Tag Archives: equity

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.

First in the South – Virginia’s Legalization Focuses on Public Safety, Health and Social Justice

By Gregory S. Kaufman, Jessica R. Rodgers
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With the signing of the Cannabis Control Act (the Act) on April 21, 2021, Virginia became the first southern state to legalize adult use cannabis and just the fourth state to do so through the legislature. Legalizing adult use cannabis through the legislature, as opposed to through the ballot box, is not the typical route states have followed up to now. Eleven of the sixteen states and the District of Columbia have legalized adult use cannabis through the use of ballot measures. Virginia joins Vermont, Illinois, New York and New Mexico (which legalized after Virginia) as one of the few states that have gone the legislative route. Under Governor Northam’s administration, the path to legalization was swift, taking less than four months from introduction to passage.

Governor Northam added amendments to the already passed Senate Bill 1406 and the General Assembly voted to approve those amendments, with the Lieutenant Governor breaking the tie in the Senate’s vote. Upon signing, Governor Northam called the law a step towards “building a more equitable and just Virginia and reforming our criminal justice system to make it more fair.” This message and the opportunities to promote social equity through a legal cannabis industry have been consistent points of advocacy made by supporters as the bill advanced to becoming law.

Prior to the Governor’s amendments, the Act under consideration set July 1, 2024 as the date on which both legal possession and adult use sales would begin. The Governor decided to accelerate the date for legal possession to July 1 of this year, a decision believed to have been influenced by data showing that Black Virginians were more than three times as likely to be cited for possession, even after simple possession was decriminalized in the state a year prior. The regulated adult use market is still set to begin making sales on July 1, 2024; however, it remains possible that this date could be advanced through the legislature in the meantime. Nevertheless, Virginia is on track to becoming the first southern state with an operating regulated commercial cannabis market.

Creating an Administrative Structure for the Adult Use Program

Virginia became the first state in the South to legalize adult use cannabis

This sweeping fifty-page law creates the Cannabis Control Authority to regulate the cultivation, manufacture, wholesale and retail sale of cannabis and cannabis product. The Act further lays the groundwork for licensing market participants and regulating appropriate use of cannabis; defining local control; testing, labeling, packaging and advertising of cannabis and cannabis products; and taxation. The Act also contains changes to the criminal laws of the Commonwealth. Companion to the Act are new laws addressing the testing, labeling and packaging of smokable hemp products and manufacturing of edible cannabis products. Additionally, the Cannabis Equity Reinvestment Board was created to address the impact of economic divestment, violence and criminal justice responses to community and individual needs through scholarships and grants.

While persons 21 years or older may possess up to one ounce of cannabis and cultivate up to four plants for personal use per household beginning on July 1, 2021, there are a host of regulations to be written in order to regulate the adult use market. These regulations will be the devil in the details of how the regulated market will work. Regardless, the Cannabis Control Act does establish the framework for adult use cannabis that is unique to Virginia and designed to promote and encourage participation from people and communities disproportionately impacted by cannabis prohibition and enforcement.

The Cannabis Control Authority (CCA) will consist of a Board of Directors, the Cannabis Public Health Advisory Council, the Chief Executive Officer and employees. The Board will have five members appointed by the Governor and confirmed by the legislature, each with the possibility of serving two consecutive five-year terms. The Board is tasked with creating and enforcing regulations under which retail cannabis and cannabis products are possessed, sold, transported, distributed, and delivered. It is expected that the Board will begin discussing regulations next year and that applications for licenses for cannabis cultivation facilities, manufacturing facilities, cannabis testing facilities, wholesalers, and retail stores will begin to be accepted in 2023. Importantly, a Business Equity and Diversity Support Team, led by a Social Equity Liaison, and the Equity Reinvestment Board, led by the Director of Diversity, Equity and Inclusion, are to contribute to a plan to promote and encourage participation in the industry by people from disproportionately impacted communities.

Regulating Participation in the Market

The Act empowers the Board to establish a robust and diverse marketplace with many entry opportunities for market participants. Up to 450 cultivation licenses, 60 manufacturing licenses for the production of retail cannabis products, 25 wholesaler licenses and 400 licenses for retail stores can be granted. These numbers do not include the four permits granted to pharmaceutical processors (entities that cultivate and dispense medical cannabis) under the Commonwealth’s medical program.

Virginia Governor Ralph Northam
Image: Craig, Flickr

In addition to the sheer number of licenses that can be granted, the Act devises a unique approach to addressing concerns of a concentration of licenses in too few hands and a market dominated by large multi-state operators. At the same time, it sets up a mechanism to capitalize two cannabis equity funds intended to benefit persons, families and communities historically and disproportionately targeted and affected by drug enforcement through grants, scholarships and loans. Over-concentration and market dominance concerns are addressed by limiting a person to holding an equity interest in no more than one cultivation, manufacturing, wholesaler, retail or testing facility license. This eliminates the ability of companies to be vertically integrated from cultivation through retail sales operations. However, there are two exceptions to the impediment to vertical integration. First, the Board is authorized to develop regulations that permit small businesses to be vertically integrated and ensure that all licensees have an equal and meaningful opportunity to participate in the market. These regulations will be closely scrutinized by those looking to enter Virginia’s regulated market once they are proposed. Qualifying small businesses could benefit substantially from the economic advantages commensurate with being vertically integrated, assuming they have the access to the capital needed to achieve integration and operate successfully. The second exception allows permitted pharmaceutical processors and registered industrial hemp processors to hold multiple licenses if they pay $1 million to the Board (to be allocated to job training, the equity loan fund or equity reinvestment fund) and submit a diversity, equity and inclusion plan for approval and implementation. Consequently, Virginia is attempting to fund, in part, its ambitious social equity programs by monetizing the opportunity for these processors to participate vertically in the adult use market.

Those devilish details of how this market will function, and how onerous compliance obligations will be, will emanate from those yet to be proposed regulations covering many areas and subject matters including:

  • Outdoor cultivation by cultivation facilities;
  • Security requirements;
  • Sanitary standards;
  • A testing program;
  • An application process;
  • Packaging and labeling requirements;
  • Maximum THC level for retail products (not to exceed 5 mg per serving or 50 mg per package for edible products);
  • Record retention requirements;
  • Criteria for evaluating social equity license applications based on certain ownership standards;
  • Licensing preferences for qualified social equity applicants;
  • Low interest loan program standards;
  • Personal cultivation guidelines; and
  • Outdoor advertising restrictions.

