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The Surge of SLB in Cannabis Debt Financing

August 12, 2022
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Investor Takeaway

Debt is becoming the primary source of growth capital in the cannabis industry. Commercial real estate (CRE), in particular, is now the most popular asset class for investors in the cannabis industry as more states are seeking increased tax revenue by lifting restrictions on cannabis and hemp for medical and recreational purposes.

  • With $120T of public-sector debt trading on the world’s bond markets, versus the total market cap for all the world’s stocks at $93.7T, debt is said to be not just big business. It is the biggest business.
  • In cannabis from Q3 2021 through Q1 2022, debt accounted for 93% of total financing.
  • With marijuana still classified as a Schedule I drug at the federal level, cannabis operators continue to face restrictions in accessing the commercial financing they need to grow. Sales Leaseback (SLB) transactions have become a popular choice of business owners looking to leverage their own assets to acquire capital from private investors.

This week’s EDGE Briefing assesses the SLB trend in the cannabis industry and provides the guidelines we follow to mitigate risk for debtors and creditors in these large-scale transactions.

Proliferation of Debt Financing

As reported in last week’s issue of the EDGE, the International Monetary Fund (IMF) finds that public-sector debt trading on the world’s bond markets totals $120T, while speculating that debt obligations issued by private sources globally doubles that total. On the other hand the World Bank finds that a total market cap for all the world’s stocks is only about $93.7 trillion. From this, the Cannabis Business Times concludes:

Debt isn’t just big business. It’s the biggest business.

How this relates to the cannabis industry is indicated by the fact that from Q3 2021 through Q1 2022, debt accounted for 93% of total financing. MJBizDaily recently explained the way large cannabis operators are almost instantly raising tens of millions of dollars when options in the traditional banking industry are few and far between.

The cannabis industry is finding this source of debt capital in Sale and Leaseback (SLB) transactions.  While common for other, more traditional types of CRE, such as the $1B transaction pending between Bally’s Corp. and a group of investors for the SLB of two of its Rhode Island casinos, now MJBizDaily reports more than a dozen public pension funds are investing in cannabis through a California REIT. This is a sign, they say, that: “institutional investors wielding billions of dollars in state funds are comfortable pumping money into the cannabis industry.”

In total, at least 16 state pension funds in the United States and one in Canada are investing in San Diego-based Innovative Industrial Properties, which leases properties to licensed medical cannabis operators, according to the Chicago Sun-Times.

Why the SLB Trend?

While debt is becoming more available its not perfect for every situation. Commercial Real Estate (CRE) in particular is becoming a critical asset class for investors in the cannabis industry. The large New York Accounting firm EisnerAmper finds that as many as 21 additional states may legalize cannabis in some form by as early as the end of the year. Returns on investment in cannabis CRE debt, they find, currently range between 12 and 15 per cent, with higher returns available on shorter term loans. Cannabis companies create significant value as they improve retail and industrial properties for cannabis use.

What are the Driving Forces?

  • According to MJBizDaily: “Unlocking the value of real estate with a sale provides money that can be used to grow a firm’s core business without diluting the value of it stock the way issuing more share would.”
  • CRE investors took notice during the pandemic when the industry was deemed one of the “essential industries” in most of the legal cannabis states. While other tenants were closing, cannabis dispensaries were thriving. com concludes: “With more states legalizing cannabis use, the sector is starting to look at lot less risky.”
  • Since Marijuana is still classified as a Schedule I drug at the federal level, states EisnerAmper, cannabis-related businesses continue to face restrictions in accessing the commercial financing they need to grow. Because of this, SLB transactions have become a popular choice of business owners looking to leverage their own assets to acquire capital from private investors.

What’s Going On in the Cannabis SLB Marketplace?

Investment news and information source Benzinga, reports these major SLB transactions:

  • $50-million deal involving Chicago-based Cresco Labs and GreenAcreage Real Estate, a New York-based REIT providing sale-leaseback and construction financing to cannabis operators.
  • $35-million sale-leaseback transaction for six properties in California, Illinois and Massachusetts when New Lake Capital Partners bought the properties owned by New York-based multi-state operator (MSO) Columbia Care.
  • $39.5-million sale-leaseback deal for Chicago-based MSO Green Thumb Industries’ cultivation facility in Pennsylvania with San Diego-based REIT Innovative Industrial Properties (IIP).
  • IIP also acquired a marijuana property in New Jersey from Ascend Wellness for $35.4 million and secured a long-term lease with the company.
  • And, last October, New York-based Acreage Holdings, another MSO, signed a $72 million sale-leaseback deal for properties in Florida, Massachusetts and Pennsylvania. The buyer was GreenAcreage, created in May to buy properties from Acreage Holdings and other cannabis companies.

What Can Strategic Investors Use as a Guide Through Debt Deals for the Right Investment to Meet A Portfolio Strategy?

Debt plays a more vital role than ever for maturing cannabis companies because debt financing interest rates, as we see it, are at the lowest point now than they will be over the next 5 to 10 years! But straight debt or traditional dilutive equity aren’t the only solutions to provide growth capital. For the step up in value for companies that have created successful cannabis retail, cultivation, and processing an SLB transaction can harvest that value while not diluting the equity in an operating company nor having the risk of traditional debt.

The primary options available to cannabis operators are these.

Sale and Leaseback Transactions

While Sale-Leaseback (SLB) transactions aren’t technically debt they do allow companies to free up liquidity from their balance sheets without dilution of the operating company. The upside of this alternative is that cannabis companies increasingly have been selling their cultivation, processing and storage facilities and immediately leasing them back as a way to instantly raise tens of millions of dollars. The potential downside is that an SLB locks the asset seller into a longer commitment than other straight debt alternatives that now are likely to be able to be secured for rates similar to the SLB. It should be noted, however, that in common debt transactions lenders will be looking for more than a mere promise to repay. A security interest and/or corporate or personal guarantee (PG) will most likely be required. An SLB is a great option in obtaining capital for cannabis operators, and one that has been used by many of the largest companies in the space.

Asset-Based Lending

Based on the valuation of real estate and equipment assets, a cannabis company can typically borrow from within the range of 40% to 75% of asset value. In the case of development projects, the loan is usually based on project costs. While less typical, there are some working capital debt options in the market as well, though the availability of this option is much less than for real estate and equipment financing.

Convertible Options

  • Up to this point, most debt financing by cannabis companies was found in convertible note options with low conversion premiums – which essentially delay dilution of equity. The company creates a note that converts to equity, often preferred stock, at a future date based on a future valuation method. These notes, similar to promissory notes with interest payable on or before a maturity date, have given investors security that they are repaid before equity holders if something goes wrong. For both the investor and the company this note structure allows the valuation question to be answered in the future while providing needed capital to the company and a more secure instrument to investors.

Sale leaseback transactions can optimize real estate heavy cannabis company balance sheets while avoiding dilution to the core operating company. At the same time the company can potentially harvest the value that has been created through developing cannabis properties.

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.

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