Finding the Silver Linings in a Stalled Market
Last year was a rollercoaster for cannabis companies. In Q3 of 2019, the “Big Four” publicly-traded Canadian cannabis corporations collectively lost $14 billion in market capital. And it wasn’t just Q3. Cannabis stocks suffered the majority of last year as companies struggled to meet revenue projections. Unsurprisingly, these enormous losses give investors a lot of pause. When the stocks are down, the capital dries up. Still today, we are in a stalled market. Furthermore, with the lack of institutional capital available in the space, cannabis companies have to rely on individual investors in large part for their capital needs, many of whom have experienced significant losses in recent months.
That said, and despite the trials and tribulations of last year, many investors remain excited and are looking for opportunities in the space, albeit with a different risk profile and focus. Countless cannabusinesses are still in need of capital, which presents opportunity. While there are indicators that show the tide may be turning, companies still need to fund raise during this stalled time. How are they doing so?
We’ve seen a couple of multi-state operators choose debt solutions rather than equity investment. In January, Curaleaf and Cresco Labs announced debt raises of up to $300 million and $200 million, respectively. However, these options aren’t available to every company. Generally, to access a debt deals a company will need a positive EBITDA against which to borrow. In most cases investors can get assets and collateral to back up their investment in the event of the company imploding. During times of market uncertainty, debt solutions become far more attractive to investors than equity investments because they entail a much lower risk profile.
I’ve seen a number of investors turn to the hybrid option of convertible debt – a loan that accrues interest with the option for the lender to convert that into equity in the future. Also, a handful of investors have been seeking warrant coverage – the option to buy stock in a company at a set price in the future. Investors are enticed by kickers – some upside to their investment aside from the interest they’ll collect. In a stalled market, investors who do the diligence have a lot to gain. There’s a ton of real opportunities out there. If you want to identify them, it requires personal research, doing your own valuations, and focusing on fundamentals. Yes, fundamentals now matter for cannabusinesses, and the companies that have strong fundamentals are in the best position to capture the available capital.
I encourage companies in the cannabis space and entrepreneurs starting to build something for the long-term. What does a sustainable business that will attract folks with capital to invest in look like? It can be quality assets, technology and IP or a good management team. What’s critically important in a stalled market is for companies to make themselves attractive to investors. Back to fundamentals. There’s no denying that it’s a challenge, but here are five considerations:
- Have a solid business model
- Understand the marketplace
- Discern your competition
- Make thoughtful projections
- Prove that you can execute
There are a lot of flashes in the pan in the cannabis space. Now that some of the hype has fizzled, get-rich-quick businesses are going to find it much more difficult to attract investors.
When it comes to hemp, investors are still trying to figure out what it’s all about. Education and asking questions are the right places to start. Since the CBD has been all the rage, many are missing the elephant that’s right in front of them. According to a 2017 report commissioned by the U.S. Congressional Research Service, hemp has upwards of 25,000 uses including as a source of grain for food, fiber for textiles, and the list goes on and on.
With the passage of the 2018 Farm Bill, hemp now has the benefit of being legal at the federal level, which opens it up to much larger sources of capital. In fact, last December, federal and state regulators, including the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Financial Crimes Enforcement Network, released a letter clarifying that banks no longer have to file Suspicious Activity Reports (SAR) on hemp businesses and producers as the crop is no longer listed on the Controlled Substances List. This is definitively a positive indication for the future of hemp banking.
On the marijuana side, it’s still about uncertainty and illegality at the federal level. The market is immature and varies widely from state-to-state. Marijuana companies are still strapped by banking issues, 280E and other challenges unique to the marijuana industry. Even though the Secure and Fair Enforcement (SAFE) Act, proposed legislation that would open federal banking services to cannabusinesses, passed the House last September, support and hope has wavered since Chairman of the Banking Committee, Mike Crapo, expressed direct opposition to the bill. This has led many to believe we won’t see any progress from Congress on the SAFE Banking Act. The reality is that there’s nothing concrete at the federal level for the marijuana industry at this time. But the opportunities are still there.
In either case, whether you’re interested in the hemp or marijuana industry, the key is finding companies with a solid management team, a thoughtful business plan, a sustainable product or service, preferably some technology, and proof that they can navigate through the market fluctuations.
A stalled market does not mean a failed market. Silver linings exist for investors and companies, but the real winners will be those in the game for the long run that focus on fundamentals.
The views and opinions expressed in the article represent the view of the author and not necessarily the official view of Clark Hill PLC. Nothing in this article constitutes professional legal advice nor is intended to be a substitute for professional legal advice.
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