Needless to say, the CCA Board has a lot work ahead in order to issue reasonable regulations that will carry out the dictates in the Act and encourage the development of a well-functioning marketplace delivering meaningful social equity opportunities.

Much work needs to be done before July 1, 2024 to prepare for its debutThe application process for the five categories of licenses will be developed by the Board, along with application fee and annual license fee amounts. It is not clear how substantial these fees will be and what effect they will have on the ability of less-well-capitalized companies and individuals to compete in the market. The Act dictates that licenses are deemed nontransferable from person to person or location to location. However, it is not entirely clear that changes in ownership will be prohibited. The Act contemplates that changes in ownership will be permitted, at least as to retail store licensees, through a reapplication process. Perhaps the forthcoming regulations will add clarity to the transferability of licenses and address the use of management services agreements as a potential workaround to the limitations in license ownership.

Certain requirements particular to certain license-types are worthy of highlighting. For example, there are two classes of cultivation licenses. Class A cultivation licenses authorize cultivation of a certain number of plants within a certain number of square feet to be determined by the Board. Interestingly, Class B licenses are for cultivation of low total THC (no more than 1%) cannabis. Several requirements specific to retail stores are noteworthy. Stores cannot exceed 1,500 square feet, or make sales through drive-through windows, internet-based sales platforms or delivery services. Prohibitive local ordinances are not allowed; however, localities can petition for a referendum on the question of whether retail stores should be prohibited in their locality. Retail stores are allowed to sell immature plants and seek to support the home growers, an allowance that is fairly unique among the existing legal adult-use states.

Taxing Cannabis Sales

Given the perception that regulated cannabis markets add to state coffers, it is little surprise that Virginia’s retail market will be subject to significant taxes. The taxing system is straightforward and not complicated by a taxing regime related to product weight or THC content, for example. There is a 21% tax on retail sales by stores, in addition to the current sales tax rates. In addition, localities may, by ordinance, impose a 3% tax on retail sales. These taxes could result in a retail tax of approximately 30%.

Changes to Criminal Laws

Changes to the criminality of cannabis will have long lasting effects for many Virginians. These changes include:

  • Fines of no more than $25 and participation in substance abuse or education programs for illegal purchases by juveniles or persons 18 years or older;
  • Prohibition of warrantless searches based solely on the odor of cannabis;
  • Automatic expungement of records for certain former cannabis offenses;
  • Prohibition of “gifting” cannabis in exchange for nominal purchases of some other product;
  • Prohibition of consuming cannabis or cannabis products in public; and
  • Prohibition of consumption by drivers or passengers in a motor vehicle being driven, with consumption being presumed if cannabis in the passenger compartment is not in the original sealed manufacturer’s container.

These changes, and others, represent a balancing of public safety with lessons learned from the effects of the war on drugs.

Potpourri

The Act contains myriad other noteworthy provisions. For example, the Board must develop, implement and maintain a seed-to-sale tracking system for the industry. Plants being grown at home must be tagged with the grower’s name and driver’s license or state ID number. Licenses may be stripped from businesses that do not remain neutral while workers attempt to unionize. However, this provision will not become effective unless approved again by the legislature next year. Banks and credit unions are protected under state law for providing financial services to licensed businesses or for investing any income derived from the providing of such services. This provision is intended to address the lack of access to banking for cannabis businesses due to the federal illegality of cannabis by removing any perceived state law barriers for banks and credit unions to do business with licensed cannabis companies.

The adult use cannabis industry is coming to Virginia. Much work needs to be done before July 1, 2024 to prepare for its debut. However, the criminal justice reforms and commitment to repairing harms related to past prohibition of cannabis are soon to be a present-day reality. Virginia is the first Southern state to take the path towards legal adult use cannabis. It is unlikely to be the last.

New York Legalizes Adult Use Cannabis

By Cannabis Industry Journal Staff
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On March 31, 2021, New York Governor Andrew Cuomo signed The Marijuana Revenue and Taxation Act (MRTA) into law, legalizing adult use, home cultivation and possession of cannabis for adults over 21 immediately. Upon signing the bill this morning, previous cannabis-related convictions are automatically expunged, according to the Governor.

The bill establishes the Office of Cannabis Management, which will launch and manage the regulatory system for the commercial cannabis market in New York.

According to Steve Schain, senior attorney at Hoban Law Group, the Office of Cannabis Management will have a five-member board that will oversee not just the adult use cannabis market, but also medical cannabis as well as the state’s hemp market. For the medical market, the new legislation provides for more patient caregivers, home cultivation and an expanded list of qualifying conditions.

New York Governor Andrew Cuomo
Image: Chris Rank, Flickr

Troy Smit, deputy director of the New York NORML chapter, says the bill might not be perfect, but it’s a massive win for the cannabis community. “It’s taken a great amount of work and perseverance by activists, patients, and consumers, to go from being the cannabis arrest capital of the world, to lead the world with a legalized market dedicated to equity, diversity, and inclusion,” says Smith. “This might not be the perfect piece of legislation, but today, cannabis consumers can hold their heads high and smell the flowers.”

The MRTA sets up a two-tier licensing structure that separates growing and processing licenses from dispensary licenses. The bill includes a social equity aspect that requires 50% of the licenses to be awarded to, “minority or women-owned business enterprise, service-disabled veterans or distressed farmers,” says Schain.

New York City
Image: Rodrigo Paredes, Flickr

Melissa Moore, New York State director of the Drug Policy Alliance, says she’s proud of the social equity plan the bill puts in place. “Let’s be clear — the Marijuana Regulation and Taxation Act is an outright victory for the communities hit hardest by the failed war on drugs,” says Moore. “By placing community reinvestment, social equity, and justice front and center, this law is the new gold standard for reform efforts nationwide. Today we celebrate, tomorrow we work hard to make sure this law is implemented fairly and justly for all New Yorkers.”

Schain says the new tax structure in the bill shifts to the retail level, with a 9% excise tax and 4%-of-the-retail-price local excise tax (split 25%/75% between the respective counties and municipalities). Revenue from cannabis taxes will enter a fund where 40% will go to education, 40% to community grants reinvestment fund and 20% to drug treatment and public education fund.

