeper into the information from that conference for enlightenment on other federal legislative options and likelihood of progress possible this year.

In last week’s issue of The EDGE we looked at not only SAFE and MORE, we also reviewed Representative David Joyce’s bills the Harnessing Opportunities By Pursuing Expungement (HOPE) Act,and the the Preparing Regulators Effectively for a Post-Prohibition Adult Use Regulated Environment (PREPARE) Act. Speaking to the issue of “Big” legislation like MORE and SAFE, Representative Joyce, in his role as co-chair of the Cannabis Coalition in the House, is attempting to break these all-encompassing bills into smaller bite-size pieces of legislation in an effort to make incremental progress. The first bill he has authored is designed to simplify the process by addressing the single issue of the expungement. The second a bipartisan bill designed to:

create a fair, honest and publicly transparent process for the federal government to establish effective regulation to be enacted upon termination of its 85-year prohibition of cannabis.

Senator Schumer’s Next Step

The cannabis industry is awaiting the next move by Senator Chuck Schumer after his COMPETES Act did not progress to the Senate last year. This year in August he promises to present the Cannabis Administration and Opportunity Act (CAOA), to Congress. In the Cannabis industry publication High Times, Steven Hawkins, CEO and President of the advocacy group the US Cannabis Council described CAOA as follows:

First of all, the proposed tax, at least in the draft, had the federal tax at 25% on top of high state taxes that exist currently. “It would just make it impossible for the industry to succeed in most states. So that would have to be addressed. And then the question of primary jurisdiction. The draft proposed that the FDA have primary jurisdiction. We certainly have concerns with the role of the FDA. We’d rather see the Tax and Trade Bureau have primary jurisdiction.”

The CAOA would also normalize income tax for legal cannabis businesses, meaning existing businesses would no longer be subject to Section 280E of the Internal Revenue Code. But some argue cannabis should be regulated more like alcohol. “The Tax and Trade Bureau is already dealing with adult-use products with alcohol and tobacco,” Hawkins said. “We’d want that agency to have jurisdiction over cannabis as well.”

Another Republican Addresses the Issue

While the Schumer legislation is still being formulated, Representative Nancy Mace, R-South Carolina, in November introduced the first Republican-backed decriminalization bill, the States Reform Act. In essence the bill would remove cannabis from the Schedule 1 controlled substance list, while establishing a baseline of federal policies and imposing a three per cent federal excise tax on cannabis sales in each legal state.

That’s right, a Republican from the very Red State of South Carolina turns out to be a major cannabis reform advocate.  Well, her story is very compelling about a life changing experience she had by coming off anti-depressant drugs that made her feel like the depression was getting worse, and using cannabis to find a more natural treatment. “Cannabis to me,” she says, “as an issue is not an on-ramp. It is often the case of an off-ramp from something else.” Having known the medical benefits of cannabis for years she asks:

Why haven’t we done anything yet? Why aren’t we doing a better job of regulating at the federal level? So, it is my job, as is every member of Congress, to do the right thing for the right people for the right reasons. And this is one of those places to do just that.

Her approach is to bring more clarity to the issues and get Democrats and Republicans to work together for cannabis reform in a bipartisan way. Clearly a cannabis bill must be able to pass both chambers of Congress and she feel MORE will not accomplish that.

It had 12 amendments by the time MORE got to the rules committee.  Only Democrat amendments were allowed even though we worked together. If you want to get anything done in DC you have to get both sides working together.

Representative Mace states the four major differences between the States Reform Act and MORE:

  • Keeping the Federal excise tax very low. Her bill proposes a 3% rate. Research on the bill showed that you really can’t go above 4.75% at the federal excise tax level.

You have to keep federal taxes very, very low. The higher the taxes are the higher the illegal market will be available in different states. You are responsible for implement at the federal level you have to keep federal excise taxes very low. 

  • “You’ve got to have certain guardrails,” she says, “because there are some people afraid that when you say ‘legalize,’ they are not thinking about free markets and competition in businesses. They think you mean you’re going to be selling to kids.” So, Mace has a section in the bill that certain federal funding could be pulled back from any state where marketing has targeted underage youth.
  • Protecting the rights of veterans. Her proposal, “Under my bill you can be prescribed cannabis as a veteran for any reason, anytime, anywhere in the country.  And you are not going to get suspended from work if you use it. That’s in there.”
  • Having the regulatory framework that MORE doesn’t have. The Reform Act treats cannabis like alcohol.

So, if you are a retailer you go through the TTB, if you are a grower you go through the Dept. of Agriculture, if you are doing medical you go through the FDA. There is already a framework there. You don’t have to wait. You can just press GO and be done with it. 

