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Alternatives to Bankruptcy for Cannabis Companies: Part 1

By Brent Salmons, Yuefan Wang
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The problems facing the cannabis industry arising from its ongoing status as a federally illegal enterprise are numerous and well documented: 280E tax burdens, limited access to banking, exclusion from capital markets, uneven access to federal intellectual property right protections and the inability to access the stream of interstate commerce. The recent woes faced by cannabis companies operating in mature markets reveal another key legal hurdle for cannabis companies, their investors and their creditors: the inability to access federal bankruptcy protection. However, cannabis companies may have access to a number of contractual and state law remedies to deal with insolvency and other financial woes.

Background

Bankruptcy laws in the United States are unique in the world; nowhere else is access to bankruptcy so available or forgiving for ordinary citizens and companies alike, allowing debtors a fresh start by either liquidating their assets or reorganizing their debt. Commentators have observed that such favorable bankruptcy laws encourage entrepreneurship and have been at least partially responsible for American innovation. Indeed, the ability of Congress to enact bankruptcy laws is enshrined in the United States Constitution. Like almost all laws in the U.S. at the time, bankruptcy was originally the domain of the various states; it was not until the late 18th century that Congress saw the importance of a uniform set of protections for debtors and passed the first federal bankruptcy law in 1800; since then, bankruptcy has been exclusively the purview of federal law, with current bankruptcy law governed by the United States Bankruptcy Code.

Yuefan Wang, attorney at Husch Blackwell

This exclusivity, however, poses a problem for state-regulated cannabis businesses: because cannabis is federally illegal, in the eyes of the United States Trustee Program, a division of the United States Department of Justice responsible for overseeing the administration of bankruptcy proceedings, the reorganization of any cannabis business amounts to “supervis[ing] an ongoing criminal enterprise regardless of its status under state law.” Therefore, since there is no such thing as state law bankruptcy, even cannabis companies operating in full compliance with state laws do not have access to any bankruptcy protections.1

All financing transactions, whether debt or equity, occur in the shadow of bankruptcy. The basic distinction between debt and equity is predicated on the favorable treatment of holders of the former compared to holders of the latter (within debt, the favorable treatment of secured debt over unsecured debt), and this is true, especially in bankruptcy. Even beyond distribution priorities, the Bankruptcy Code’s provisions on automatic stays, avoiding powers, and discharge fundamentally shape the relationship between debtors and creditors: a bankruptcy judge has the power to impose the Bankruptcy Code on the relationship between a debtor and its creditors, no matter their previous contractual relationships. Just as the possibility of litigation is a Sword of Damocles hanging over any legal disputes, the prospect of a bankruptcy filing affects any negotiations between a debtor and its creditors ab initio. Therefore, when financial problems arise and a cannabis company must begin the difficult task of approaching its lenders for relief, it does so without an effective incentive for creditors to come to the table available to other companies in otherwise similar situations.

Alternatives to Bankruptcy

Just as disputants often prefer the contractual certainty of a settlement agreement to the capriciousness of a jury, debtors and creditors may choose extra-judicial solutions for insolvency. The downward trend in bankruptcies over the last few decades may partially be the product of such out-of-court arrangements, and debtors and creditors are increasingly comfortable with them as an alternative to voluntary or involuntary bankruptcy filing. While the effectiveness of these solutions is, in industries other than cannabis, ultimately evaluated with bankruptcy in mind, these solutions may also be preferable for a creditor of a cannabis company that is defaulting on its obligations.

Contractual Remedies: Lender Workouts, Exchange Offers and Composition Agreements

Given that the relationship between a debtor and its creditors is essentially contractual, the parties may choose to modify their relationship in any manner to which they can mutually agree. A lender workout is an agreement for a financially distressed company to adjust its debt obligations with a creditor (or often multiple creditors given that a lender’s payment obligations to one creditor necessarily affect its obligations to its other creditors). These contractual adjustments are tailored to the particular situation and can take the form of deferrals of payments of interest or principal, extensions of maturity dates, covenant relief (e.g., adjustment of the lender’s debt-to-asset ratio or other financial covenants which would otherwise trigger an event of default), and/or debt-for-equity swaps. This last option (including its related concepts, such as grants of options or warrants) is especially prevalent in the cannabis industry, given that cannabis companies often do not have traditional bank debt (though, at the same time, such solutions may be increasingly unattractive to creditors given lower valuations and the prevalence of equity as a form of consideration in cannabis mergers and acquisitions transactions).

Brent Salmons, attorney at Husch Blackwell

Similarly, an exchange offer restructures a faltering company’s capital stack. Typically, a company facing a default will offer its equity-holders new debt or equity securities in exchange for its outstanding debt securities, which new securities have more favorable terms, such as covenants, events of defaults and maturity. Exchange offers have the same goal as lender workouts in that they seek to eliminate a class of securities with an impending maturity date, event of default or breach of a covenant.

Composition agreements are contractual arrangements between a debtor and its creditors whereby the creditors agree to accept less favorable claims in order for the debtor to reorganize its operations so that the debtor’s future inflows can meet its reduced outflows, with the alternative being a complete collapse of the debtor (in which case no one, or perhaps only the most senior secure lenders, is repaid). These agreements often provide for oversight by a committee of the creditors and will often involve contractual promises by creditors to forbear from exercising their previously existing rights until a defined triggering event.

Statutory Remedies: UCC Article 9 Sales and ABCs

If the contractual remedies described above are akin to Chapter 11 bankruptcy proceedings, whereby a company in dire (but ultimately salvageable) straits continues to operate while its debt obligations are reorganized, state law statutory remedies are analogous to Chapter 7 bankruptcy proceedings; the business is a sinking ship and must liquidate its assets to maximize payments to its creditors (in the bankruptcy context, per the rules of absolute priority). Such liquidation is governed by rules under state law which may be available to cannabis companies.

If a creditor has a security interest in the collateral of a debtor, then the most popular option is usually a sale under Article 9 of the Uniform Commercial Code (UCC). The UCC is a standardized set of laws and regulations for conducting business, including lending. The UCC itself is not law; rather it is a codex that has been adopted by most states and incorporated into their statutes as law, usually with some variations. UCC Article 9 deals with secured transactions and, in particular, provides for the sale and disposition of collateral subject to a security interest upon a default by the debtor. Similar to a §363 sale under the Bankruptcy Code, a sale under UCC Article 9 provides for a “friendly foreclosure” whereby a defaulting debtor and its lenders cooperate to facilitate a sale of the secured collateral.

Article 9 imposes certain parameters on such dispositions, including that foreclosure sales be “commercially reasonable”, which the UCC specifies as meaning that the collateral be sold in a reasonable and customary manner on a recognized market, at then-current market prices. If the sale was approved in a judicial proceeding, by a bona fide creditors’ committee, by a representative of creditors or by an assignee for the benefit of creditors, then this creates a presumption of commercial reasonability under the UCC.

A less common option is an assignment for the benefit of creditors (ABCs). Laws governing such assignments vary by state and are generally rare, with California being a notable exception where both ABCs are more common and where cannabis is legal. An ABC is initiated by the debtor, which then enters into an agreement to assign its assets to a third-party assignee, which holds such assets in trust for the benefit of the creditors and is then responsible for their liquidation, similar in principle to a trustee in bankruptcy.

ABCs, however, are generally not suitable for cannabis companies as the third-party assignee would not be able to take possession of a licensed cannabis business, or certain assets such as cannabis plants, distillates and other products, without itself being licensed by the relevant state regulatory agency. A similar problem occurs under Article 9 sales, whereby the purchaser of the collateral must be licensed in order to possess and operate cannabis product and, more importantly, the all-important state-issued licenses which provide a cannabis company with the authority to operate as such; the pool of potential purchasers is therefore limited to those purchasers already licensed or which are willing to undergo the burdensome process of becoming licensed, hence shrinking the market for such assets and reducing their value. These issues may be resolved in some states by the assignor/seller entering into a management services agreement with the assignee/purchaser, pursuant to which the assignee/purchaser effectively manages the operations of the cannabis business. These agreements, however, need to be carefully drafted so that they are not seen as constituting ownership of the business by the assignee/purchaser (until the actual transfer of the licenses occurs), as defined under applicable state law.