It appears that businesses already established in New York’s medical market get a head start on the new adult use market, while other businesses enter the license application process, according to Schain. “Although the existing Medical Marijuana licensees should be able to immediately to sell Adult-Use Cannabis, it will take up to two years for the New York’s Adult Use Program to launch and open sales to the public,” says Schain.

A Q&A with Matt Hawkins, Co-Founder & Managing Partner at Entourage Effect Capital

By Aaron Green
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The cannabis industry saw close to $15.5B in deals across VC, private equity, M&A and IPOs in 2020 according to PitchBook data. Early and growth stage capital has been a key enabler in deal activity as companies seek to innovate and scale, taking advantage of trends towards national legalization and consolidation. Entourage Effect Capital is one of the largest VC firms in cannabis with over $150MM deployed since its inception in 2014. Some of their notable investments include GTI, CANN, Harborside (CNQ: HBOR), Acreage Holdings, Ebbu, TerrAscend and Sunderstorm.

We spoke with Matt Hawkins, co-founder and managing partner at Entourage Effect Capital. Matt started Entourage in 2014 after exiting his previous company. He has 20+ years of private equity experience and serves on the Boards of numerous cannabis companies. Matt’s thought leadership has been on Fox Business in the past and he has also recently featured on CNBC, Bloomberg, Yahoo! Finance, Cheddar and more.

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

Matt Hawkins: We’ve been making investments in the cannabis industry since 2014. We’ve made 65 investments to date. We have a full team of investment professionals, and we invest up and down the value chain of the industry.

I had been in private equity for 25 years and I kind of just fell into the industry after I’d had an exit. I started lending to warehouse owners in Denver that were looking to refinance their mortgages out of commercial debt into private debt, which would then give them the ability to lease their facilities to growers. I realized there would be a significant opportunity to place capital in the private equity side of the cannabis business. So, I just started raising money for that project and I haven’t looked back. It’s been a great run and we’ve built a fantastic portfolio. We look forward to continuing to deploy capital up to and through legalization.

Green: Do you consider Entourage Effect Capital a VC fund or private equity firm? How do you talk about yourself?

Hawkins: In the early stages of the industry, we were more purely venture capital because there was hardly any revenue. We’re probably still considered a venture capital firm, by definition, just because of the risk factors. As the industry has matured, the investments we make are going to be larger. The reality is that the checks we write now will go to companies that have a track record of not only 12 months of revenue, but EBITDA as well. We can calculate a multiple on those, and that makes it more like lower/middle-market private equity investing.

Green: What’s your investment mandate?

Matt Hawkins, Co-Founder and Managing Partner at Entourage Effect Capital

Hawkins: From here forward our mandate is to build scale in as many verticals as we can ahead of legalization. In the early days, we were focused on giving high net worth individuals and family offices access to the industry using a very diversified approach, meaning we invested up and down the value chain. We’ll continue to do that, but now we’re going to be really laser focused on combining companies and building scale within companies to where they’re going to be more attractive for exit partners upon legalization.

Green: Are there any particular segments of the industry that you focus on whether it’s cultivation, extraction or MSOs?

Hawkins: We tend to focus on everything above cultivation. We feel like cultivation by itself is a commodity, but when vertically integrated, for example with a single-state operator or multi-state operator, that makes it intrinsically more valuable. When you look at the value chain, right after cultivation is where we start to get involved.

Green: Are you also doing investments in tech and e-commerce?

Hawkins: We’ve made some investments in supply chain, management software, ERP solutions, things like that. We’re not really focused on e-commerce with the exception of the only CBD company we are invested in.

Green: How does Entourage’s investment philosophy differ from other VC and private equity firms in cannabis?

Hawkins: We really don’t pay attention to other people’s philosophies. We have co-invested with others in the past and will continue to do so. There’s not a lot of us in the industry, so it’s good that we all work together. Until legalization occurs, or institutional capital comes into play, we’re really the only game in town. So, it behooves us all to have good working relationships.

Green: Across the states, there’s a variety of markets in various stages of development. Do you tend to prefer investing in more sophisticated markets? Say California or Colorado where they’ve been legalized for longer, or are you looking more at new growth opportunities like New York and New Jersey?

Hawkins: Historically, we’ve focused on the most populous states. California is obviously where we’ve placed a lot of bets going forward. We’ll continue to build out our portfolio in California, but we will also exploit the other large population states like New Jersey, New York, Arizona, Massachusetts, Michigan, Ohio and Illinois. All of those are big targets for us. 

Green: Do you think legalization will happen this Congress?

Hawkins: My personal opinion is that it will not happen this year. It could be the latter part of next year or the year after. I think there’s just too much wood to chop. I was encouraged to see the SAFE Banking Act reappear. I think that will hopefully encourage institutional capital to take another look at the game, especially with the NASDAQ and the New York Stock Exchange open up. So that’s a positive.

I think with the election of President Biden and with the Senate runoffs in Georgia going Democrat, the timeline to legalization has sped up, but I don’t think it’s an overnight situation. I certainly don’t think it’ll be easy to start crossing state lines immediately, either.

Green: Can you explain more about your thoughts on interstate commerce?

Hawkins: I think it’s pretty simple. The states don’t want to give up all the tax revenue that they get from their cultivation companies that are in the state. For example, if you allow Mexico and Colombia to start importing product, we can’t compete with that cost structure. States that are neighbors to California, but need to grow indoors which is more expensive, are not going to want to lose their tax revenues either. So, I just think there’s going to be a lot of butting heads at the state level.

The federal government is going to have to outline what the tax implications will be, because at the end of the day the industry is currently taxed as high as it ever will be or should be. Anything North of current tax levels will prohibit businesses from thriving further, effectively meaning not being able to tamp down the illicit market. One of the biggest goals of legalization in my opinion should be reducing the tax burden on the companies and thereby allowing them to be able to compete more directly with the illicit market, which obviously has all the benefits of reduced crime, etc.

Green: Do you foresee 280E changes coming in the future?

Hawkins: For sure. If the federal illegality veil is removed – which means there’ll be some type of rescheduling – cannabis would be removed from the 280E category. I think 280E by definition is about just illegal drugs and manufacturing and selling of that. As long as cannabis isn’t part of that, then it won’t be subject to it.

