When it comes to small business opportunities these days, few phrases give people the old dollar-sign-eyes more than “legal cannabis”.
From states like Michigan where it’s been approved for both medicinal and adult use, to places like South Carolina where legalization has been a popular topic for ballots and voters, cannabis is slowly turning into one of America’s biggest businesses.
You don’t need us to tell you that – Investopedia reports that (as of Nov. 2020) over 340,000 American jobs were devoted to the handling of plants at various stages along the retail cycle, and the industry was estimated at over $13 billion as of 2019.
Not bad for a plant that’s still technically illegal under federal law, huh?
If you’ve read this far, it probably means you’re hoping to be among the lucky ones who can strike it rich with their own cannabis business. A noble undertaking, but are you really prepared to make your mark? In a field as competitive – and occasionally complicated – as cannabis can be, you really need to lead with your best foot forward, and make sure you’re as well prepared for the various challenges of a fairly new industry as possible.
With that in mind, below is a list of the five things you’ll need to double-check and make sure you actually have access to before embarking on your new business venture.
The right shelving & equipment
You see this a lot with smaller businesses as well as, er, ‘independent growers’. A lot of people assume that they can just buy some greenhouse shelves, line the walls of their business with it, and call it a day, right?
This approach leads to problems more often than not. Even above and beyond the inherent concerns of helping your plants grow safely (and productively!), the sort of equipment you use should reflect the sort of business you’re trying to run. A cannabis retail outlet, for example, is going to need different sorts of shelves and tables than a dispensary or growing facility, as the work being done is completely different.
It will take a little research, but it helps that a lot of businesses these days are starting to offer shelving specifically designed for various cannabis operations. Check to see if any of the big warehouse suppliers near you have gotten into the cannabis game yet – Shelving Inc, Metro, and Rack & Shelf are a few of the bigger shelving names with cannabis offerings as of this writing.
Long gone are the days when all you needed to be successful in cannabis was a booth at the shady flea market, a pun name and a big sign that said “Head Shop” to throw off the authorities.
Far too many cannabis businesses launch themselves headlong into a business plan without stopping to think of a good name, or just settling for the first one they think of. With as crowded as the playing field is quickly becoming, it might honestly be worth it to pay someone to help you come up with a decent logo and branding – it’ll go a long way towards helping you stand out against everyone else using a green font. Places online like High Hopes specifically offer these services for cannabis businesses, so you know they’ll be able to figure out what you’re about more quickly.
An understanding of your consumer base
The exact sort of work your cannabis business performs is going to affect what your potential customer base can be – and vice versa.
Early on in the planning stages, make sure to figure out exactly who you’re going to sell your products to, as this will inform nearly every other decision your business makes. Do you want to sell directly to the customer, or to work as a distributor for CBD/cannabis retail outlets? Are you prepared to manage and run your own storefront, or are you just going to rent warehousing space to sell your plants to other retailers? If so, do you know who the businesses are in your area that you could work with? Or, if you are planning on entering the retail space, do you know how many other cannabis businesses could be operating in your desired geographical area? Finding an audience may be the hardest part of opening any business, but it’s important work.
Banking that understands your industry
Maybe the biggest drawback to being involved in an industry as comparatively new as cannabis, is that a lot of the old methods of doing business aren’t quite available to you. Many financial institutions of various sizes are limited in the ways they can help finance cannabis businesses, from not understanding the regulations and needs of your industry, all the way to being unable to assist cannabis businesses with banking in the first place.
It might be advantageous to look into banks, credit unions or financing companies in your area that specifically offer banking services (like business accounts and the like). A few examples include Aery Group from New Mexico, or Seed to Sale in Michigan. (It’s important to note that many of these companies, such as Aery Group, can only service the state they’re located in due to different state-by-state regulations – check ahead to make sure you find a place that can help you!)
Knowledge of the needed licensing and regulatory requirements
Getting a license to open any business is a tricky prospect on a good day, but for an industry as wide-ranging and varied as cannabis, getting licensed can require a lot of homework.