  1. While absolutely true for “plant-touching” companies, recent cases in the federal Ninth Circuit Court of Appeals provide some (fact-dependent) hope for cannabis-adjacent companies such as those housing the employees or intellectual property of a plant-touching operational cannabis company (this structure itself largely a solution to deal with federal illegality).

The Distressed Cannabis Business: An Alternative to Bankruptcy

By Paula Durham, Scott E. Evans
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Bankruptcy is Not an Option

Bankruptcy courts do not provide protection to cannabis and cannabis-related businesses.Bankruptcy can be a very helpful tool for a distressed business. Bankruptcy allows a business to stop collection actions, discharge certain debts, cancel unfavorable contracts and provides breathing room to restructure the business.

What if your cannabis operation is struggling or failing – file for bankruptcy, right? Not so fast. Despite cannabis being legalized or decriminalized for certain activities at the state level, it remains illegal at the federal level. Therefore, the bankruptcy court will not provide protection to cannabis and cannabis-related businesses (CRB).

Alternatives to Bankruptcy

A State Court receiver may be the best alternative when bankruptcy is not an option.Enter the state court receivership. Receivership is an equitable remedy that is often employed as an alternative to a bankruptcy proceeding. A receivership can address business insolvency or can be a temporary remedy during legal proceedings between disputing business partners, with control of the enterprise hanging in the balance.

In either scenario, the court appointed receiver takes control of the business and must assess the posture of the business and determine the best path forward. The receiver’s options run the gamut from operating the company as is, restructuring operations to maximize profit or closing shop and liquidating the business as a whole or in pieces. The receiver has a fiduciary responsibility to determine the option that best satisfies creditors, similar to duties required of a trustee in a bankruptcy.

The importance of having a receiver well-versed in the cannabis industry cannot be overstated.Distressed cannabis companies are often prime candidates for receivership. Cannabis is a burgeoning industry with huge growth and profit potential. However, worlds have collided in the Green Rush, where business-minded individuals, often with little knowledge of cannabis, have partnered with individuals well-versed in cannabis culture, cultivation and consumption, but with little experience operating a business. Add a dash of complex state laws and regulatory drama in the form of the federal/state divide on legality, a dollop of fraud potential due to the largely all-cash nature of the business and you’ve created the perfect recipe for insolvency, litigation or both. In these often-chaotic conditions it is easy for a cannabis company to become unprofitable. A receiver can add significant value by stabilizing the business while the litigation proceeds or while developing a restructuring plan. In either case the goal of a receivership is to maximize the value of a business for the benefit of its stakeholders.

If you are considering restructuring options for your cannabis operation, a receivership can be an excellent choice. However, a cannabis receivership is not for the faint of heart. There are two significant areas that distinguish cannabis receiverships from receiverships involving non-cannabis businesses: First, the complex regulatory environment and second, banking. The importance of having a receiver well-versed in the cannabis industry cannot be overstated. Making a mistake in these areas can cause more harm than good. 

Complex Regulatory Environment

Cannabis operations are subject to a complicated regulatory framework that varies by state as well as by type of legalization (medical versus adult use cannabis). Receivers unfamiliar with the cannabis industry and the associated regulatory framework will be behind the curve on day one.

Upon appointment over a cannabis entity a receiver becomes responsible for the regulatory posture of that entity.Regulatory hurdles begin at the outset of a receivership. Although receivership is an excellent restructuring option for cannabis operators in distress, regulations surrounding the authorization requirements for those operating the business on a day-to-day basis (including receivers) vary by state. Some states, but not all, even have specific regulations for receiverships.

For example, the rules and regulations for cannabis operators in Colorado administered by the Colorado Marijuana Enforcement Division (MED) include provisions for receiverships. Specifically, the MED requires court appointees, including receivers, to register with the State Licensing Authority as Temporary Appointee[s] of the Court within seven days of appointment.

Similarly, Washington State cannabis regulations directly address receiverships. Specifically, Title 314 allows receivers or trustees to operate a licensed cannabis business, but the receiver must be qualified by the Washington State Liquor Control Board (LCB). Qualification requirements include  active status on the LCB preapproved receiver list or submission of an application to serve as a receiver for a licensee within two days of appointment. Furthermore, to serve as a receiver of a Washington state cannabis licensee the receiver must meet residency requirements.

Conversely, the Arizona cannabis laws and rules do not specifically address cannabis receiverships. Nevertheless, Arizona does require anyone volunteering or working at a medical or recreational cannabis dispensary to be registered with the Arizona Department of Health Services as either a Dispensary Agent (DA) or a Facility Agent (FA). Therefore, a receiver appointed over a licensed cannabis business in Arizona must obtain the applicable registration upon appointment in order to take control of the licensed entity in a compliant manner.

The fun doesn’t stop after the initial appointment hurdles are cleared. The regulatory environment across the country is a patchwork of complex laws. States that have legalized or decriminalized cannabis on some level have instituted often complex rules surrounding the cultivation, manufacture, wholesale and retail sale of cannabis. Even seemingly simple concepts such as the definition of cannabis are not so simple in some states. For example, Massachusetts includes cannabidiol (CBD) in its definition of cannabis while Arizona does not.

Some states, like California, do not allow the sale of cannabis licenses. Other states, like Colorado, allow for the transfer of commercial cannabis licenses. In a turnaround situation it is particularly important to understand the options available to liquidate a licensee’s assets.

Similarly, many, but not all states have rules requiring cannabis product testing by accredited laboratories prior to retail sale. Most states require THC potency testing, while others (like California and Colorado) also require testing for pesticides and toxins. Conversely, testing for toxins and contaminates is voluntary in Florida. Product testing is expensive and time-consuming, and operators must have a comprehensive system in place to ensure compliant product is available for sale to retail and wholesale customers.

Even taxes are different for cannabis businesses. A receiver must understand and be able to manage a cannabis business in order to comply with and minimize taxes under the infamous 280e regulations of the U.S. tax code.

Upon appointment over a cannabis entity a receiver becomes responsible for the regulatory posture of that entity. Accordingly, the receiver must ensure that any regulatory deficiencies are identified and corrected in order to ensure compliant operation.

We’ve highlighted just a few of the myriad of regulatory concerns facing a receiver upon appointment. It is critical to engage a receiver who has experience working under the complex cannabis regulatory structure for your distressed cannabis operation.

Banking

One of the most important things a receiver does upon appointment is to identify and secure the assets of the entity in receivership, including cash. This normally involves opening a bank account in the name of the receivership entity that is controlled solely by the receiver and moving cash assets into the controlled account.

This typically ordinary task is not so easy with a cannabis operation. Because cannabis remains illegal under federal law, processing funds derived from the sale of cannabis (even sales that are legal at the state level) can be considered by the Department of Justice (DOJ) as aiding and abetting criminal activity or money laundering.A receiver must negotiate the complex banking regulations regarding cannabis businesses and effectively manage the large amounts of cash, which may not be bankable.

The Financial Crimes Enforcement Network (FinCen) issued guidance in 2014 that cleared the way for financial institutions to service canna-businesses (2014 Guidance). The 2014 Guidance requires financial institutions who choose to provide services to CRBs to design and implement a thorough customer due diligence review that includes, in part, analyzing the licensing of the entity, developing an understanding of the business operations of the entity, and ongoing monitoring of the entity. In addition, financial institutions are required to file a Suspicious Activity Report (SAR) for every transaction they process for a CRB, should they choose to accept the business.

While this is a positive step forward, it is a heavy compliance burden that comes at a cost. Naturally, compliance costs incurred by banks to service cannabis operators are passed on to the customer; fees of $2,500 per month per account are not uncommon. The high compliance costs, coupled with the significant regulatory risk, keeps most banks out of the cannabis market; thus, making it hard, but not impossible, for a receiver appointed over a cannabis operation or CRB to obtain banking.

While banking options do exist, the reality is that most canna-businesses operate on a cash basis. Distressed cannabis operations may not have the cashflow to afford banking services, at least at the outset of a receivership. Further compounding the banking problem, some banks that are open to cannabis are not open to receiverships, further limiting banking options.