Green: What have been some of the winners in your portfolio in terms of successful exits?

Hawkins: When the CSC started allowing companies in Canada to own U.S. assets, the whole landscape changed. We were fortunate to be early investors in Acreage and companies that sold to Curaleaf and GTI before they were public. We are big investors in TerrAscend. We were early investors in Ebbu which sold to Canopy Growth. Those were huge wins for us in Fund I. We also have some interesting plays in Fund II that are on the precipice of having similar-type exits.

You read about the big ones, but at the end of the day, the ones that kind of fall under the radar – the private deals – actually have even greater multiples than what we see on some of the public M&A activity.

Green: Governor Cuomo has been hinting recently at being “very close” on a deal for opening up the cannabis market in New York. What do you think are the biggest opportunities in New York right now?

Hawkins: If it can get done, that’s great. I’m just concerned that distractions in the state house right now in New York may get in the way of progress there. But if it doesn’t, and it is able to come to fruition, then there isn’t a sector that doesn’t have a chance to thrive and thrive extremely well in the state of New York.

Green: Looking at other markets, Curaleaf recently announced a big investment in Europe. How do you look at Europe in general as an investment opportunity?

Hawkins: We have a pretty interesting play in Europe right now through a company called Relief Europe. It’s poised to be one of the first entrants to Germany. We think it could be a big win for us. But let’s face it, Europe is still a little behind, in fact, a lot behind the United States in terms of where they are as an industry. Most of the capital that we’re going to be deploying is going to be done domestically in advance of legalization.

Green: What industry trends are you seeing in the year ahead?“We’re constantly learning from other industries that are steps ahead of us to figure out how to use those lessons as we continue to invest in cannabis.”

Hawkins: Well, I think you’ll see a lot of consolidation and a lot of ramping up in advance of legalization. I think that’s going to apply in all sectors. I just don’t see a scenario wherein mom and pops or smaller players are going to be successful exit partners with some of the new capital that’s coming in. They’re going to have to get to a point where they’re either selling to somebody bigger than them right now or joining forces with companies around the same size as them and creating mass. That’s the only way you’re going to compete with companies coming in with billions of dollars to deploy.

Green: How do you see this shaking out?

Hawkins: That’s where you start to look into the crystal ball. It’s really difficult to say because I think until we get to where we truly have a national footprint of brands, which would require crossing state lines, it’s going be really difficult to tell where things go. I do know that liquor, tobacco, beer, the distribution companies, they all are standing in line. Big Pharma, big CPG, nutraceuticals, they all want access to this, too.

In some form or fashion, these bigger players will dictate how they want to go about attacking the market on their own. So, that part remains to be seen. We’ll just have to wait and see where this goes and how quickly it goes there.

Green: Are you looking at other geographies to deploy capital such as APAC or Latin America regions?

Hawkins: Not at this point. It’s not a focus at all. What recently transpired here in the elections just really makes us want to focus here and generate positive returns for investors.

Green: As cannabis goes more and more mainstream, federal legalization is maybe more likely. How do you think the institutional investor scene is evolving around that? And is it a good thing to bring in new capital to the cannabis market?

Hawkins: I don’t see a downside to it. Some people are saying that it could damage the collegial and cottage-like nature of the industry. At the end of the day, if you’ve got tens of billions of dollars that are waiting to pour into companies listed on the CSC and up-listing to the NASDAQ or New York Stock Exchange, that’s only going to increase their market caps and give them more cash to acquire other companies. The trickle-down effect of that will be so great to the industry that I just don’t know how you can look the other way and say we don’t want it. 

Green: Last question: What’s got your attention these days? What’s the thing you’re most interested in learning about?

Hawkins: We’re constantly learning about just where this industry is headed. We’re constantly learning from other industries that are steps ahead of us to figure out how to use those lessons as we continue to invest in cannabis. We all saw the correlation between cannabis and alcohol prohibition. The reality is that the industry is mature enough now where you can see similarities to industries that have gone from infancy to their adolescent years. That’s kind of where we are now and so we spend a lot of time studying industries that have been down this path before and see what lessons we can apply here.

Green: Okay, great. So that concludes the interview!

Hawkins: Thanks, Aaron.

Cannabis Revival and Year of the SPAC’s: What’s To Be Expected the Rest of 2021?

By Michael Sassano
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The unusual nature of 2020 gave rise to a reciprocally roller-coaster-like cannabis market. Cannabis was cemented officially as an essential industry with the rise of COVID-19, and November elections resulted in even more United States markets welcoming medical and adult-use sales.

The stagnant cannabis stock market of 2019 became a thing of the past by the end of 2020. Throughout the course of last year, bag holders anxiously watched cannabis options creep back up. Now, nearly two years since market decline in 2019, the cannabis stock market is exploding with blank checks and buyout fever. Much of this expectant purchasing is due to Canadian companies considering U.S. market entrance. Combined with the recent surge in the use of special purpose acquisition companies (SPACs) to invest, this has led to an increase in asset prices.

A SPAC is defined as “a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.” Though they have existed for decades, SPACs have become popular on Wall Street the last few years because they are a way for a company to go public without the associated headaches of preparing for a traditional IPO.

In a SPAC, investors interested in a specific industry pool their money together without knowledge of the company they’re starting. The SPAC then goes public as a shell company and begins acquiring other companies in the associated industry. Selling to a SPAC is usually an attractive option for owners of smaller companies built from private equity funds.

The U.S.-Canadian market questions that this rising practice asks are: Can Canadian companies enter a bigger market and be more successful? Is it advisable for U.S. companies to sell their assets to Canadian corporations whose records may be marred by a history of losses and a lack of proper corporate governance? Regardless — if both SPAC’s and Canadian bailout money is here, what comes next?

What is Driving this Bull Market?

Underpinning these movements are record cannabis sales internationally, making last year’s $15 billion dollars’ worth of sales in the U.S. look small in comparison. New markets have opened up in various states and countries throughout 2020, and that trend is only expected to continue. New demographics are opening up, especially among older age groups. This makes sense, as most cannabis sales — even in a recreational setting — are people treating something that ails them like insomnia or aches and pains.