Even if you’re lucky enough to be setting up shop in a state that allows for the sale of cannabis, the licensing process can vary widely from state-to-state. In New Mexico, for example, it can take months to acquire a license simply due to the amount of paperwork, research and submissions required to cement your business. Before going too far down the rabbit hole of opening your business, make sure to take the time you need to completely research and understand the various local and state regulations you’ll need to adhere to for your business to get off the ground.
Obviously, there’s going to be a lot of other hurdles and requirements that come with starting a business – but by remembering these five things, you’ll be off to a much better start than many others.
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?
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!
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.
Update: The House Judiciary Committee has passed the legalization bill, HB0209, by a 6-3 vote. After moving out of the Judiciary Committee, the bill now awaits a floor hearing, which is expected to come within the next week or two during the legislative session that ends on April 2.
A bipartisan group of lawmakers in Wyoming have introduced a bill to legalize cannabis in the state’s legislature. First reported by Buckrail.com, HB0209 was assigned on March 2. The bill would legalize possession, home grow and sales for adults, as well as establish a regulatory framework for licensing, tracking and taxation.
In November 2020, voters in Montana and South Dakota passed ballot measures that legalize adult use and sales of cannabis. About a month after Election Day, the University of Wyoming conducted a poll that found roughly 54% of Wyoming residents now support legal adult use cannabis. In 2018, UW found that 85% of Wyoming residents support medical cannabis legalization.
In March of 2019, Wyoming Governor Mark Gordon signed a bill into law that essentially legalized hemp in the state. That bill was a boon for the state’s agricultural economy, giving many farmers a much-needed boost in their crop diversity.
You can find the current version of HB0209 here. Sponsors of the bill include: Representatives Jared Olsen (R-Laramie), Mark Baker (R-Sweetwater) Eric Barlow (R-Campbell/Converse), Landon Brown (R-Laramie), Marshall Burt (L-Sweetwater), Cathy Connolly (D-Albany), Karlee Provenza (D-Albany), John Romero-Martinez (R-Laramie), Pat Sweeney (R-Natrona), Cyrus Western (R-Sheridan), Mike Yin (R-Teton) and Dan Zwonitzer (R-Laramie) and Senators Cale Case (R-Fremont) and Chris Rothfuss (D-Albany).
According to Buckrail, if the bill becomes law, Wyoming could get roughly $49.15 million in tax and license fee revenue in 2022. That number would mean a sizable windfall for the state that saw an 8.5% decline in tax revenue in 2020. Governor Gordon proposed budget cuts as high as 15% for agencies across the state last year. Most of the revenue generated from cannabis taxes would be earmarked for education.
There is a significant increase in demand for all cannabinoid products across the board—including CBD, THC, CBG and THCV—from recreational users, consumer packaged goods and pharmaceutical companies. And the next great race is on for the hottest arrival to scientific cannabis therapeutics: rare cannabinoids.
Research shows rare cannabinoids are poised to be the future of cannabis investing, providing better health benefits in addition to impacting the pharmaceutical, CPG, nutraceuticals, cosmetics and pet care markets significantly. According to recent reports, the biosynthesis of rare cannabinoids will be a $25 billion market by 2025 and $40 billion by 2040.
The companies that will revolutionize this market are ones with the highest quality and lowest prices, which means that biosynthetic cannabinoid companies will be the leaders in investment and capturing market share. We will also see a major consolidation in this market amongst the grow, harvest and extraction companies, increasing efficiencies and driving down costs.
What are rare cannabinoids and why should we care?
Rare cannabinoids such as CBG, CBN, THCV, THCA and others have significantly better and more specific health benefits than just CBD on its own. Biotech companies like ours, Biomedican, which has a patent-pending biosynthesis platform, can produce pharmaceutical grade, non-GMO, bioidentical, synthetic cannabinoids with 0.0% THC at 70-90% less cost. Producing 0.0% THC means that rare cannabinoids can be added into nutraceuticals, CPG and cosmetics/lotions with zero changes in current cannabis regulations. Also, we produce the same exact product every time (not possible through plants), which is extremely important for pharmaceutical companies conducting clinical trials.
Why are rare cannabinoids important?