“The States Reform bill is the last man standing,” she says. “There is no other bill in Congress today that has any chance in Hell of moving forward.”

What is not as apparent in the States Reform Act as it is in MORE is the social equity piece.  Mace points out, though, a phased expungement and release provision is part of her bill, as well as help for disadvantaged businesses. But the rest of the bill is driven by the states.

There is a thing called Federalism, the idea of federalism is routed in the states having more power and more control because the government that is closest to the people is the government that governs best. If you give it to the states to handle you’re going to get a lot more Representatives on board and that’s what it takes to get bipartisan support.  And again, you have to have a bill at the federal level that is bipartisan.

So Where Do the Various Pieces of Legislation Stand? What Can We Expect Next?

Those were questions posed to Steven Hawkins of the US Cannabis Council. His response was that regarding current pieces of legislation – States Reform, CAOA, MORE, and SAFE – he says: “None of the efforts around the legalization are ripe enough in Congress to pass. None of those are geared yet for passage, but here is what is embedded is that we are now at a point of maturity where we are seeing not only a bill being put forward by the Democrat side, which has been happening for a while, but now the Republican side. That’s a sign of maturity in Congress.”

What he would like to see is that with the passage of a bill like SAFE it would be the first time Congress has to recognize the cannabis industry in a substantial way. “That makes it easier for everything else to come after,” he says. “Because after SAFE we start having the real serious discussions and movement around taxation and then the other pieces moving through Congress.” He remains hopeful that SAFE has a chance of passing in this Congress.

Michael Bronstein, Co-Founder & President of the American Trade Association of Cannabis and Hemp (ATACH) summed up the sentiment expressed by several of the experts gathered at the Benzinga conference by saying: “This industry is married to politics.”

Politics is to the cannabis industry is what chocolate is to peanut butter. It’s a part of the bread and butter of the industry and the reality is that our biggest business partner right now is the federal government.”

So, increasing the level of activism and interaction with political representatives at all levels is what he encourages the industry to do.

What This Means to Strategic Investors 

Operators such as Jamie L. Pearson, President and CEO of Bhang Inc., says of the slow legislative process, “It is what it is.” “My job as the CEO of a multi-national brand is to not only be on top of what is happening now, be aware of what I can do in the confines of the law; but then, be ready for what might come.”

Lender to the industry, Leonard Tannenbaum, CEO of Advanced Flower Capital (NASDAQ: AFCG) sums up the eventuality of the passage of legislation such as SAFE by saying, “We are going to help our borrowers either way.  If you can get bank financing cheaper, we’ll fall behind the banks. We want your cost of capital to go down, we want our cost of capital to go down, and continue to be a trusted partner in the industry.”

Representative Mace sums up her position in the process of formulating federal cannabis legislation:

As a business (in the cannabis industry) you ought to be profitable, you ought to be able to make a buck or two. You ought to be able to write off expenses on your taxes. You ought to be able to trade on the U.S. stock exchange not the CSX. 

Making the Right Decision for Your Investment Portfolio

So, understanding the de-scheduling process at the federal level and carefully helping clients navigate state and local requirements is something your investment banking advisor must provide for a successful strategic investment in cannabis at this stage in the industry. And whatever the future of federal legalization holds, investment in those operators that can scale into leadership positions is the soundest investment strategy. Then, when full legalization does occur those companies will have strong exit possibilities with valuations superior to their peers. However, especially in emerging markets, due diligence is key to identify the real players from the pretenders.

The approach we take with our clients for risk mitigation prior to presenting strategic cannabis investment opportunities: evaluating the prowess and the passion of the executive team, assessing the competitive advantage of the company and how quickly they can scale for growth, and determining how well they are ready for the regulatory regime in their home and target growth markets. We take these steps before presenting the company to our extensive network of pre-qualified investors.

How We Can Help 

At Highway 33 Capital, we see these challenges daily in our role as an investment banking intermediary as we arrange for the financing of growth companies in the cannabis and hemp markets. Finding the right fit for your strategic investment portfolio, or the proper way to appeal to a source for your growth funding requires transacting deals where the operators’ objectives and scalability are a strategic fit for investors’ portfolios.

We excel at structuring deals to meet client investment strategies in emerging opportunities with our core expertise in Cannabis along with other highly regulated markets in the fields of Pharma, Biotech, Healthcare, Agtech, Clean/ClimateTech, and CBD/hemp companies. We specialize in thoroughly vetted companies looking to drive growth and enterprise valuations through M&A, non-dilutive debt financing and/or capital investments ranging from $5M to $100M+.

Let’s talk about putting the power of this expertise to work for you as a Sell-side or Buy-side client.

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