A receiver therefore must be prepared to quickly secure all cash assets of the receivership entity and ensure appropriate internal controls are in place to control cash on an ongoing basis.

Cannabis has been legalized or decriminalized in a majority of U.S. states but remains illegal at the federal level. Therefore, federal bankruptcy protection is not generally an option available for a distressed canna business. However, not all is lost because state receiverships offer an excellent restructuring option for distressed cannabis operations.

Digital Assets & Cryptocurrency in Cannabis

By Itali Heide
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As the cannabis industry experiences a significant shift toward general acceptance and mainstream adoption, new modes of operation are popping up everywhere. The evolution and expansion of the industry beg for constant innovation, and the integration of NFTs and cryptocurrencies as payment options is at the crossroads between tech and cannabis.

Crypto and NFTs have grown in popularity in recent years. Non-fungible tokens are an interesting asset in the art and collectibles world, while cryptocurrency has made a name for itself by providing a unique kind of financial independence. More and more payment processors are embracing these new payment methods, and the cannabis industry is also slowly welcoming them.

In order to fully understand the cannabis-crypto connection, Swaroop Suri, founder of Melee Dose, a cannabis brand that’s been embracing NFTs and crypto as payment options, shared some insights. Their innovative approach to creating unique cannabis experiences with technology and creative branding makes them a pioneer of this movement.

What’s Happening with Cannabis and NFTs?

NFTs and cryptocurrency are exciting developments in an industry that carries the reputation for having a rocky relationship with the banking industry. The legal gray area surrounding the connection between cannabis businesses and the banking industry has given way to an onslaught of challenges, with many banks shunning cannabis because of its federally illegal status. While traditional banking can limit cannabis companies’ access to basic financial services, the decentralization that’s characteristic of blockchain opens up many doors.

In recent years, different brands have tested the waters by using cryptocurrencies and NFTs to enhance marketing and offer alternate payment options. While it’s still early in the game, trends are starting to appear.

Bitcoin quickly became one of the more popular cryptocurrencies

One of these trends is using NFTs in marketing and branding, creating unique digital assets that can be collected. This gives an air of exclusivity, creates more immersive experiences, and helps forge a brand identity. NFTs are often a great tool to engage with customers and create a sense of community.

Melee Dose recently started integrating NFTs from Bored Ape Yacht Club (BAYC) into product packaging and branding. This has allowed the brand to offer unique experiences, foster community engagement, enhance storytelling and demonstrate adaptability to an ever-changing world.

“This collaboration merges the worlds of fashion, art and technology, providing our customers with exclusive “IRL” products incorporating digital assets and driving brand affinity”, says Swaroop Suri. “By embracing the digital revolution and connecting with the influential BAYC community, we aim to redefine consumer experiences and build lasting relationships with our audience.”

Crypto Payments Aren’t Futuristic Anymore

Payment is another trend to look out for. Cryptocurrencies are becoming more accepted in many big industries, including cannabis. With traditional banks limiting access to banking services, crypto allows cannabis companies to offer decentralized and secure payment options.

Cryptocurrency offers more enhanced privacy than traditional payment methods, which is great for those who want to stay under the radar. Lower transaction fees are another plus, as a decentralized system is more flexible. The speed of crypto payments is also an enticing feature, as payments are usually processed more quickly than traditional payment methods.

Swaroop Suri, Founder of Melee Dose

So, how are brands accepting crypto as payment? Is it safe? Melee Dose started accepting cryptocurrency payments on their e-commerce store by partnering with Coinbase Payments, a leader in the crypto industry with a strong reputation and ease of integration.

Cryptocurrency may seem perilous to those who don’t know much about it, but siding with the right company can help ease those fears. Addressing concerns about crypto volatility, Suri “opted for a feature provided by Coinbase Payments that allows for immediate conversion of cryptocurrency payments into our local currency, ensuring stable revenue despite market fluctuations.”

By working closely with reliable payment partners like Coinbase Payments and implementing necessary features, companies like his are able to successfully overcome crypto roadblocks, providing customers with increased flexibility and convenience.

The Future of Crypto, NFTs & Cannabis

The future of integration between cannabis, crypto and NFTs is exciting and always on the move, meaning there are opportunities constantly arising and challenges ahead we have yet to tackle. As cannabis legalization continues to evolve, we might expect changes in regulatory frameworks that impact how cryptocurrency is used in the industry. While we can’t say what those changes might be, the fact that NFTs and crypto have become mainstream indicates a clear adoption, as the industry finds ways to integrate them. From blockchain integration and creative marketing to payment options and immersive experiences, they are here to stay.

Swaroop Suri and his team might’ve gotten in on the game early, but they know the future is expansive: “It’s possible that NFTs could become a significant part of cannabis marketing strategies in the future,” He says. “The cannabis industry can use NFTs in various ways, such as tracking crops and using intellectual property to promote products through packaging artwork, which is what our team at Melee Dose has accomplished.”

NFTs won’t stop there. “There is a possibility to use NFTs for establishing VIP programs that offer exclusive discounts and access”, Suri says. “The ownership of an NFT could grant special privileges and perks to customers when shopping with an e-commerce company, fostering a deeper connection with the brand and community and leading to customer loyalty in the long run.” NFTs offer diverse possibilities for cannabis brands to improve their marketing techniques and get creative.

When it comes to crypto payments, brands will surely continue to add crypto as an option in addition to merchant processors. Highly-regulated industries like cannabis can find many benefits in crypto, as experienced by Suri: “Accepting cryptocurrency can mitigate some of these issues by providing an alternative payment option that is not subject to the same restrictions as traditional payment methods.”

Final Thoughts

The excitement surrounding crypto and NFTs is understandable, and as the cannabis industry introduces new opportunities for those who are at the intersection of these two global forces, companies everywhere are changing their relationship with technology.

There are other brands hopping onto the this train as well. Household cannabis brands and popular companies like Plain Jain, Highland Pharms, American Green and Pharma Hemp are just some of the many that have begun accepting crypto as payment.

As the industry continues to evolve and grow, staying ahead of the curve and embracing technology with critical thinking and environmental consciousness is key. As a new, dynamic and exciting space with as many opportunities as it is filled with challenges to tackle down the road surrounds us, the one thing we know for sure is that this is just the beginning.

Financing the Cannabis Industry Part 3: A Q&A with Matt Hawkins, Founder of Entourage Effect Capital

By Aaron Green
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Businesses often require outside capital to finance operating activities and to enable scaling and growth. Financing in the cannabis industry is notoriously challenging with regulatory obstacles at the local, state and federal levels. Recent market dynamics pose additional challenges for both financiers and cannabis operators.

We sat down with Matt Hawkins, Founder and Managing Partner of Entourage Effect Capital (EEC) to learn more about EEC and to get his perspective on recent market trends.

Aaron Green: In a nutshell, what is your investment/lending philosophy?

Matt Hawkins, Founder & Managing Partner at Entourage Effect Capital

Matt Hawkins: Entourage Effect Capital’s long history and experienced leadership allow us to access and construct high potential later-stage growth investments with sought-after industry leaders. We want to get ahead of what is happening on the regulatory and federal level to build scale with our investments.

Green: What types of companies are you primarily financing? What qualities do you look for in a cannabis industry operator or operating group?

Hawkins: Essentially, we are focused on investing in companies that will benefit the most when legalization occurs. We are currently working on multiple such deals, and separately, we are excited by how our newly minted, early-stage focused Arcview Ventures Seed Fund will provide a pipeline to the next generation of leading growth opportunities. When evaluating opportunities, we always look for the potential for scale and a strong management team.

Green: Capital market dynamics have led to significant public cannabis company revaluations in 2022. How has this affected your business?

Hawkins: As an industry, we all want companies to be valued for what they are worth, and right now, there are a lot of companies where that’s not the case due to the downturn in valuation. For us, it works the other way, because we are now able to invest at lower valuations with the hope of more upside when valuations reset.

Green: Debt on cannabis companies balance sheets have increased significantly in recent years. What is your perspective on that?