The human body contains different cannabinoid receptors that help regulate critical processes, including learning, memory, neuronal development, appetite, digestion, inflammation, overall mood, sleep, metabolism and pain perception. This considerable involvement of cannabinoid receptors, critical to many physiological systems, underscores their potential as pharmaceutical targets.
Pharmacological research has uncovered several medical uses for cannabinoids, which bind to cannabinoid receptors. They’ve been shown to help with pathological conditions such as pediatric epilepsies, glaucoma, neuropathic pain, schizophrenia and have anti-tumor effects as well as promote the suppression of chemotherapy-induced nausea. This ongoing research is becoming more prevalent and has the potential to uncover therapeutic uses for an array of cannabinoids.
In addition to the medical field, other prominent sectors have adopted the use of cannabinoids. There is an increasing demand for cannabinoids in inhalables, the food industry and in hygienic and cosmetic products. Veterinary uses for cannabinoids are also coming to light. The use of naturally occurring cannabinoids reduces the need for synthetic alternatives that may produce harmful off-target effects.
So how does this affect the investing market?
Where there is demand, significant and growth investments follow. All the major players from nutraceuticals, CPG, cosmetics and pet care companies are driving the demand for rare cannabinoids. We are seeing a major investment shift from commodity-based prices for cannabis and CBD to the new biosynthesis technology which offers significantly better health benefits and higher profit margins. Those unique qualities of rare cannabinoids open an enormous opportunity to create new drugs and food supplements for treating various medical conditions and improving the quality of life. This creates a massive global opportunity for all companies in these categories differentiating their products from competitors.
There will be big winners and losers in these markets, but at the end of the day, the highest quality and lowest cost producers will capture most of these markets. Biomedican has the highest quality, highest yields and lowest cost of production in the industry. Which we believe will make us the clear leader in the biosynthesis rare cannabinoid markets.
Which rare cannabinoid to invest in first?
Early reports indicate THCV (not to be confused with THC) could contain a variety of health benefits: it may help with appetite suppression/weight loss, possibly treat diabetes as well the potential to reduce tremors and seizures caused by conditions like multiple sclerosis, Parkinson’s disease and ALS.
There has been an explosion of interest in THCV due to its potential health benefits. We are seeing major players in the nutraceutical, health food and pharmaceutical industries clamoring to add THCV to their product lines. Companies can now produce THCV through biosynthesis, creating a pharmaceutical-grade, organic, bioidentical compound at 70-90% less than wholesale prices. This is exactly what the largest players in the market want: a pharmaceutical-grade, consistent product at significantly less cost. The current prices and quality have limited THCV production, but new breakthroughs in biosynthesis have solved those issues, so we expect a tsunami of orders for THCV in 2021.
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.
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.
After a slow start following a disappointing 2019, M&A in the cannabis space closed 2020 with a bang, with more than $600 million in deals announced immediately following the November elections. Prospects for the New Year are expected to continue the explosive year-end trend with a backlog of nearly $2 billion in deals heading into 2021. The COVID-19 pandemic boosted sales of cannabis products, and election results opening up five new states to legal cannabis use and possible federal regulatory reform are further boosting prospects. Analysts now predict the U.S. cannabis market is poised to double by 2025.
Growth is expected to be led by multi-state operators who have achieved scale, cleaned up their balance sheets and stockpiled dry powder for roll-up acquisitions. Cannabis companies raised nearly $134 million in the two weeks before Election Day, a 185% increase over the same period last year. Most of the money flowed to multistate operators. In addition, the biggest stocks by market capitalization saw a roughly 20% bump ahead of the election and now are trading at record volumes, providing plenty of stock currency for further acquisitions.
Among the headline acquisitions last year:
Curaleaf continued its multi-state expansion with two of its largest acquisitions – the all-stock purchases of its affiliated cannabis oil company Select and of Grassroot, another MSO player. Curaleaf is now the largest cannabis company in the world based on annualized revenues, with annualized sales of $1 billion and operations in 23 states and 96 open dispensaries. Curaleaf also raised $215 million privately last year end for further expansion.