Cannabis is set to take off, and we are entering only the second phase of its market expansion. The world is becoming competitive. Well-run companies that are profitable in key markets are prime targets for bigger, growing companies. At the same time, the world of SPACs will continue to drive valuations. Irrespective of buying assets, growing infrastructure is and will continue to be greatly needed.

The Elusive Profitability Factor

When Canada blew up, one of the biggest changes was companies began focusing the year on cost cutting and — most importantly — profitability. Profitability became the buzzword. But bigger companies are on the search for already-profitable enterprises, not just those that have the potential to be. However, profitability is currently still unobtainable in Canada. Reasonable forecasters should expect this year will show a few companies getting bailed out while many others will be forced to either merge for survival or declare bankruptcy.

An ideal company’s finances should highlight not only revenue growth, but also profitability. Attention should be focused on how well businesses are run, and not on how much money they have the potential to raise or spend. Over the years, there have been many prospective companies that spent hundreds of millions only to barely operate, and are now shells in litigation. Throwing money at any deal should have been a lesson learned in the past, but SPACs are tempting because they are trendily associated with new, interesting management styles and charismatic businesspeople.

Companies should be able to present perfect and clear financials along with maintenance logs for all equipment. In today’s day and age, books must be stellar and clean. As money pours into SPACs, asset valuations for all qualities of companies will rise. The focus instead becomes about asset plays, which will cause assets to continue rising as money is poured into SPACs.

Once upon a time, if number counters presented a negative review or had to dig too much, executives would turn a cold shoulder on investment. But in the age of SPACs, these standards of evaluation will be greatly undervalued. Aging equipment and reportability of every piece of equipment may or may not be properly serviced and recorded in a fast-moving market. Costs of repair or replacing equipment that isn’t properly maintained may be a problem of the past. Because when money comes fast, none care for the gritty details.

Issues for SPACs

Shortage of talent and training has become a big concern already in the era of SPACs. How many quality assets are out there? Big operators in the U.S. are content and don’t see Canada as an enticing market to enter. So, asset buys are likely to primarily be in the U.S. Large companies like Aphria may buy out some of the major American players, but most Canadian companies will use new funding rounds to pay down debts. Accordingly, they will then be forced to piece together smaller operators as a strategy.

A cannabis company’s personnel and office culture are very important when looking to integrate into a larger corporate culture. Remember, it’s not just the brick and mortar that is being invested into, it is also the people that run a facility. Maintaining employee retention when a deal occurs is always critical. Your personnel should be highly trained and professional if you want to exit. Easy to plug-in corporate structures make all the difference in immediately gaining from the sale or having to retool the shed and bring in all new people.

The rise of the SPAC-era and Canadian entry into the U.S. market will cause asset increases, but it is only the second chapter in the market expansion of cannabis. Proper buys will nail profitability, impeccable books, proper maintenance records and will have created an efficient corporate structure with talented personnel. The rest will be overpriced land buys that will require massive infrastructure spending. The basics of a well-run organization don’t change. The cannabis market is going to ROAR, but don’t worry if the SPACs pass you by- they are buying at the start of cannabis only.

New Cannabis Coalition Launches to Advance Cannabis Reform

By Cannabis Industry Journal Staff
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According to a press release published on February 8, a number of associations, advocacy organizations and cannabis businesses launched the U.S. Cannabis Council (USCC), which they claim is the largest coalition of its kind.

The 501(c)4 nonprofit organization goals are to advance social equity and racial justice, and end federal cannabis prohibition, according to their debut press release. The USCC says it will focus on federal reforms that achieve those goals above as well as promoting a safe and fair cannabis market on a national level.

The USCC’s Interim CEO is Steven Hawkins, who is also the executive director of the Marijuana Policy Project, which is one of the founding members of the USCC. “USCC is a unified voice advocating for the descheduling and legalization of cannabis,” says Hawkins. “Legalization at both the state and federal level must include provisions ensuring social equity and redress for harms caused to communities impacted by cannabis prohibition.”

In the press release, Representative Earl Blumenauer (D-OR) is quoted saying he is looking forward to working with the USCC on Capitol Hill. “As founder and co-chair of the Congressional Cannabis Caucus, I’ve seen firsthand that our most successful cannabis wins have been secured by a team,” says Rep. Blumenauer. “That’s why I am glad to see this first-of-its-kind alliance. We have a unique opportunity in the 117th Congress to advance cannabis reform, but we must remain united to create the change we know is possible.”

Founding members of the USCC include Acreage Holdings, Akerna Corp, the American Trade Association of Cannabis and Hemp, Canopy Growth, the Cannabis Trade Federation, Cresco Labs, MedMen, Marijuana Policy Project, PharmaCann, Vireo, Wana and much more. For a full list of its founding members, visit their website here.

Learning from the First Wave Part 1: How Law Shapes the California Cannabis Industry

By Todd Feldman
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As a cannabis lawyer, I spend a lot of time thinking about the ways that regulations affect a cannabis company’s bottom line. Since I’m in California, the ways are many.

In late 2017 I became the chief compliance officer for an Oakland startup that carried out delivery, distribution, cultivation and six manufacturing operations. A big part of my job was preparing my company, along with several equity cannabis companies, for California’s First Wave of cannabis licenses.

For the most part, First Wave licensees came from California’s essentially unregulated medical cannabis market, and/or from California’s by-definition unregulated “traditional” market. When California began issuing licenses in January 2018, many First Wavers were unprepared because their businesses practices had evolved in an unregulated market. A big part of my job was to help them adapt to the new requirements. As a result, I saw the regulations, and the effects of regulations, in sharp relief.

Regulation touches virtually every aspect of the legal cannabis industry in California. So anyone who wants to understand the industry should have at least a basic understanding of how the regs work. I’m writing this series to lay that out, in broad strokes.

Some key points:

  • The regulated market must be understood in relation to the previous unregulated (medical) market as well as the ongoing traditional market.
  • Regs define the supply chain.
  • Regs are designed to ensure product safety and maximize tax revenue.
  • Many regulations mandate good business practices.
  • Local enforcement of building, health and safety codes tends to be zealous and costly.

A Tale of Three Markets

California’s regulated cannabis market can only be understood in relation to the medical market that preceded it, and in relation to the traditional market (illegal market) that continues to compete with it.