Hawkins: Debt is at its highest in industry. Operators don’t want to take equity capital at this point because valuations have come way down. However, we are lucky to have been in this business for a long time so that we can create our own deals. Our reputation precedes us — as a result, combined with the strength of our portfolio, people want us in their capital stack.

Green: How does the lack of institutional investor participation in the cannabis industry affect your business?

Hawkins: The lack of institutional capital in the industry makes it difficult for a large chunk of companies to grow and scale. For the industry to grow, there needs to be a different type of investor, investors who are not scared to go through the peaks and valleys we go through as an industry, whereas retail investors take their losses and move on. Everybody’s competing for the same small pool of money; managing cash is the most important factor for operators, whether private or public, big or small.

Green: What would you like to see in either state or federal legalization?

Hawkins: The illicit market still has a strong presence, and until we get regulatory reform, it’s going to continue. Reducing the tax burden on legalized markets would bring more revenue to both operators and the government because they’d reduce the market share of the illicit market, with the price offset trickling down to the retail customer.

Passing the SAFE Banking Act would create consequential changes for the cannabis industry. There is also a small chance that the New York Stock Exchange and the Nasdaq could start listing legal plant-touching businesses. If that happens, more institutional capital would enter the market and flush the industry with cash, with market caps going way up. There is a lot of unease and uncertainty with retail investors that prop up the stocks in the space, and it will continue until there is regulatory movement, even on the private side.

Green: What trends are you following closely as we head towards the end of 2022?

Hawkins: I don’t see anything happening unless the SAFE Banking Act passes. Otherwise, things are status quo, especially with public companies. For private companies, we’re going to see a lot more consolidation, especially in California.

M&A in Cannabis: A Guide for Buyers and Sellers

By Abraham Finberg, Rachel Wright
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Mergers and acquisition activity in the cannabis space tripled from 2020 to 2021, and that pace is on track to continue in 2022. With big players entering the global cannabis market, we’re fielding more questions about mergers and acquisitions of cannabis businesses.

In this guide, we look at the evolution of the U.S. cannabis industry and some best practices and considerations for M&A deals in this environment.

The New Reality of Cannabis M&A Activity

The industry has evolved since adult use cannabis was first legalized in some U.S. states in 2012. More cannabis companies have a professional infrastructure—legal, financial and operational—with executive teams and board members ensuring the organization establishes proper governance procedures. Investors and private equity firms are showing more interest, and some cannabis companies have celebrated their first IPOs on the Canadian Securities Exchange (CSE).

At the same time, we are seeing a kind of “market grab” by multistate operators (MSOs) looking to acquire various licenses and expand their market share. MSOs tend to understand the current state of the market. For example, in California and some other states, there is a surplus of cannabis on the market for various reasons, partially due to so-called “burner distribution”—rogue distributors using licenses to buy vast amounts of legally grown cannabis at wholesale prices and selling the product on the black market, thereby undercutting retailers and other legal cannabis businesses. Another reason for the surplus is simply the entrance of many legal cultivators into the market over the past year.

Due to these trends, MSOs are interested in acquiring the outlets to be able to sell the surplus cannabis within California and other new markets.

Transferring Cannabis License Rights

One of the biggest challenges to M&A activity in the cannabis sector is the difficulty of transferring or selling a cannabis license.

Different types of cannabis licenses in California

Cannabis licenses are not expressly transferable or assignable under California law and many other states. However, the parties involved aren’t without options. For example, a business that is sold to a new owner may be able to retain its existing cannabis license while the new owner’s license application is pending, as long as at least one existing owner is staying on board. At the state license level, a change of up to 20% financial interest does not constitute a change in ownership, although the Bureau of Cannabis Control (BCC) must be notified and approve the change.

This process can take a while—often a year or more—since licensing involves overcoming hurdles at the local level as well as the state level with the BCC. It’s crucial to talk with legal counsel about the particulars of the license and location early in the process to best structure the terms of the agreement while complying with state and local requirements.

Seeking a Tax-Free Reorganization in the Cannabis Space

In many cannabis mergers and acquisitions, the goal is to accomplish a tax-free reorganization, where the parties involved acquire or dispose of the assets of a business without generating the income tax consequences that would result from a straight sale or purchase of those assets.

IRC Section 368(a) defines various types of tax-free reorganizations, including:

Stock-for-stock exchanges (IRC Section 368(a)(1)(B)

In a stock-for-stock reorganization, all of the target company’s stock is traded for a portion of the stock of the acquiring parent corporation, and target company shareholders become minority shareholders of the acquiring company.

Often, it’s tough to meet the requirements to qualify for this type of tax-free reorganization because at least 80% of the target stock must be paid for in voting stock of the acquirer.

Additionally, companies may be saddled with too much debt. If the acquirer assumes that debt, it may be classified as consideration paid to the seller and therefore disqualify the transaction as a tax-free reorganization.

In other M&A deals, the acquiring corporation may be unwilling to assume the debt of the target corporation—perhaps because showing these items on its balance sheet would impact its debt-to-equity and other financial ratios.

Stock-for-asset exchanges (IRC Section 368(a)(1)(C)

Rather than acquiring the target company’s stock, the acquirer may purchase its assets. In a stock-for assets exchange, the buyer must purchase “substantially all” of the target’s assets in exchange for voting stock of the acquiring corporation.

A stock-for-assets format offers the buyer the benefit of not having to assume the unknown or contingent liabilities of the target. However, it’s only feasible if the acquirer purchases at least 80% of the fair market value of the target’s assets AND all or virtually all of the deal consideration will be stock of the acquirer.

Tax Consequences Arising from Sale of Assets

If the sale price doesn’t consist primarily of the buyer’s stock, the transaction may be a standard asset sale. This leads to very different tax results.

If the seller is a C corporation, it will typically face double taxation—paying tax once on the sale of assets within the corporation and again when those profits are distributed to shareholders. If the target company has net operating losses (NOLs), it can use those NOLs to offset the tax hit.

If the seller is an S corporation, it won’t have to pay corporate tax on the transaction at the federal level. Instead, shareholders will pay tax on the gain on their individual returns.

For the buyer, the benefit of an asset sale is that the assets acquired get a “step-up basis” to their purchase price. This is beneficial from a tax perspective, as the buyer can depreciate the assets and may be able to claim accelerated or bonus depreciation to help offset acquisition costs.

Reverse Triangular Merger

Often, in practice, we come across what is termed as a reverse triangular reorganization. In this type of merger,

  1. The acquiring company creates a subsidiary,
  2. The subsidiary merges into the target company before liquidating,
  3. The target company then becomes a subsidiary of the acquirer, and
  4. The target company’s shareholders receive cash.

Structuring the deal this way may work to overcome the hurdle of transferring the license but may not qualify as a tax-free reorganization.

Bottom Line

The circumstances and motivations for mergers and acquisitions in the cannabis industry are diverse. As a result, there is no one-size-fits-all approach to structuring the transaction. In any event, it’s crucial to start the process early and seek advice from legal counsel and tax advisors to minimize the tax burden and ensure that both parties to the transaction get the best deal possible. If you need assistance, contact your 420CPA strategic financial advisor.

Cannabis Receiverships: A Viable Alternative to Bankruptcy

By Oren Bitan
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Doing business in California’s legal cannabis industry remains a risky endeavor. The majority of the industry is still unlicensed, tax rates at the state and local levels are high (notwithstanding a recent reprieve from California’s cultivation tax) and there are not enough licenses to meet geographic demand throughout the state. Outside financing remains difficult to secure for equipment, tenant improvements, account receivables and working capital because, under the federal Controlled Substances Act (CSA), cannabis remains a Schedule I narcotic. Therefore, entrepreneurs, investors and lenders who have stakes in state-sanctioned cannabis enterprises expect to see returns that justify the higher level of risk, which places additional financial pressure on cannabis businesses. In addition to the industry specific challenges, the United States economy is on the verge of a recession that may further hamper the industry notwithstanding the industry’s resiliency during the pandemic when it was deemed to be an “essential” industry that benefited from consumer spending of stimulus monies.