Close behind, Aphria and Tilray announced in December that they will merge, creating what they say will be the largest cannabis company in the world with an equity value of roughly $3.8 billion. The combined entity will have facilities and offices in the U.S., Canada, Portugal and Germany. The deal is expected to close during the second quarter of this year.
Also in December, Illinois-based Verano Holdings LLC unveiled plans to go public at a $2.8 billion valuation through a reverse takeover of a Canadian shell company. That deal followed the announcement that Verano will merge with Florida-based AltMed.
In addition, publicly traded New York cannabis firm Columbia Care signed a definitive agreement last month to acquire Green Leaf Medical, a privately held Maryland-based cannabis manufacturer and retailer, for $45 million in cash and $195 million in stock. The acquisition is expected to close this summer. Including Green Leaf’s inventory, the Columbia Care will operate 107 facilities, including 80 dispensaries and 27 cultivation and manufacturing facilities. Columbia Care also took advantage of cannabis fever last year by raising $100 million privately.
Also in December, Ayr Strategies announced it would acquire Liberty Health Sciences, one of the largest cannabis companies in Florida, for $290 million in stock, as well Garden State Dispensary, a New Jersey marijuana company for $41 million in cash, $30 million in stock and $30 million in the form of a note. This follows Ayr’s $81 million acquisition of an Arizona medical marijuana operator in November. Voters approved marijuana use in Arizona and New Jersey in November. Ayr has completed a string of acquisitions in Nevada, Massachusetts, Pennsylvania, Arizona, Ohio and, upon the closing of December’s deals, New Jersey and Florida.
Not all cannabis companies will rely on acquisitions, however. Trulieve, as an example, has focused its efforts on Florida and organic growth. It remains to be seen whether a multi-state approach fueled by acquisitions or a single-state organic growth model will prove the more lasting. Growth and profitability in the short term likely will continue to be hampered by limits on economies of scale due to federal restrictions and differing state laws.
In light of the maturing industry and the 2019 bust, the valuation model for acquisitions in the cannabis space is evolving from one based on sales, typically associated with emerging growth industries, to a more mature industry model based on profits or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). Most cannabis MSOs have stabilized and generate positive EBITDA, which justifies the evolution away from a sales-driven model.
From a legal standpoint, the same limitations that have vexed the cannabis industry for years will continue to challenge deal makers until there is greater clarity on the federal front. Institutional investor reluctance, financial industry constraints, haphazard state regulation and the unavailability of federal forums such as national copyright and trademark registration will continue to be issues for acquirers and their lawyers in the space.
Acquisition agreements will continue to have to address the federal Damocles’ sword should expected relaxation of federal enforcement under the Biden administration and further legislative relief does not materialize as expected. Although the U.S. House in December passed the “Marijuana Opportunity Reinvestment and Expungement Act” (MORE) to remove cannabis from the Controlled Substances Act, the Senate did not take up the bill in 2020 and it will have to be re-introduced in 2021. Notably, the MORE Act does not affect existing federal regulation of cannabis, such as the Food, Drug and Cosmetics Act, under which the FDA has limited the use of CBD in certain products despite hemp being removed from the Controlled Substances Act in 2018.
The cannabis M&A market is moving into a more mature phase, as MSOs will be choosier in their approach rather than continuing the land-grab mentality of years past. Due to improved financial strength, 2021 should see these MSOs continuing to expand their footprints either within existing states or new ones. Although uncertainties abound, further consolidation and expansion through add-on acquisitions is likely to continue apace in 2021, providing plenty of opportunities for deal makers and their lawyers.
While we’re pleased to report that 2020 is almost over, 2021 will be a mixed bag. New jurisdictions will open their doors to cannabis and consumption will continue to rise, but competition from new operators and illicit supplies will increase. As California’s cannabis industry matures and turns the page on a bizarre year, market uncertainty will linger as the pandemic drags on and overtaxation and regulation strangle profits. But let’s remember, cannabis has been cultivated for over 6,000 years and has withstood far worse—this market isn’t going anywhere and will continue to grow and become more impactful.
