Investor Takeaway Debt is the Biggest Business in Cannabis
The International Monetary Fund estimates $120 trillion of public-sector debt trading on the world’s bond markets. Given that debt obligations issued by private sources globally doubles that amount, that contrasts with the fact that a total market cap for all the world’s stocks is only about $93.7 trillion. From this, the Cannabis Business Times concludes that debt isn’t just big business. It’s the biggest business. This relates to the cannabis industry with factors such as debt being associated with the industry-specific dynamics of cannabis. For the past year, stock prices among the peer group’s leaders have been declining, weakening their raise of more capital on equity markets. From the third quarter of 2021 through the first quarter of 2022, debt accounted for 93% of total financing, with private companies raising a record 10% of that total. Yet, caution is recommended in these transactions by looking at factors ranging understanding Rule 144A of Reg D, to assessing potential repayment roadblocks.
The Proliferation of Debt Debt is the Biggest Business in Cannabis
The International Monetary Fund estimates $120 trillion of public-sector debt trading on the world’s bond markets. This they speculate is equal to the same total of debt obligations issued by private sources globally, totaling $240 trillion. Compared to the total market cap for all the world’s stocks is only about $93.7 trillion, as estimated by the World Bank.
From this, the Cannabis Business Times concludes that:
debt isn’t just big business. It’s the biggest business. Debt is the Biggest Business in Cannabis
According to the Times, the drivers behind debt in the cannabis industry are factors such as these:
- While Internal Revenue Code Section 280E, as applied today, prohibits cannabis businesses from deducting that interest along with many other standard expenses, it all hinges on cannabis’s classification as a Schedule-I drug and the murky legal definition of “trafficking,”according to the Congressional Research Service. So it was just a matter of time before the cannabis industry switched from equity to debt as an emergent funding source.
- Part of that has to do with the industry-specific dynamics of cannabis. For the past year, stock prices among the peer group’s leaders have been declining, weakening their appetite for raising more capital on equity markets
- More and more companies are mature enough to deliver the cash flow, which bond buyers find attractive.
Major Recent Debt Financing Transactions Debt is the Biggest Business in Cannabis
MJBizDaily reports that debt accounted for 74.5% of total capital raised in 2020. That was the first year in cannabis history that debt exceeded equity in capital raised.
Equity issuance dried up as the optimism regarding federal legalization evaporated and stock prices again plunged.
From the third quarter of 2021 through the first quarter of 2022, debt accounted for 93% of total financing, with private companies raising a record 10% of that total.
Here are some to the latest cannabis industry transactions as the pace set last year for debt financing continues in 2022. Debt is the Biggest Business in Cannabis
MarketWatch reported that on January 28 Trulieve Cannabis closed a $75M private placement of 8% senior secured notes due 2026. This was its second tranche of senior notes following a massive $350M debt offering that closed on Oct. 6.
In late February Columbia Care Inc. closed a $185M debt offering priced at 9.5% in senior secured first lien notes from an unnamed source due 2026.
- Canaccord Genuity Corp. led these debt deals for both Trulieve and Columbia Care.
- Both of these transactions followed the trend continuing into 2022 where cannabis companies are raising capital with non-dilutive debt as opposed to turning to the public markets as share prices decline.
- The goal according to a news release statement by Columbia Care CEO Nicholas Vita, “This non-dilutive financing provides Columbia Care with additional flexibility to continue executing on our strategic growth initiatives,”
From its press release in April Fluresh, one of the largest vertically integrated cannabis operators in Michigan, announced what the company claims: FLURESH COMPLETES HISTORIC CANNABIS INDUSTRY FINANCING WITH $48 MILLION IN ENGAGEMENTS FROM FEDERALLY CHARTERED BANK.
- The secured Bank Note closed on December 28, 2021, and is for aggregate gross proceeds of $25 million. The Bank Note has a variable interest rate and, at the time of closing, bore an interest rate of 5.75% per annum with 50% of the aggregate proceeds capped at 7.0%. The lender also completed a $23 million debt refinancing of Fluresh’s Grand Rapids, Michigan property alongside the closing of Fluresh’s Bank Note.
- The Bank Note is a senior secured obligation of Fluresh and is payable in monthly installments until the maturity date of December 28, 2024. The Bank Note is secured by Fluresh’s property in Adrian, Michigan.
From a press release by High Tide Inc. (Nasdaq: HITI) (TSXV: HITI) (FSE: 2LYA), a leading retail-focused cannabis company with bricks-and-mortar as well as global e-commerce assets, announced that it closed a short-term debt financing from an arm’s length credit provider for CAD$5M.