These outside pressures increasingly lead to ownership disputes and creditor defaults that result in litigation and the need for restructuring. In some instances, business partners cannot agree about control and finances of the licensed businesses and in other instances unpaid creditors file suit to enforce their interest in a company’s assets. And sometimes a local municipality discovers wrongdoing by an operator and initiates a health and safety lawsuit to cease the illegal condition.

Bankruptcy reorganization is an option typically utilized by struggling businesses to shed or restructure debt. Cannabis businesses, however, cannot take advantage of bankruptcy remedies because bankruptcy is a product of federal law and federal law still prohibits the sale of cannabis.

As a result, stakeholders in legal California cannabis enterprises must consider alternatives to bankruptcy to collect what they can on their loans and investments in the event the enterprise becomes insolvent or requires restructuring. A well-established alternative to bankruptcy is a state court remedy – the appointment of a receiver over the assets of a business or over the entire business operations. Through the receivership process, stakeholders may obtain many of the same protections available to them through bankruptcy

A. Federal Illegality Bars Access to Bankruptcy Protection

Over the past ten years, bankruptcy courts have routinely prohibited licensed cannabis businesses from seeking bankruptcy protection because cannabis remains illegal at the federal level under the Controlled Substances Act (CSA). Bankruptcy trustees are typically charged with managing and operating property in the same manner that the owner would be bound to do if in possession thereof. Because cannabis remains illegal at the federal level, trustees are not able to manage and operate licensed cannabis businesses.

B. Receivership as an Alternative to Bankruptcy

Under California law, a receiver is a neutral agent of the court appointed to preserve, control, manage and ultimately dispose of property that is subject to the litigation before the court.1 The receiver, therefore, holds property for the court, not the parties to the litigation.

Appointment of a receiver is a statutory provisional remedy. Other than corporate dissolutions under Code of Civil Procedure section 565, the law does not have a specific cause of action to appoint a receiver. Thus, the proponent of a receiver must have a valid cause of action in an underlying lawsuit.

1. The Appointment of a Receiver

The appointment of a receiver rests within the trial court’s discretion. Code of Civil Procedure section 564 contains the broadest statutory authority to appoint a receiver. Subdivision (b), details twelve possible situations in which a receiver may be appointed, most of which are beyond the scope of this article. The most common of these is a lender’s request to appoint a receiver when a borrower defaults on a loan and the lender seeks the appointment of a receiver over its collateral. The statute, however, clarifies that the situations listed in the statute are not exclusive: a court may appoint a receiver “[i]n all other cases where necessary to preserve the property or rights of any party.”

The receiver’s powers are limited by the statute under which the court appointed the receiver and those conferred by the court. The appointment order should, therefore, detail the duties the receiver owes to the court, and actions that the court authorizes the receiver to take to perform those tasks. The order should also specify the property that will be part of the receivership estate.

2. The Receiver’s Powers

The receiver has general statutory powers.2 The statutory powers include (i) commencing or defending litigation; (ii) taking and possessing property of the receivership estate, (iii) receiving rent, collecting debts, and making transfers, and (iv) acting in accordance with the court’s instruction with respect to the property.3 But the court’s authorization is necessary to sue the receiver and for the receiver to commence litigation.4 In the foregoing scenarios, the receiver is immunized personally from tort liability, but not in his or her official capacity as receiver.5

In addition to taking possession of property, the receiver may dispose of receivership property with the court’s approval.6 If the receiver is an equity receiver, the receiver may take possession and satisfy creditors from all the debtor’s assets.7

The court may further authorize the receiver to issue “certificates of indebtedness” to raise money to administer the receivership estate.8 This device permits the receiver to provide liquidity to the estate and gives the certificate holder an interest-bearing priority claim against the receivership estate.

3. Liquidating Cannabis Assets Through a Court Appointed Receiver

After the court appoints the receiver, the receiver should have sufficient powers to, among other things: (i) take over the management of the company; (ii) open bank accounts; (iii) borrow money by issuing receivership certificates; (iv) manage all of the company’s property; (v) hire counsel and other professionals; and (vi) sell the receivership estate’s assets for the benefit of the creditors. To maximize repayment to the creditors, the receiver may hold an auction to sell the assets and assist in facilitating the cancellation of company’s state license while the buyer of the assets secures its state license after the local license is transferred.

State cannabis licenses may not be sold or transferred.9 Yet, to maximize recovery for the creditors, the receiver may need to participate in the regulatory process to maintain a license during the pendency of the receivership and to assist in the amendment of a license while a prospective buyer seeks to obtain its own license. To do so, the receiver will first need to qualify as a licensee under state law to join as a licensee on the license and further the licensee as a going concern. Next, the principals of the prospective buyer will themselves need to qualify as licensees under the license. Then, once the sale of the company’s assets (including any interest in the license) to the buyer closes, the receiver and the company’s original owners will terminate their capacities as licensees of the license, leaving only the new owners as licensees. Thus, the proposed order should be written with attention to ensure the receiver has powers to further the foregoing and not diminish the value of the receivership estate.

After the conclusion of the sale of all assets, the receiver will need to obtain a discharge from the court of his or her duties as receiver. The receiver may do so by the parties’ stipulation or by motion. Together with the request for a discharge, the receiver should seek approval to pay: (i) any lenders to the receivership estate; (ii) professionals that the receiver hired; and (iii) him or herself for his or her services. Upon the court’s approval, the receivership will be terminated.

The conflict between federal and California law regarding cannabis continues to be an impediment for stakeholders in California’s cannabis market. Because of this conflict, stakeholders in California’s legal cannabis market lack access to vital traditional institutions, such as bankruptcy remedies. As a result, stakeholders must be prepared to consider alternatives such as a court appointed receiver, which can be a useful alternative to both secured creditors and unsecured creditors. Stakeholders who pursue a court appointed receiver will benefit from a long-established body of law and experienced professionals.

References

  1. Cal. Rules of Ct., r. 3.1179(a).
  2. Cal. Civ. Proc. Code §§ 568-570.
  3. Free Gold Mining Co. v. Spiers, 136 Cal. 484, 486 (1902); Steinberg v. Goldstein, 129 Cal. App. 2d 682, 685 (1954).
  4. Vitug v. Griffin, 214 Cal. App. 3d 488, 493 (1989).
  5. Chiesur v. Superior Court, 76 Cal. App. 2d 198, 201 (1946).
  6. Helvey v. U.S. Bldg. & Loan Ass’n, 81 Cal. App. 2d 647, 650 (1947).
  7. Turner v. Superior Court, 72 Cal. App. 3d 804, 812 (1977).
  8. Cal. Civ. Proc. Code § 568.
  9. See e.g., Cal. Code Regs. tit. 16, § 5023(c).

A Q&A with George Mancheril, Founder & CEO of Bespoke Financial

By Cannabis Industry Journal Staff
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Bespoke Financial was the first licensed FinTech lender focused on the legal cannabis industry. Founded in June of 2018, Bespoke offers four types of lending products: Invoice financing, inventory financing, purchase money financing and a general line of credit. With just over two years of originating loans to clients, they have benefitted from being a first mover in the cannabis lending space.

George Mancheril is the founder and CEO of Bespoke Financial. He has over fourteen years of experience in finance, with a special focus on asset-based lending, off balance sheet financing of commercial assets and structured credit. Following a stint with Goldman Sachs, he worked at Guggenheim Partners Investment Management’s Structured Credit Group in Los Angeles where he worked on structuring esoteric asset financing for a variety of commercial assets including airplanes, container leases and receivables.

Since 2018, Mancheril and his team at Bespoke Financial have deployed over $120 million in principal advances without any defaults and across eleven states. We sat down with Mancheril and asked him about the history of his business, how it’s been received so far and how the past few years of financial activity in the cannabis sector might shape the future.

Cannabis Industry Journal: What is Bespoke Financial in a nutshell?

George Mancheril: Bespoke Financial is the first licensed FinTech lender focused on the legal cannabis industry. Bespoke offers legal cannabis businesses revolving lines of credit that address the top problem in the industry – lack of access to non-dilutive, scalable financing to capitalize on growth opportunities and improve profitability. Due to the federal illegality of cannabis, traditional banking institutions cannot work with our clients even though these operators are working within the legal regulatory framework of their state. Bespoke solves this problem for businesses across the cannabis supply chain along with ancillary companies affected by the lack of access to traditional capital markets.