Access to Traditional Finance Services
The U.S. Senate will likely pass legislation providing cannabis businesses access to traditional banking and financing services. This will be a game changer for the industry. Valuations will go up. Increased liquidity will smooth transactions. Companies will look to affordable debt to expand their footprints and capacity to compete on a new scale. Full federal legalization could be a game changer if 280E tax restrictions are lifted and interstate and international cannabis trade open up, but the timing of this is hard to predict.
Continued Quarantine-Induced Consumption
Cannabis consumption will continue to increase as Californians seek to ease pandemic-related stress, temper quarantine conditions, and sample an eye-popping array of new products. Sophisticated consumers will be open to spending more on unique and niche products. But hemp-derived cannabinoids may present a new source of competition, especially if CBD remains unregulated. By the end of 2021, cannabis beverages will begin to compete with mainstream alcohol categories. Pharmaceuticals will increasingly take notice of this industry and the increasing share of consumers turning to plant-based remedies.
Ever More Cultivation Opportunities
In pursuit of revenue, agricultural counties will liberalize their policies on cannabis cultivation by permitting more acreage and streamlining permit processes. Neighborhood groups will push back, but policymaker concerns will be assuaged when they see cannabis farms operating innocuously (and sustainably) around the state. Advances in seed breeding, pest-and-disease control, outdoor growing techniques and odor abatement technology will help too.
Cities and counties will revisit opening their borders to cannabis retail storefront and delivery as they attempt to fill budget gaps. Many cities will allow cannabis retail for the first time and/or expand the number of licenses available. These new dispensaries will provide a much-needed outlet for the influx of licensed flower and will continue to spur innovation and consumer education. But a “second wave” of retail speculators seems poised to let optimism override judgement, setting themselves up for failure or acquisition by incumbents.
Getting Social Equity Right
2021 will be a pivotal year for social equity, which will establish a foundation for a just cannabis economy. The industry will have to grapple with how to ensure that those most impacted by the criminalization of cannabis and most often excluded from traditional financing exposure are provided with equitable access to meaningful opportunities. As California’s regulated cannabis market grows, getting social equity right will be important if the industry is to firmly establish itself as an inclusive industry that addresses impacts on marginalized communities and responds to customer demands.
California’s new CalCannabis Appellations Program will provide cultivators and brands a way to credibly market the value of their unique growing regions and cultivation methods. These distinctions only apply to cannabis planted in the ground, excluding greenhouse and warehouse grows. The expectation is that high-end consumers, trained to recognize place-based designations and quality certifications in other products, will reward products that boast these designations. How many consumers will be willing to pay the premium and how long full implementation of the program will take, remains to be seen.
Prices May Begin to Drop
2020 was a great year for the few fully licensed cultivators in California permitted to sell to the regulated market. 2021 may be different. Numerous licensed cultivation projects will complete the permitting processes and come online next year. While growing demand may outpace supply at first, by Q3 supplies could swamp the market. Premium flower is perhaps an exception. Adding to the pricing pain, as always, is California’s illicit market, which will continue to undercut prices, as legal growers toil to comply with a labyrinth of state and local regulations. Nonetheless, cannabis will remain the most profitable crop on a per acre basis for some time.
The drop in prices coupled with continued high taxes and regulatory burdens will result in turnover of assets and businesses. Less efficient and inexperienced cultivators will struggle, many unable to ultimately withstand pricing pressure. Others will be hit by enforcement actions for failing to comply with California’s myriad regulations. Retailers, already burdened by punitive tax structures, real estate finance commitments and onerous local regulations, will need to be disciplined and have a clear strategy to address new competition.
Driven by business failures and renewed investor interest, California’s regulated cannabis industry may consolidate rapidly in the second half of 2021. Institutional finance will enter the space with a much more disciplined approach than prior capital sources. Traditional agricultural interests will invest in cannabis cultivation projects. Well-run retail chains will begin to outcompete, and then acquire, mom-and-pop competitors. Big brands will continue to expand their shelf space, relegating smaller competitors to niche and novelty status.
In short, the cannabis industry will continue to be highly dynamic, exciting, enticing and risky.
All major industries took a hit during the COVID-19 pandemic, but in many states, cannabis dispensaries were labeled as essential, which has allowed the industry to continue with some alterations. The impact now will come from what innovations and improvements the industry can leverage going forward.