The Before Times

California’s legal medical cannabis market goes back to 1996, when the Compassionate Use Act passed by ballot measure. One fact that shaped the medical market was that it was never just medical – while it served bona fide patients, it also served as a Trojan horse for adult-use (recreational) purchasers.

Another fact that shaped the medical market was a near complete lack of regulation. On the seller’s side, you had to be organized as a collective. On the buyer’s side, you had to have a medical card. That was it.

Meanwhile, the cannabis supply chain was entirely unregulated. This tended to minimize production costs. It also meant that a patient visiting a dispensary had no way of verifying where the products had been made, or how.

The Regulated Times

Licensing under the Medical and Adult-Use Cannabis Regulation and Safety Act (the “Act”) began on January 1, 2018. It was the beginning of legal adult-use cannabis in California. It was also the beginning of the Regulated Times, as the Act and accompanying 300-plus pages of regulations transformed the legal cannabis market.

 For example:

  • The Act defines the cannabis supply chain (as a series of licensees).
  • Across the supply chain, the internal procedures of cannabis companies are subject to review by state agencies;
  • Cultivators and manufacturers cannot sell directly to a dispensary – they must go through a distributor;
  • All cannabis must be tested for potency and a long list of contaminants by a licensed testing laboratory before it may be sold to consumers;
  • And beginning in 2019, all licensees were required to participate in the California Cannabis Track and Trace (CCTT) program, which is designed to track all cannabis from seed to sale.

Just as importantly, the Act establishes a dual licensing system – that is to say, in order to operate, a cannabis company needs a local permit (or other authorization) as well as a state license. In fact, local authorization is a prerequisite for a state license. And your local jurisdiction will have its own rules for cannabis that apply in addition to the state rules, up to and including a ban on cannabis activities.

Needless to say, operating in the Regulated Times is a lot more complicated and expensive than it was during the Before Times.

Especially when you consider the taxes. For example, in the City of Los Angeles, sale of adult-use cannabis is taxed at 10%, which means that any adult-use purchase in L.A. gets a 34.5% markup:

  • 15% state cannabis excise tax, plus
  • 10% Los Angeles Adult Use Cannabis Sales tax, plus
  • 5% sales tax.

Note that the distributors must collect the excise tax from the retailer, so the 15% markup is not necessarily visible to the consumer. Similarly, consumers are generally unaware that there is a cultivation tax of $9.65 per ounce (or about $1.21 per eighth) of dried flower that the distributor has to collect from the cultivator.

Theoretically, all of this might be unproblematic if licensed retailers were only competing with each other. Which brings us to:

The Traditional Market

The traditional market is the illegal market, which is to say, the untaxed and unregulated market.

Legalization of adult-use cannabis was supposed to destroy the traditional market, but it hasn’t. As of early 2020, the traditional market was estimated to be 80% of the total cannabis market in California. This is not surprising, since the traditional market has the advantages of being untaxed and unregulated.

The traditional market has a pervasive negative effect on the legal market. For example, the traditional market tends to depress prices in the legal market and tends to attract talent away from the legal market. Some of these effects will be discussed in the following articles.

This article is an opinion only and is not intended to be legal advice.

Cresco Labs Acquires Bluma Wellness

By Cannabis Industry Journal Staff
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Cresco Labs, one of the largest multistate operators (MSOs) in the country, announced the acquisition of Bluma Wellness Inc., a vertically integrated cannabis company based in Florida.

Cresco Labs, with roots in Chicago, Illinois, operate 29 licenses in 6 states across the United States. With this new acquisition, Cresco Labs solidifies their ubiquitous brand presence in the most populous markets and cements their position in Florida, a new market for them.

According to the press release, the two companies entered an agreement where Cresco will buy all of Bluma’s issued and outstanding shares for an equity value of $213 million. They expect the transaction to be completed by the second quarter of this year.

Charles Bachtell, CEO of Cresco Labs, says their expansion strategy is based largely on population. “Our strategy at Cresco Labs is to build the most strategic geographic footprint possible and achieve material market positions in each of our states,” says Bachtell. “With Florida, we will have a meaningful presence in all 7 of the 10 most populated states in the country with cannabis programs – an incredibly strategic and valuable footprint by any definition. We recognize the importance of the Florida market and the importance of entering Florida in a thoughtful way – we identified Bluma as having the right tools and key advantages for growth.”

Bluma Wellness operates through its subsidiary, One Plant Florida, which has 7 dispensaries across the state and ranks second in sales in the state. They also have an impressive delivery arm of their retail business, deriving 15% of their revenue from it.

Q&A with Bruce Macdonald, Chairman of C21 Investments

By Aaron Green
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Multi-state operators (MSOs) are on the rise in the United States, navigating complex regulatory frameworks to drive profitability through economies of scale and scope. C21 Investments is a vertically integrated cannabis company with operations in Nevada and Oregon; traded on the Canadian Stock Exchange (CXXI) and on the OTCQX (CXXIF). The company recently secured a commitment from Wasatch Global Investors, JW Asset Management (Jason Wild/TerrAscend) and CB1 Capital Management (Todd Harrison) who, in addition to C21’s CEO, provided an equity commitment for repayment of all convertible debt.

We spoke with Bruce Macdonald, Chairman of C21 Investments. Bruce joined C21 in 2018 after reviewing the company as a personal investment and getting to know the senior management team. Prior to C21, Bruce had a long and successful career in finance and capital markets at one of Canada’s largest banks.

Aaron Green: Can you give a brief overview of C21?

Bruce MacDonald: C21 is a cannabis company that has operations in both Nevada, and in Oregon. Oregon is fundamentally a wholesale business, and we recently announced a divestment of some non-core assets in the state. Our cash cow and where we currently see our best opportunity for future growth is our Nevada operations. We run a seed-to-sale business in the state with two dispensaries doing about $35M a year in revenue, with a 40% EBITDA Margin, and servicing 600,000 customers.

Aaron: Can you tell me about a little bit about your background and how you got involved in a cannabis company?

Bruce: I spent 37 years working for RBC in the capital markets business. I started as a floor trader, back when there was such a thing as a floor, and over the years held a number of positions, ultimately working my way up to Chief Operating Officer of the bank’s global capital markets division. Throughout my time, I built a lot of businesses, which was why C21 and this opportunity was so interesting to me.