CIJ: How does your company help cannabis businesses?

George Mancheril, Founder & CEO of Bespoke Financial

Mancheril: Bespoke Financial offers 4 lending products – all are structured as a revolving line of credit but each allows our clients to access capital in a unique way based on their specific needs. Our Invoice Financing product, allows businesses to borrow capital against their Accounts Receivables in order to manage general business expenses, particularly if the borrower’s business growth is slowed due to a long cashflow conversion cycle. Inventory Financing and Purchase Money Financing allow our clients to finance payments to their vendors, which helps our clients achieve economies of scale by increasing their purchasing power. Lastly our general Line of Credit allows for the most flexibility for our clients to utilize our financing by either financing payments made directly to vendors or drawing funds into the client’s bank account to manage business expenses.

CIJ: I know the company is only a few years old, but can you tell me about your company’s success so far?

Mancheril: [Clarification, Bespoke was founded in June 2018 so we’ve been around for 3 years but we now have over 2 years of originating loans to clients.] Bespoke Financial has benefitted by being a first mover in the cannabis lending space as the first licensed lender specifically addressing the financing needs of cannabis operators, starting in early 2019. Over the past 2 years we have developed and refined our proprietary underwriting model to identify over 50 active clients spanning the entire cannabis supply chain. Since inception, Bespoke has deployed over $120 million in principal advances without any defaults to date and expanded our geographic footprint across 11 states. Our growth and success highlights our company’s expertise in structuring financing solutions which address the unique capital needs of cannabis companies.

CIJ: Can you discuss how the recent M&A activity, current and recent market trends, as well as the pandemic has affected your company’s growth?

Mancheril: The cannabis industry overcame a variety of challenges presented by the COVID-19 pandemic, ending the year with record sales in both new and existing markets. The support from state and local governments, evidenced by the industry’s essential business designation and the easing of regulations, coupled with increasing consumer adoption of cannabis combined to increase the industry’s demand for capital throughout the pandemic. Bespoke was well positioned to partner with cannabis companies across the supply chain and was proud to help our clients thrive during this pivotal period.

Jeeter was able to grow sales over 1,000% within the first year of working with Bespoke

Coming into 2021, the cannabis industry and investors shared a very positive outlook for the future based on the previous year’s experience and expectations of material easing of federal regulation. While M&A activity in the industry has increased over the past 6 months, the overall consensus has been that both the frequency of exit opportunities and the corresponding valuations will continue to increase as federal decriminalization opens new sources of capital and materially changes investors’ valuation assumptions. In general, we’ve seen cannabis companies focused on both capitalizing on the increasing opportunity presented by the industry’s organic growth and maximizing the benefits of future regulation changes by utilizing the resources and capital currently available to increase revenue, expand into new markets, and work towards profitability. All of these factors have further compounded the industry’s demand for financing and we expect to see continued growth in our lending activity in line with the industry’s growth.

CIJ: Who has been your most successful client?

Mancheril: We have a handful of cases studies and client success stories here on our website. One of the most exciting growth stories we have seen has been our client DreamFields whose in-house brand, Jeeter, is now the #1 pre-roll brand in the state of California. Prior to working with Bespoke, the brand was not ranked in the top 25 but was able to grow sales over 1,000% within the first year of working with us and achieve the #1 spot in their product category.

A Q&A with Rob Sechrist, President of Pelorus Equity Group and Manager of the Pelorus Fund

By Aaron Green
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The cannabis industry in the United States represents about a $50 billion asset class making it one of the largest new asset classes in the country. Commercial real estate lending is a key enabler for companies seeking to expand and scale. Pelorus Equity Group is one of the largest commercial lenders in cannabis with over $170 million deployed since its first cannabis transaction in 2016.

Since 1991, Pelorus principals have participated in more than $1 billion of real estate investment transactions using both debt and equity solutions. Pelorus offers a range of transactional solutions addressing the diverse needs of cannabis related business operators. While most cannabis private equity lenders focus on real estate acquisition and refinancing, Pelorus has leveraged its experience in more than 5,000 transactions of varying size and complexity to offer value-add loans, a rarity in the industry.

We spoke with Rob Sechrist, president of Pelorus Equity Group and manager of the Pelorus Fund. Rob joined Pelorus in 2010 after several years in the California real estate market. In 2018, Pelorus launched the Pelorus Fund where Rob is currently the manager. The Fund converted to an REIT in 2020.

Aaron Green: How did you get involved in the cannabis industry?

Rob Sechrist: Pelorus is a value-add bridge lender. We’ve been lending for a long time, originally in the non-cannabis space. We’ve done 5000 transactions for over a billion dollars – more than a lot of banks.

In 2014, our local congressman Dana Rohrabacher passed the Rohrabacher-Blumenauer Amendment that defunded the Department of Justice from prosecuting any cannabis related business in a medically licensed state. We were a supporter of that legislation and once that passed, we took a serious look at utilizing our expertise in being a value-add lender and applying it to the largest asset class of real estate that is newly coming about today. That cannabis related asset class is about $50 billion.

Rob Sechrist, president of Pelorus Equity Group and manager of the Pelorus Fund

We decided that we had the expertise to move into this space and to build these facilities out for our borrowers so that the cannabis use tenants would have a fully stabilized facility and make it operate. After the amendment passed in 2014, by 2016 we had originated our first transaction. Since that time, we’ve originated 51 transactions in the cannabis space for over $177 million so far. It wasn’t that big of a pivot when you’re just providing the value-add loan.

“Value-add” in the loan business means that a portion of the loan amount, let’s just say is a million dollars, maybe 250,000 of that, is a pre-approved budget to go back into the property. In cannabis property those are typically tenant improvements and/or equipment to fully stabilize that tenant. So, we’re the first fully dedicated lender in the nation exclusively to cannabis and we’ve done more transactions than anybody else in the nation.

Green: What are some challenges of cannabis lending compared to traditional lending?

Sechrist: The number one challenge in cannabis is that you must disclose to your investors that you’re originating the loans to cannabis use tenants. Many people have concerns that lending indirectly might be federally illegal. If you did not disclose that to your investors when you form that capital stack to fund these transactions, you’re going to run into issues. So, you would need to create a vehicle where you disclose to your investors that you’re intending to lend into cannabis and it’s still federally illegal. Doing one-off stand-alone transactions deal by deal is not sustainable if you’re going to be a large lender.

There are other challenges. Because cannabis is still federally illegal, it gives insurers and other third parties the ability to deny a claim, or certain lender protections. Some examples include errors and omissions insurance, title insurance, property insurance, etc. and all of them say in those policies that if you’re doing something federally illegal, then the policy is null and void. So, you must think your way through very carefully all the things that could potentially be an issue. You also have to disclose to those third parties and find a way to get them to acknowledge it to make sure you have the coverage if you ever have to make a claim. That’s a very difficult process.

Green: How has the investor profile in cannabis lending changed over time?

Sechrist: Our fund was structured to allow for institutional capital from the inception. We were able to do that because we are completely non-plant touching. Our fund only lends to the owners of commercial real estate. We do not lend to any cannabis licensed operator directly whatsoever. Our borrowers – the owners of the properties – would then have a lease agreement with the cannabis use tenant. Even if it’s an owner-operator, those are separate entities. That’s how we’ve distinguished ourselves.

Pelorus Equity Group, Inc. Logo

Regarding the investor profile, the first $100 million plus we raised was primarily from retail investors who were individuals writing checks up to a million dollars. Once we had three years of audited track record and our fund was $100 million, we then pivoted over to family offices and institutional investors and pension funds. We’re now working primarily with those types of investors.

The reason that we started with retail investors is that it’s very easy for me to explain our model to a single decision maker and answer their questions. Once I move into family offices or institutional investors, the opportunity goes to a credit committee where I’m relying on some other party to educate the investor about our investment. It’s enormously challenging at that point if it’s not me doing the talking. I know the answers, but I’m having to rely on somebody else to answer questions. We’ve tried to educate everybody we speak with and craft our documentation in such a way that even when it’s not myself answering the questions directly, people can understand how we thread the needle through some of the legal hurdles.