From changes to protocols and buyer behaviors to supply chain disruptions, there were many new hurdles for the industry in addition to the ones cannabis businesses already faced, such as funding. But the silver lining could be that businesses within the cannabis industry become less of a specialty and more ‘every day’ than ever before.
The effects of the pandemic on the cannabis industry
Overall, the industry has fared well, in part thanks to its distinction as an essential service in states where cannabis is legal. It’s possible states made this decision for the same reason that alcohol businesses were deemed essential in most places: hospitals are not equipped during pandemic times to take care of people who are being forced to detox or those suffering from anxiety because they don’t have access to their legal drug of choice.
In a multitude of ways, cannabis businesses have adapted to bring calm in a storm while at the same time making manufacturing adjustments to meet the CDC guidelines. For example, there is more attention placed on individually pre-packaged products for single use; something that is less sharable as an experience but eminently practical.
Another area that has shifted a little is in the limiting of the exchange and interaction between business owners and staff relative to the customers. It’s all in the aim of mitigating the risk of exposure, but it has changed the dynamic in many cannabis businesses. This is the new normal for the time being and the industry has adapted well.
Ultimately, retail cannabis businesses today are no different than the retail of candy, cigarettes or alcohol. Certainly, segments of the industry have still struggled. Lack of tourism and the curbside/take out circumstances at dispensaries took their toll. But without the opportunity to still conduct business in some capacity, 50-60% of all operators would have gone out of business. Plus, as many people use cannabis to offset medical symptoms, including pain management, there is a legitimate need for cannabis to be available. The pandemic has provided the opportunity for many who might not have tried it before to give it a chance to help them medicinally.
Behaviors have changed, including those of buyers
Driven by consumer interests, many dispensaries have adapted to provide curbside pickup options, delivery of online orders and more. That has meant that the customer also needs to be more knowledgeable about cannabis: the experienced consumer knows what they like and want and can make their choices at a distance. Someone who is new to cannabis use might find navigating the choices and options a little more difficult, without the help of experienced staff. The breadth of material online and the ability of some dispensaries to share content that helps the consumer to make choices, in the absence of walking around the dispensary, have been additional tools at the disposal of businesses.
That said, the cannabis industry today is not a vastly different one: it is adapting to the new rules and new reality. Whether this way of doing business—at a distance—is a temporary or permanent solution will be dependent upon what federal and state regulators dictate in the months ahead, but there is likely to be ongoing demand for being able to order online and keep social distance protocols in place.
An interesting example is the Ontario Cannabis Store (OCS) in Ontario, Canada. This is a government run shop that has retail as well as a robust online presence, with free delivery during the pandemic. This has facilitated an increase in new customers, which had already jumped, post legalization. People who might have felt uncomfortable going into a dispensary can still learn about cannabis online and order it, from the relative comfort and safety of their sofa.
Supply chain disruptions and the cannabis industry
The industry has long been focused on overseas suppliers. With the arrival of the pandemic and restrictions on obtaining products from other countries, supply chains have been disrupted for many cannabis businesses. That has forced many to shift their supply chains to more local manufacturers, in North and South America.
In the long run, this should have a positive impact for the industry, so that despite the short-term disruption to the supply chain, which is having an impact on the industry as a whole, there could be an upside for local producers, growers and manufacturers. It will take time to know how this will all play out.
Funding and other issues for the cannabis industry
For a new cannabis startup in these times, the key will be what it has always been for any business, just to a greater degree: due diligence. Companies that want to open a cannabis business, whether during the pandemic or not, need to evaluate the opportunity as one would any investment. It’s all about the numbers: data for the industry as a whole and specifically from competition. These days, that data is widely available and more and more consultants and investors have expertise in this industry. “Overall, there is more interest in the industry than ever before”
It’s vital to be extremely well versed, particularly for businesses that are relatively new in the industry, because the single biggest issue for many has and will continue to be funding and investment. The cannabis industry is no different than any other business, except for the fact that it is a specialty business. With that comes the need to look for funding among investors who have some knowledge or appreciation for the industry.
