Cash Is King, But It’s Canadian Stock Transactions That Are Fueling Cannabis M&A Growth
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Cash Is King, But It’s Canadian Stock Transactions That Are Fueling Cannabis M&A Growth

New report outlines how cannabis businesses are raising capital in a risk-prone legal environment.

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June 20, 2019

In a new report titled Cannabis Private Investment Review, seasoned market observers have put together an overview of investment practices that are forming around the legal status of the cannabis plant. With all signs pointing to skyrocketing market values in the U.S. and elsewhere, private investors and publicly traded companies are finding ways to meet their own needs and participate in an industry that’s still circumscribed by risk. 

The report was compiled by MGO & ELLO, Fox Rothschild, Poseidon Asset Management and Mazakali. Pitchbook provided the data.

The report covers a gamut of private investment questions and ramifications, but it’s the section on market consolidation that points to clear trends in business investments (both plant-touching and otherwise).

Josh Horn, partner and co-chair of the Cannabis Law practice at Fox Rothschild, tells Cannabis Business Times that this rising investor interest in the industry is still backdropped by a thundering question: “When is it going to be legal in the U.S.?”

The level of risk remains high, and the question of “exits ramps”—opportunities to find a return on an investment—is one that still needs an answer.

“People always have that question, whether they’re risking loss of investment because of the federal-state legal dichotomy,” Horn says. “That has always been and remains a question. Clients that are doing private investment in the space, that’s typically their primary focus.”

For cannabis businesses, this is the tricky part: Access to capital is always a going concern. It’s a challenge to raise traditional capital for M&A deals, as well. There are limited resources.

To that end, many U.S.-based companies are pulling off reverse-takeovers of shell companies in order to trade publicly on Canadian exchanges.

And then using their Canadian stock as a cash supplement for mergers and acquisitions. By going to Canada, U.S. companies have greater access to capital. There’s less dependency on a venture capital fund, for instance, when a company can pitch their business to the investing public buying stocks on the Canadian Securities Exchange. With that investment comes the opportunity to grow a business’s footprint back in the U.S., where a fragmented market with limited business licenses means time is of the essence for a lot of these acquisition deals.

For smaller U.S. cannabis companies, then, potential sellers have an opportunity to court well-capitalized public companies in Canada. As the report states: “Where the market will see further consolidation, however, is at the regional level. Relatively established cannabis companies will look to acquire more capabilities and locations in an effort to dominate regional markets.”

Much like private investors looking for that exit ramp, cannabis business on the sell side are looking for an acquisition proposal, a stock swap or a similar buyout arrangement.

“More frequently, in what you’ve seen publicly reported, a lot of the smaller companies are getting acquired by companies that are listed on Canadian exchanges,” Horn says. “I think that’s the trend. Unless and until we have real federal reform in the U.S., where you have a significant opening of the financial markets, I think you’ll continue to see that trend of smaller companies looking for a liquidity event—and maybe, more likely than not, looking to companies that are publicly traded in Canada to do it.”

Already, this trend is clear from market headlines in mainstream business publications and investment blogs.

“I think companies that are publicly traded in Canada have a bit more flexibility in the M&A space at this point, because they use stock in lieu of cash,” Horn says. “Whereas in the VC [venture capital] space, you may have a more limited pool of potential buyers, because—how many VCs have a few hundred million dollars cash laying around for a big acquisition? Some do, I'm sure. And there are some very wealthy family offices and private investors in the space, but I just think, between the two, there may be a bit more flexibility in having a stock deal with trading listed company than with traditional VC.”

Cash may always be king, but for now a great deal of the international cannabis market movement is driven simply by stock transactions and consolidation proposals. Because of how Canada and the U.S. treat the industry, respectively, a different approach to raising capital is forming along the border.