My involvement in the cannabis sector was a bit of an accident, but it’s turned into a passion. It actually found me. I was an investor in the C21 IPO. I sat down with management to understand the investment and given my experience, they asked if I would consider becoming a member the Board. Since joining the Board, my involvement has been primarily focused on strategy and the financing side of the business. While I certainly didn’t anticipate it, it’s turned into a 24/7 gig and a challenge I am thoroughly enjoying.

Bruce Macdonald, Chairman of C21 Investments

Aaron: Can you tell me about the history of C21 becoming a MSO? Did you start in one state?

Bruce: While this history predates my time at the company, my understanding is that as a Canadian company, we had first mover advantage to be able to access public funding and get established in the US cannabis space. As part of that, the team at that time reviewed approximately 100 different properties. Because we were based out of Vancouver, the focus was primarily the Western states like Washington, Oregon, Nevada and California. Arizona wasn’t in the game yet. The first transaction C21 did was in Oregon, with a company called Eco Firma. In all, there were four acquisitions in Oregon, and one in Nevada. In fact, it was the investment in Silver State (Nevada) that was by far the most meaningful. As far as our Oregon assets are concerned, we have worked hard to integrate and streamline them into an efficient operation.

So, when I joined the Board, we were just completing the paperwork on the acquisitions, and finalizing our strategy and business plan to go forward.

Aaron: Today there are a number of MSOs. How does this more crowded market impact your value proposition; how do you think about gaining and maintaining strategic advantage?

Bruce: It’s important first to start with strategy. From a strategic perspective, we had the advantage of being the first operator in Nevada with Silver State. Sonny Newman, our CEO, started the business back in 2013. We run a seed-to-sale business so we have a deep knowledge of all aspects of the operation and really know the Nevada market. In fact, 70% on a dollar volume basis of the 700 SKUs that we sell are products that we manufacture. It’s a critical piece of our strategic advantage.  

What I would say is our most important strategic advantage is the fact that C21 is a stable, self-sustaining operator. What I mean by that is we’re one of the few businesses that actually makes money. This is what really allows us to be strategic and disciplined in our approach to growth. For example, it’s been more than 18 months since we did our last capital raise and that’s by choice. Every decision we make is through the shareholder lens and focusing on delivering value to customers and shareholders.

Looking at our value proposition, simply put, it comes down to four things – the right products, at the right price, in the right location, with the right environment. Some people might call this motherhood, but there’s a lot of work that goes behind each of them. 

Great quality products, that’s table stakes. You have to be a top-notch grower and generate quality products that people demand if you want to build a loyal customer base. Right price – to some it sounds like just putting the right sticker on the package – it’s not. It’s all about making sure you are efficient in your operations because to be profitable, you have to be a low-cost producer to deliver on a lower price promise. Tons of work has gone into our operation around being a “right price” business. 

Right location is another important element of our value proposition. We wanted to build a loyal customer base which for us meant focusing more on locals than on tourists. This is why Sonny positioned the dispensaries on commuter paths.

The last key factor is having the right environment to sell our products. In Nevada, the company ended up building fit-for-purpose dispensaries rather than fitting ourselves in a strip mall. We cater to over 600,000 clients a year. Now we’re doing 10,000 curbside pickups a month. With that type of volume, logistically speaking you need ample parking, a well-lit exterior so people feel safe, and of course, great curb appeal. These factors are essential in maintaining a loyal customer base.

Aaron: Tell me more about Silver State Relief and why it has been so successful?

Bruce: I think what you’re really asking for is: what is Sonny’s secret sauce? There are a few ingredients that go into it. As I highlighted, it was a purposeful decision to build a business with a loyal customer base focused primarily on locals. That needs product, price, and convenience. Sonny lives in the Reno area, which is one of the main reasons Silver State is located up North.  

Critical to success has been the culture of the organization. Let’s start with the company being nimble and I’ll give you an example. The early days of the pandemic included the complete shutdown of dispensaries. We went from serving over 1500 customers a day in our stores to the next day being told that we could offer delivery only. Within a week, we were able to pivot and had lockboxes, regulatory approvals and a delivery capability. When you look at our Nevada operation, we ended up with just a 10% dip in our revenues for the quarter, even though we had to live through six weeks of delivery-only and then a phase of curbside-only.

Another key element of the culture is our laser focus on cost management. We’ve talked a little about cost management, but it’s absolutely critical, especially in the context of the high cost of capital that we see in this sector. Add to that the punitive tax impact of 280e where federal tax is applied to gross margins which means SG&A and interest are non-deductible expenses for tax purposes. So, to enhance our profitability, we are intent on having the lowest SG&A of the public cannabis companies. We’re also among the lowest in interest expense. That whole drive for efficiency has given us a formula and a mantra that has allowed us to have a stable business with significant cash flow. We get to make strategic decisions — not hasty or desperate ones — and focus on what’s good for the shareholder.

Aaron: How was C21 capitalized?

Bruce: We did a $33M raise on the RTO of a listed shell company. That was how C21 was established, and then signed contracts with the Oregon and Nevada properties.

Aaron: I recently saw a press release about expanding the Nevada cultivation. Can you give me some more details? 

Bruce: We announced that we are tripling our capacity within our existing 100,000 square foot warehouse facilities. We’re going to build out another 40,000 square feet, and we currently use 20,000. That’s the tripling. Expanding our cultivation was clearly the next logical step in our growth story. This should yield us an additional 7,500 pounds of high-quality flower. We can do this very cost effectively with about $6M in capex, and we anticipate funding the project internally. We will still leave another 40,000 square feet of expansion capacity as market needs justify.

This announcement was significant, but I don’t think it was fully understood by the market. Just to play with some numbers, 7,500 pounds of flower has a wholesale market value today of about $17M. It will cost us approximately $2M in incremental operating expense to add these additional grow rooms. We already pay the rent, so we just need to pay for the people, power, fertilizer and product testing. When you do the simple math, we see this as a big win for shareholders and extremely accretive on an after-tax basis. 

Historically, we always used to grow more than we needed, but with the increase in demand that’s going on in the market, we now run at a flower deficit. In the near term, this build-out will allow is to meet our current retail needs, with the balance that we will sell on the wholesale market. Ultimately, this positions us well on a seed-to-sale basis to support our plans to extend our retail footprint in Nevada. 