Some of the key concerns traditional investors will have include:
Regulatory differences from state to state: since cannabis is still illegal at the federal level, there can be an array of hurdles at state and local level that make cannabis businesses trickier to work with.
There are religious based/morality issues for some lenders in dealing with the industry. These aren’t dissimilar from issues with other industries such as adult entertainment and gaming. It’s also fair to point out that, morality aside, these industries have thrived in the last several decades.
So, while traditional banking institutions will often deal with the proceeds from the cannabis industry, including allowing bank accounts for these businesses, there is far less of a chance that they would invest in a cannabis business, for fear of risking their license. They can even go so far as to refuse to include income from a cannabis business in the determination of a loan application.
There are more unique lending or investing groups that either specialize in cannabis or are starting to open their books to specialize in cannabis. Overall, there is more interest in the industry than ever before, as it becomes normalized in American society: more participants and more insiders of the industries that are willing to invest in the right idea.
Will legalization be more likely in the future?
The fact that cannabis businesses and dispensaries have been deemed essential services during the pandemic, where they legally operate, has shed new light on the relevance of these businesses and the advantages of more widespread legalization.“Consumers will help drive the innovations as they demand clean consumption methods”
In fact, the pandemic has normalized a lot of new behaviors, including the acceptable use of cannabis to help with stress and anxiety. People are, perhaps thanks to staying at home more, doing the legwork to understand how cannabis could be useful to them in managing their stress. The medicinal benefits of cannabis have long been researched and understood: consumers are coming into the fray to express their interest in it, which can only fuel the possibility of more widespread legalization.
Add to this the fact that the cannabis industry is a growth industry. There are companies and jobs that aren’t coming back, post-pandemic. There is an opportunity to grow the cannabis industry to the general benefit of many, both as business owners and employees. The revenue generated from taxation following legalization would also benefit many state coffers. Federal level legalization would be the panacea to eliminate the mixed message, state by state regulation that currently exists.
Opportunities for innovation, moving forward
As more and more people become interested in the industry, and as cannabis use is normalized within society through legalization, the opportunities for the industry can only expand.
For an industry that started on the simple concept of smoking cannabis, the advances have already been legion: edibles, nanotechnology-based formulations for effective, clean consumption and many more innovations.
In a world that increasingly sees smoking as a negative, for the obvious impact to lung health, there are so many opportunities to grow the industry to find consumption methods that are safe and still deliver the impact of the inhaled version.
Here again, consumers will help drive the innovations as they demand clean consumption methods. The technology is available to make this possible; it only takes innovation and education to find the best ways to move this industry forward.
As legalization expands—and particularly if it is dealt with at the federal level—the industry will be able to capitalize on existing infrastructure for manufacturing and distribution, allowing new businesses to grow, get funded and thrive in the new normal.
In June 2020, John W. Elias, a prosecutor in the United States Department of Justice’s Antitrust Division, testified to the U.S. House Committee Judiciary that investigations of cannabis mergers were pursued based on Attorney General William Barr’s personal dislike for the cannabis industry rather than legitimate antitrust issues. Specifically, Elias testified, among other things, that since March 2019, the Antitrust Division has conducted ten investigations of mergers in the cannabis industry. Further, Elias testified that, “While these were nominally antitrust investigations, and used antitrust investigative authorities, they were not bona fide antitrust investigations.” Elias went on to state that, with respect to a proposed $682 million merger between two cannabis companies, MedMen and PharmaCann, career staff in the Antitrust Division initially examined the transaction to determine whether there should be no investigation, a brief investigation or a full investigation. Upon conclusion of its review, career staff determined that “the cannabis industry appeared to be fragmented with many market participants in the states that had legalized the product.” Accordingly, staff concluded that the proposed combination between MedMen and PharmaCann was “unlikely to raise any significant competitive concerns.”
Notwithstanding the career staff’s determination, Attorney General Barr ordered the Antitrust Division to issue “Second Request” subpoenas. According to Elias’s testimony, a “Second Request” subpoena is a full investigation of a proposed merger. Moreover, Elias stated, “Across the entire American economy, the Antitrust Division performs the full Second Request investigation on around 1-2% of the thousands of mergers filed each year – ordinarily, only the most concerning deals.” Based on the foregoing, Elias testified that Attorney General Barr’s decision to pursue the MedMen/PharmaCann combination was based on his dislike for the cannabis industry rather than any legitimate antitrust concerns.