Green: How do you prioritize deal flow, and what are the qualities of a successful loan applicant?

Sechrist: We typically maintain a pipeline of around $150 million in transactions at any one time.

Applicants must have real estate. We’re not doing business loans or operator loans directly to tenants or business operations. So, that’s the starting point. We want a real estate piece of collateral where we feel more than comfortable with the loan-to-value and ratios and the loan to cost and other figures, that we feel that this transaction is going to be a success for our borrower and ultimately the tenant.

Next, we will only work with very experienced operators who have a proven track record where this is not their first transaction. Ideally, we are working someone who is looking to expand their operations and who is ready to either move from being a tenant of their previous facility and buying their next facility.

The next aspect that we’re looking for is the strength of the borrower’s guarantor. They must be able to qualify to support that transaction. Many of our transactions are millions or 10s of millions of dollars. You must have a sponsor that can support that size of a transaction.

Green: What sort of value-adds should a cannabis property owner look for in their lender?

Sechrist: Most people that are looking for loans are only familiar with getting loans for themselves on their owner-occupied house. Most loans have points, they have a rate and a term, loan-to-value and things like that.

“We wanted to make sure that when we underwrite the transaction, that every single piece of capital is necessary to get that facility all the way to where that tenant can start generating their first crops and make their lease payments.”When you move into construction loans or value-add lending, there are other elements that are more important than the pricing of the loan. The number one thing is to get that property fully stabilized and built as quickly as possible. Cannabis tenants are generating 10 to 15 times more revenue per month than non-cannabis tenants.

If you go to a bank and borrow money it may be a third of what it costs to borrow from us, but they process draws maybe once a month. So, if you’re having to advance the money for improvements of the property, and then the bank reimburses once a month, at a certain point you’re not going to be able to advance any more money until you get reimbursed. The project comes to a stop. So, in your mind, you might have saved an enormous amount on the pricing of the rate, but it’s costing you dearly in revenue and opportunity costs. We typically process 50 to 100 draws post-closing on transactions, and we get that facility built and the money reimbursed to all the contractors on a multiple-times-a-week basis. It’s happening in real flow all the time.

A typical problem for a tenant is that the tenant improvements are orders of magnitude higher than a non-cannabis tenant – anywhere from $150 to $250 per square foot. In addition, the equipment is often enormously expensive as well. It’s tough to put money into a buildout for a building that you may not own. Our vision at Pelorus was, let’s not force these tenants – the cannabis operators – to raise equity at the worst possible time when they’re not generating revenue through the facility. Let’s shift that capital balance for those tenant improvements and equipment from the from the tenant to the owner of the building, which is where it’s secured and adds value to that building anyway. Our vision was to shift that money from the balance sheet of the tenant over to the owner of the real estate so the tenant didn’t have to sell equity to come up with that money. Then the tenant is paying for the improvements in the lease rate and the borrower is paying for improvements in the note rate. And so we’ve shifted tenant improvements from being an equity component to now it’s just priced in the debt. This way you know what the terms are and you know what your total exposure is there.

We wanted to make sure that when we underwrite the transaction, that every single piece of capital is necessary to get that facility all the way to where that tenant can start generating their first crops and make their lease payments. Most of our peers in the space don’t look at it that way. They just do the acquisition or the refinance. They don’t do anything for the tenant improvements. They don’t do anything for the equipment. The tenant is left out there to either raise that equity or the borrower – the owner of the real estate – is having to come up with that additional capital on their own. We think you’re set up for failure in that circumstance. So, we blend all that into one capital stack. It’s important that the tenants can get all the way up to being able to cash flow and support that facility and be fully stabilized so they can refinance into a lower cost bank or credit union transaction.

Green: What federal policies and trends are you monitoring?

Sechrist: First, I think that it’s important to remind people that the Rohrabacher-Blumenauer Amendment has protected everybody from any prosecution. So, there’s no jeopardy out there that exists. The second thing I like to tell people is there are 695 banks on FinCEN’s website of cannabis Tier 1 depositors, and of those, we’re tracking numerous FDIC insured state banks and credit unions that are lending directly. We’ve been paid off by banks.

So, there’s this massive misconception that there’s no banking at all and that everything is happening by cash. The only cash buildup that happens is at the retail dispensary level because credit cards aren’t allowed for retail sales at the dispensaries. Out of the 2,000 transactions that we’ve either processed or reviewed, not one has ever not had banking set up. So, it is a big misnomer that there’s no depositor relations for Tier 1 banking, which is plant touching.

Tier 2/3 depositors are ancillary, which is what we are at Pelorus. There are 100 private lenders and dozens and dozens of state and federal credit unions or state banks and credit unions, not federal, that are FDIC insured and lending. Those banks are difficult to get loans from because they only want to do urban environments. They want to do fully stabilized companies and they want to use alternative views and the facility has to have seasoning for cash flow. It’s difficult to qualify for them. So, banking and lending exists out there, and most people are not aware of that.

Green: What are you most interested in learning about? This could be either in cannabis or in your personal life.

Sechrist: My two passions are snowboarding and racetrack driving. I just came back from the Mille Miglia race in Italy, and I do a lot of driving on the racetracks. I’m always looking to learn from those experiences.

In the cannabis sector, social equity programs are happening across the nation and cannabis licenses are being issued to operators. We would like to help participate in some system of educating these applicants that win the awards. Lending to an owner of a property who just won a license but has no experience is going to be problematic. Somebody needs to be thinking that out and making sure that these people that win have enough experience and education to set them up for success. Cannabis is one of the most complicated businesses ever, and they’ve got this license as their ticket, but they need to know how to make sure they’re going to be successful.

Green: Great Rob, that concludes the interview.

Sechrist: Thanks Aaron.

Buyer Beware For Distressed Cannabis Assets

By Joanne Molinaro, Geoffrey S. Goodman, Ronald Eppen
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The legalized cannabis industry remains a budding market in the United States. As the legislative dominoes started to cascade from state-to-state across the country, entrants of all categories—operators, investors, lenders, and retailers—were willing to stand in line for their tickets.  However, signs of fatigue, caused largely by the continuing murkiness of regulatory guidance and investors’ waning appetite for reading the legislative crystal ball, were already surfacing towards the end of 2018 and continued its slide downward into 2019. From March 2019, market capitalization for the 33 biggest cannabis stocks was down 45% by the end of 2019, falling from $54 billion to $30 billion and projected revenues dropped a whopping 17% as well.

Has COVID Made Things Worse?

Against this backdrop, COVID-19 arrived on the scene. Surprisingly (or perhaps not), cannabis seemed to be somewhat insulated from unprecedented disruptions to supply chains and artificial nose dives in demand. Many operators noted a sharp uptick in sales as states implemented shelter-in-place orders. Ironically, the supply chain hurdles created by the lack of federal legalization rendered operators—even multistate operators (MSOs)—uniquely equipped to handle the supply chain woes that others were struggling to contain. Meanwhile, as more and more states slapped the essential label onto both medical and adult use cannabis, operators were permitted to run business as usual (under the circumstances) and legalized cannabis started to look a little more “normal” in the most abnormal of times.

Thus, for a moment, cannabis looked like it might be a counter indicator (or recession-resilient)—while others were going down, cannabis was going up. But, after this brief surge, sales settled down and states began reporting decreases from this time last year and the outlook for the cannabis industry remains unclear.

Is This An Opportunity?

Declining demand, coupled with the issues described above, spells cash-flow problems for cannabis companies – many of which are still relative “infants” compared to their consumer goods counterparts and thus may have yet to create a “rainy day fund.” However, liquidity issues can create opportunities for those who still have cash to inject. In the last year, 13 special-purpose acquisition companies (SPACs) have listed on exchanges with an eye towards “cheap cannabis assets.”Cheap cannabis assets (or distressed cannabis assets) can offer a lowered barrier to entry into what many still believe to be a bull market. However, investors should proceed with caution. While the assets themselves may bear bargain basement price tags as the world grapples with the current recession, the cost of entry is more onerous than many realize. It is thus critical for potential investors to do their pre-due diligence on the who, what, when, where and how of acquiring distressed cannabis assets.