Aaron: It sounds like the decision was made based on both revenue growth and supply chain consolidation?

Bruce: Yes, and just the pure profitability of it! You can’t get a bigger, better bang for your buck from spending $6M to generate $17M with ongoing operating costs of $2M.

Aaron: The next question here is about the recent note restructuring and, and how the debentures was restructured. How’d that come about and what is the advantage now of having gone through that process? 

Bruce: This all fits into our medium-term growth strategy. For C21, the first thing we focused on was getting our house in order to ensure that we were efficient and profitable. We knew we needed to have a scalable machine to grow. The second step, which the debt restructuring relates to, was around fortifying our balance sheet. To support our growth plans, we needed to have a solid foundation.

Our balance sheet had two things that needed fixing. One was that we had an $18M obligation coming due to our CEO. The effect of the restructuring extended this obligation over the next 30 months at favorable terms. Additionally, $6.5M of convertible debentures were reaching maturity in January of 2021. And while the debentures were in the money and theoretically would convert to shares, we didn’t want to take the risk that our stock price could drift a bit and all of a sudden there could be significant cash required for redemptions. We’ve seen a lot of companies suffer significant unwanted dilution when their debentures get out of control. So, we approached Wasatch, Jason Wild’s JWAM and CB1 Capital, three seasoned investors, who provided a backstop whereby they would purchase any shares not taken up by people though the conversion of their debentures, so that we would be able to pay any debenture holders back cash with the money we would receive as the investors took shares. In exchange for providing this backstop, C21 gave them an upside participation in the form of warrants. I think it was absolutely critical to get this in place. And it’s phenomenal to have these three names in our corner. We couldn’t imagine better partners.

Aaron: So, what’s next for C21? 

Bruce: I hope you are getting the feeling that here at C21 our objective is to play the long game. That means we make measured decisions with the interest of shareholders top of mind. We’ve worked hard in 2020 to get our house in order, fortify our balance sheet, and generate significant cash flow. I think we’re clocking in at around $12M in trailing annual cash flow, which interestingly, is about the same number that Planet 13 is doing. That’s obviously a fantastic result for a company with $150M of market cap.

“We are working with urgency to break the back of these sector economics.”When we think about our medium-term growth strategy, we will continue to make our decisions through a cash flow and earnings lens rather than hype and flash. While we will remain opportunistic with respect to strategic alternatives, the core of our expansion is going to focus on where we already have a proven track record: Nevada. We’re big believers that to achieve long term success, you have to own your home market. And what I mean by that is today we’re about 5% of the Nevada market. Owning your home market looks more like a 15% share. That is our focus. I think we’ve shown that our disciplined approach delivers results – results such as having top five metrics in Net Income, Cash Flow and EBITDA Margin, across the range of public companies that we can see.

I think it’s key we’re getting noticed. We talked about the strategic investors, but we’re also one of the 17 plant-touching companies that’s in the MSOS ETF. So, we’re going to follow our clear growth trajectory, focused on the bottom line and delivering for shareholders. If you look under the hood right now, you see a 10% cash flowing company, which is a pretty rare bird in our industry. We’re excited about where we are.

One thing I haven’t touched on in great detail is our plans for expanding our retail footprint. How do you grow in the dispensary space? Aaron, I think what’s key here is looking at the expected return relative to the cost of capital. For example, if you targeted buying a dispensary with $20M in revenues, and are able as we are, to generate 25% in after-tax cash based on those revenues, then once optimized, it would generate $5M in earnings. An asset like this is going to trade at roughly one and a half times revenues. So, you’re going to have to pay $30M. For the people that have been going out and borrowing money at 15%, their annual cost would be $4.5M. We’re not going to give four and a half to the moneylenders, it just doesn’t make sense for shareholders. We are working with urgency to break the back of these sector economics. It is something we believe will be afforded to companies with stable earnings and profitability such as ours. Of course, no deal’s a deal until it’s on the tape, but we are very hopeful that we have cracked the code ahead of SAFE Banking to get capital costs down. This is just a little bit of an inside look into our thought processes.   

Aaron: Okay, awesome. All right. That concludes the interview.

Aphria & Tilray Merger Creates World’s Largest Cannabis Company

By Cannabis Industry Journal Staff
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On December 16, 2020, Aphria Inc. (TSX: APHA and Nasdaq: APHA) announced a merger with Tilray, Inc. (Nasdaq: TLRY), creating the world’s largest cannabis company. The two Canadian companies combined have an equity value of $3.9 billion.

Following the news of the merger, Tilray’s stock rose more than 21% the same day. Once the reverse-merger is finalized, Aphria shareholders will own 62% of the outstanding Tilray shares. That is a premium of 23% based on share price at market close on the 15th. Based on the past twelve months of reports, the two companies’ revenue totals more than $685 million.

Both of the companies have had international expansion strategies in place well beyond the Canadian market, with an eye focused on the European and United States markets. In Germany, Aphria already has a well-established footprint for distribution and Tilray owns a production facility in Portugal.

tilray-logoAbout two weeks ago, Aphria closed on their $300 million acquisition of Sweetwater Brewing Company, one of the largest independent craft brewers in the United States. Sweetwater is well known for their 420 Extra Pale Ale, their cannabis-curious lifestyle brands and their music festivals.

Once the Aphria/Tilray merger is finalized, the company will have offices in New York, Seattle, Toronto, Leamington, Vancouver Island, Portugal and in Germany. The new combined company will do business under the Tilray name with shares trading on NASDAQ under ticker symbol “TLRY”.

Aphria’s current chairman and CEO, Irwin Simon, will be the chairman and CEO of the combined company, Tilray. “We are bringing together two world-class companies that share a culture of innovation, brand development and cultivation to enhance our Canadian, U.S., and international scale as we pursue opportunities for accelerated growth with the strength and flexibility of our balance sheet and access to capital,” says Simon. “Our highly complementary businesses create a combined company with a leading branded product portfolio, including the most comprehensive Cannabis 2.0 product offerings for patients and consumers, along with significant synergies across our operations in Canada, Europe and the United States. Our business combination with Tilray aligns with our strategic focus and emphasis on our highest return priorities as we strive to generate value for all stakeholders.”