- The Company has chosen to proceed with a small debt facility at this time as the Company’s proposed non-dilutive credit facilities with ConnectFirst Credit Union for CAD$30M (as previously announced on April 18, 2022) has been delayed until July 2022. The Company issued the Lender a non-convertible subordinated secured debenture of the Company that matures on June 21, 2023.
And, in June Pelorus Equity Group, the leading provider of commercial real estate loans for the cannabis sector, announced it has closed an $11.8M financing with Juva Life Inc., a life science company with pharmaceutical research and development and consumer-facing operations in cannabis production and distribution.
- The primary purpose of the financing, which closed on June 15, 2022, is to finance the exercise of the tenant’s purchase option on its recently completed Stockton, CA cultivation facility, as well as provide working capital and R&D funding. The facility was recently completed at a cost of $17M.
- Juva also plans to use a portion of the funds to further its clinical research and development programs. on Juva-019 and Juva-041, novel compounds targeting the treatment of inflammation.
Debt Financing Guidance for Strategic Investors and for Operators
With debt financing dominating the path to strategic cash raises in the cannabis industry and experts predicting that to remain stable in 2022, at Highway 33 we, nonetheless, assist our clients to proceed with caution. The guidance we provide our clients covers detail beyond just the likelihood of being able to repay creditors:
- While Rule 144A of Reg D provides, as Canna Business Times points out, a safe harbor from registration requirements for private resales, providing liquidity to the secondary market, when collateral is pledged as part of a listing, a PPM must specify this value.
- Careful assessment of cash flow is required that will cover the yield investors expect in these private placement opportunities in the cannabis industry.
- Cannabutterdigest.com reminds us that operators are selling cultivation, processing, and storage facilities and then immediately leasing them back (in SLB transactions) as a mechanism to secure tens of millions in investment capital. These investment ploys lock in the asset seller for a much longer period than straight debt deals. One drawback to these asset sales is that they increase expenses through the leasebacks.
- In addition, Washington DC law firm YK Law warns of the potential of loan repayment delays that advisors should have creditors consider:
- Delays in payments and Receivables – affecting cash flow. Armored car companies have required that a client have a set amount of cash ready for pickup before committing a vehicle and driver to the job. This, of course, has the effect of slowing down the movement of funds through the entire ecosystem.
- Increased likelihood of litigation over non-payment. Given that litigation is not a fast and efficient process for dispute resolution there is a risk that the use of litigation to resolve late payment scenarios could worsen the slow payment problem across the industry.
- Financial interest holder reporting. If someone is a financial interest holder, then they must be reported as such to state and local authorities. Failure to timely report a financial interest holder to regulators may result in fines, penalties and administrative proceedings against the license.
Will the Smaller Operators be left Behind in the Search for Low Interest Debt Financing?
It is easy to see why the large MSOs qualify for the low rates in these multi-million dollar transactions. However, what about the smaller and single state operators? Will they ever be able to qualify for low interest rate debt financing for their operations, growth and acquisition needs?
Highway 33 Capital CEO, David Hofer, explains how sources of capital the company utilizes can make single digit (yes, single digit) loans available in the $5M to $30M range based on the following underwriting criteria:
- The borrower must own their commercial real estate property that is green zoned, has cannabis licensing, and must be generating revenue with sufficient cash flow to service the debt.
- Funds may be used for acquisition financing or to pay off construction and bridge loans and land contracts.
- Investors will take first lien position on the mortgage and these can be full recourse, limited, or no recourse in some cases.
Rates range from 7-10% with standard origination fees, with terms ranging from 2 – 5 years. Hofer says the timeframe from application to funding is approximately 90 days. All applications are handled by senior members of the firm’s management team.
How We Can Help – Finding the Right Fit for Your Investment Strategy
If you are an Accredited Investor seeking the right cannabis industry fit for your strategic investment portfolio, or if you are an operator seeking the proper way to appeal to a source for your growth funding CLICK HERE to begin the process with us.
At Highway 33 Capital, we see decision-making challenges daily in our role as an investment banking intermediary as we arrange for the funding of growth companies in the cannabis and hemp markets via M&A, asset sale/purchase, and debt transactions to:
- clarifying the investment needs and objective of all parties
- determining the real value in the business by calculating a well-substantiated valuation
- and matching the right investors with the right funding opportunity – the right operators whose objectives and scalability are a 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.