Where Do Distressed Cannabis Companies Go?

Ordinarily, distressed companies requiring capital restructuring look towards the US Bankruptcy Code. Deploying the broad injunctive relief afforded by the automatic stay as both a sword and shield, ailing companies can focus on lining up debtor-in-possession financing while they prospect feasible long-term exit strategies (through a reorganization, asset sale, or some combination of the two). The other major advantage of a chapter 11 is, of course, the “free and clear” order—the veritable clean slate provided by a federal court to good faith purchasers of the distressed assets that allow buyers to proceed with very few strings attached.

These federal benefits are not available to adult use and medical cannabis companies (hemp companies can file for chapter 11). Indeed, some bankruptcy courts have shut the door on not just the operators themselves, but companies that have even tangential dealings with cannabis companies.  With federal legalization, that will likely change; however in the meantime, distressed cannabis companies must look to pseudo-bankruptcy proceedings that offer some of the benefits that a federal bankruptcy can.

Is A State Receivership A Good Restructuring Vehicle For Distressed Cannabis Companies?

The number one option for many distressed cannabis companies will be state receivership. Much like a chapter 11 bankruptcy, the receivership provides for a stay against actions against the company’s assets, i.e., the breathing space it needs to hatch a plan for rehabilitation or exit the game as painlessly as possible. The receiver will be empowered to run the business while ironing out its operational/cash issues or conduct an orderly sale of the assets, usually through an auction process, during which the secured lender will be afforded the right to credit bid. The costs associated with that sale may be charged to the sale proceeds. Thus, in many ways, the state receivership acts like a federal bankruptcy.

How Is A State Receivership Different From A Federal Bankruptcy?

There are two main differences that investors should be aware of between a federal bankruptcy and a state receivership.

As with anything else that’s up for sale, where there’s a will, there’s a way.First, the court appointed receiver (often handpicked by the company’s primary secured lender) will be calling most of the shots from an operational, transactional, and financial perspective. That receiver may not have the kind of operational know-how of running a cannabis company that a typical debtor-in-possession might, making any major transaction more challenging. Even if the receiver has some background in the cannabis industry, he or she will still have a steep learning curve when it comes to the company’s specific business.

Second, the laws vary from state to state on whether a receiver can sell assets free and clear of any and all liens, claims, and encumbrances without the consent or satisfaction of those claims. Accordingly, buyers of distressed cannabis assets will want to take a close look at potential successor liability risks on a state-by-state basis.

Can Anyone Buy Or Invest In Distressed Cannabis Assets?

While many industries offer pay to play options for investors and lenders, the cannabis industry may not be as welcoming. Many lenders eyeing potentially lucrative refinancing possibilities that include an “equity kicker” (e.g., warrants) should be aware that states and municipalities often require investors aiming to own or control a substantial portion of the company’s business to satisfy most, if not all, of the regulatory requirements for holding the various licenses for operating in the cannabis space. For those interested in MSOs, a deep dive into each applicable state or city’s licensing requirements will be necessary.  Similarly, many states have onerous disclosure requirements for owners or financial interest holders of cannabis companies. Failures to disclose can lead to license suspensions or even forfeitures.

These are just some of the hurdles potential investors and lenders may need to scale. But as with anything else that’s up for sale, where there’s a will, there’s a way.

Jennifer Whetzel

Branding for Cannabis Companies 101: Part 1

By Jennifer Whetzel
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Jennifer Whetzel

Busy entrepreneurs often skip steps in their business development process, particularly in the cannabis space. Since this is a new industry, there isn’t a long history of marketing/advertising efforts to look back on; the standards are still being developed. But more often, businesses simply may not have a budget large enough to pay an agency, and they may not feel confident executing these efforts on their own.

Fortunately, you can do a lot independently to get your name out there. This three-part series will give you a quick primer on branding – what it is, why it’s important and how to do it. But first, we need to discuss the differences between branding, marketing and advertising so that you know what kind of tools you have at your disposal.

What is Branding?

Branding should be considered a prerequisite to marketing and advertising.

Branding: Who
Marketing: What & Why
Advertising: Where & When

Branding is simply thinking about your company from the inside-out. It’s asking yourself questions about the kind of person your brand would be, down to its beliefs, personality and sense of style. Ultimately, we do this to build a deep emotional connection with potential customers. When you know who you are and put yourself out in the world, you’re signaling to them that you are a good match for each other.

When you have a brand that consistently forms emotional relationships with customers, that bond converts to both income and long-term company value, making your spending on marketing and advertising go further. It gives you a competitive advantage over companies with weak or non-existent branding (and in the U.S. cannabis industry, there are plenty of those). Moreover, it’s a key factor that venture capitalists and friendly Fortune 500s look for in potential investments.

So, what should you be asking yourself when it comes to branding? Start with exploring the fundamentals. Decide on the philosophical, emotional and visual characteristics of your brand.

As far as the philosophical questions go, it’s important to codify your mission, brand values, customer promise, core competency and future vision to build a strategic brand. Think about what you’re offering, how it will change lives, and what unique qualities will help you make it all happen.

The Four Ps: Product, Price, Place and Promotion.The philosophical characteristics help you decide who you are. Your emotional characteristics are the ones that connect you with the world. These would include your creation story, your brand personality and tone of voice. How does your brand see and respond to the world? Why? People love consistency. Having a consistent presentation makes your brand feel more authentic; in turn, people are more receptive to you.

The visual qualities are how the world should see you. These assets should include your color palette, fonts, imagery and logo. Making decisions about your brand’s appearance may feel subjective and overwhelming to people, but it doesn’t have to be. Basically, evaluate these ideas and assets in terms of how your audience is likely to respond to these elements. For example, how does your happy-go-lucky audience feel about a logo that is lime green versus corporate blue? Which color best reflects your brand sensibility? You know who you are; the visual characteristics are how you plan to show it.

Marketing

As a discipline, marketing traditionally involves making strategic decisions about the four Ps: Product, Price, Place and Promotion. These decisions become significantly easier once you have defined your brand.

Essentially, marketing addresses the way your brand lives in the world. It tells potential customers what you sell, and why they should choose your brand. It involves making thoughtful decisions and having a strategy for decisions such as product names and your corporate culture.

You also need to think about your pricing strategy and how that manifests in front of customers. For example, are you a high-end product with a premium price or the Walmart of weed? What’s your customer service strategy? Are your budtenders in flannel or lab coats?By now, you know who your brand is and how you want to present it to the world. Now you need to get consumers to see it that way. That’s where advertising comes into play.

Marketing also involves decisions about collateral—namely, your product packaging, brochures, signs and trade show booths. It also impacts your brand’s in-person presence. That could include experiences like events your company attends, trade shows where you have a booth or table, sensory experiences or even AR/VR experiences with your product.

By now, you know who your brand is and how you want to present it to the world. Now you need to get consumers to see it that way. That’s where advertising comes into play.

Advertising

Generally, advertising relates to paid campaigns that are carefully written and designed to tell potential customers where, when, why and how to connect with your brand and buy your products and services.

Fortunately, you have the tools to thrive by putting in the work to get to know your brand.These campaigns are often launched within the space of owned media, such as television commercials, radio and print ads and billboards. There are tons of digital and social media options. Your job is to find the ones that your customers interact with and decide what you want to say about yourself. For example, what kind of sites would you want to place ads on? What state of mind are customers in when they go to those sites? And what message do you want them to get from you in that moment?

Normally, answering these questions would be daunting. But since you’ve already decided who your brand is, you may already know what colors you want to use for this ad. You’ve already considered what your mission is. You know how your brand should appear to the world. And since you’ve unlocked these truths, you’ll be able to develop campaigns that feel genuine, unique, and memorable.

Connecting with consumers and making them remember you isn’t optional. It’s what will ultimately decide whether your business survives or not. Fortunately, you have the tools to thrive by putting in the work to get to know your brand. It’s tough, and it may not come easily at first. But we don’t start a business because it’s easy. We accept the risks and frustrations because we love what we do. Tell everyone why they should too.