There are some immediate impacts to Attorney General Barr’s decision – not limited to the MedMen/PharmaCann merger but potentially reaching any cannabis companies considering a merger or similar transaction. For example, a politically motivated probe would more than likely result in a drop of stock prices for publicly trade cannabis companies. Moreover, non-bona fide antitrust investigations of cannabis businesses could result in proposed merger transactions eventually not coming to fruition.
However, Attorney General Barr’s decision could arguably have longer term and more widespread effects on the cannabis space, and could affect situations not involving mergers or other proposed business combinations. In particular, the fact that legitimate cannabis businesses that comply with all applicable laws are still subject to unwanted and unnecessary scrutiny conceivably could lead to something that regulators had hoped would be curbed through the legalization of cannabis for adult use: cannabis operators gravitating towards the omnipresent black market. Despite cannabis being legal in 33 jurisdictions for medicinal use and 11 jurisdictions for adult use, the black market continues to thrive for several reasons, one of them being that the cost of regulatory compliance is so significant. Attorney General Barr’s decision may have created another reason for cannabis operators to abandon their plans to continue operating as or become legitimate businesses and instead revert back to operating in the black market.
Indeed, Attorney General Barr’s decision is a concern for cannabis operators because it shows that, notwithstanding that any particular operator may be compliant with state and/or local regulations, it does not mean that such cannabis operator is going to be permitted to conduct “normal” business that a non-cannabis business would be able to conduct, simply because of the underlying nature of the business. Stated differently, following the rules does not mean that a cannabis business will be left alone by people in charge who simply do not like the cannabis space.
Cannabis operators are very mindful of being targeted because of the nature of their business, and having regulations in place with which they could and would comply provided them with some level of certainty that they would not be targeted, or so they thought. Particularly in states like California where the regulations are complex, current and aspiring cannabis operators tend to be very concerned about being compliant with cannabis regulations from the inception of their business operations, believing that being compliant will assist them in flying under the proverbial radar and not become targeted unnecessarily simply because they are in the cannabis space. Attorney General Barr’s decision may have taken away or, at the very least, significantly decreased, that level of certainty. His decision to investigate a proposed merger of two legitimate cannabis businesses sends the message that it does not matter if a cannabis business is being compliant, and that there are other, completely subjective reasons why its operations could be investigated. This makes it extremely difficult for current and aspiring cannabis operators to determine what actions they can take to avoid unwelcome investigations or other scrutiny. If a cannabis operator is unable to mitigate scrutiny by complying with rules, this raises the concern that cannabis businesses will go back to black market activity, not only because the cost of compliance is high, but because being compliant does not necessarily protect them.
Attorney General Barr’s decision is likely not the only instance of a decision regarding cannabis businesses that was made notwithstanding existing statutes or regulations that do not support such a decision. In fact, since adult use became legal in certain jurisdictions it is not uncommon to see news discussing applicants for cannabis licenses who were denied licenses, notwithstanding that those applicants complied with all applicable laws and regulations. When applicants were denied even after complying with all rules and regulations, and when no other legitimate reason was cited for the denial, there is an indication that the denial was based on political or other personal feelings concerning the cannabis space. This not only potentially calls into question the integrity of the cannabis space, but again could lead cannabis operators back to the black market.
There are many costs of regulatory compliance for a cannabis operator, including, without limitation, high application and license fees, development and mitigation fees and exorbitant taxes. Other than the fees and taxes assessed on cannabis businesses, there are other expenses, such as the cost to construct a facility, security costs and the general operational costs that all businesses must pay, such as rent or payroll. What incentive does a cannabis operator have to expend significant resources – time, money and otherwise – to become a legitimate, licensed cannabis business if doing so does not provide any type of protection against investigations that are politically motivated or otherwise based on negative personal feelings toward the cannabis space? It may be that Attorney General Barr’s decision has given cannabis operators one more reason to reconsider going back to black market activity.
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