With the easing of global marijuana regulations and the ratchetting-up of competition, industry leaders everywhere are scrambling to fortify their businesses’ market positions by creating full-service organizations through the acquisition of synergistic products, licenses, locations and expertise. Yes, 2019 is shaping up to be even bigger for cannabis stocks, which raises broad questions: How ready are most companies in the cannabis industry, really? Should every cannabis company be looking to go public? And what does going public truly entail?
Going public is a costly, complicated process that requires a large team of managers, lawyers, accountants, investment bankers and consultants. The entire proposition is fraught with risk, and too many companies are going public without proper planning and justification, says Hadley Ford, CEO and director of iAnthus Capital Holdings Inc., which owns and operates licensed cannabis cultivation, processing and dispensary facilities throughout the U.S. He describes the process as a potential train wreck.
“You have to have a reason and strategy for doing it,” Ford says. “It’s much harder to be a public company than a private company. If you screw up, you will be forgotten.”
In this article—Part I of a two-part series—cannabis industry experts share the key the reasons to go public and offer a 7-point checklist of considerations before making a final decision.
The reason iAnthus went public in the first place was because no other way to get money existed. “A year ago, I couldn’t get a lender to pay attention,” Ford says. According to iAnthus, the company became the first multi-state operator in the U.S. to go public and raise money in Canada—a feat many thought too tough to tackle and now widely copied.
Going public helps cannabis companies manage their overall cost of capital—the mixture of returns needed to persuade an investor to make an investment. To investors, the cost of capital represents the opportunity cost of making a specific investment. If an investment fails to get a return that exceeds the cost of capital, investors will take their money elsewhere. So, if a cannabis company can run its business or even expand operations at lower cost of capital than competitors, that is a “differentiator,” Ford says.
“The access to capital has been critical to fuel our rapid global growth,” says Cam Battley, chief corporate officer for Edmonton, Alberta, Canada-based Aurora Cannabis, now a fully integrated cannabis company.
This past fall, Aurora closed a debt deal worth as much as CA$250 million with the Bank of Montreal, a landmark for Canada’s marijuana industry. The new debt facility will be made up of a CA$150-million term loan and a CA$50-million revolving credit facility, both of which mature in 2021. Under the accord, Aurora has the option to upsize the facility to CA$250 million.
The deal marked a seismic shift in how big banks view the cannabis industry in Canada. Traditionally, for cannabis companies in growth mode, the only way to raise money was to issue more stock or extend convertible debentures—long-term debt that can be converted into stock after a set period. The option of taking out a traditional loan just wasn’t available.
“All that is evident in a significant change in attitudes with respect to the cannabis industry,” Battley says of the Bank of Montreal deal. “Institutions are now more comfortable with the cannabis industry. A brand-new global industry is being created in real time.”
And that industry is hitting public markets in diverse ways. While Aurora opted for an initial public offering, California-based FLRish (doing business as Harborside) went public in Canada through a reverse takeover (RTO). With RTOs, a private company typically trades shares with a public “shell” company in exchange for the shell’s stock, essentially transforming the acquirer into a public company.
Here, Lineage Grow Co. acquired all issued and outstanding Harborside securities. In return, Harborside received newly issued Lineage shares valued at CA$200 million. The result was a vertically integrated cannabis company now known as Harborside Inc.
Andy Berman, CEO of FLRish, says FLRish emerged owning most of the outstanding shares, controlling five of the seven board seats and retaining their executive team. Lineage also came with three stores and two grows, one indoor and one outdoor, so it rounded out Harborside’s vertically integrated portfolio of assets and supported its strategic growth plans, compared to just an empty “shell.”
The company recognized that if it wanted to grow, it needed to raise money. Investors coming into the cannabis industry want to know that a company has a “going-public strategy,” Berman says.
“We wanted to attract high-caliber, high-quality investors,” Berman says.
As Harborside learned, going public provides an opportunity to raise capital fast by reaching a wider distribution of investors. A new report titled, “Going Public in Canada,” from the MGO | Ello National Cannabis Alliance, lists six reasons to raise capital:
- expand existing operations,
- introduce new product lines,
- enter new markets or states,
- invest in research and development,
- pay down debts and improve financial performance, and
- mergers and acquisitions (M&A).
The final bullet point was key in iAnthus’ going-public strategy. Going public gave iAnthus the opportunity to acquire other license holders who lacked the capital to continue operations and were looking for an exit, including MPX Bioceuticals, which iAnthus acquired in an all-stock transaction this past fall in what was at the time the largest public cannabis transaction in the U.S.
Two other reasons to go public exist, but are not identified in the MGO | Ello National Cannabis Alliance report: talent acquisition and brand awareness. “You can issue options to your employees, so they can share in the wealth creation,” Ford says. “It becomes a tool to attract top talent.”
Scott Greiper, president and founder of Viridian Capital Advisors, a data-driven strategic and financial advisory firm dedicated to the cannabis industry, adds, “Everyone is trying to build their brand and differentiate.”
CHECKLIST ITEM #1: Build operational and managerial strength
Cannabis companies need sophisticated operations, sound finances and a veteran management team to be taken seriously by capital markets.
“In this industry, we’re looking for experience,” says Greiper. “The CEOs of [our] clients don’t come from cannabis. They come from tech; they come from food, ag tech, healthcare, with demonstrable track records of building business and scaling those businesses.”
CHECKLIST ITEM #2: Get comfortable with being public (in every sense of the word)
Being public requires frequent and transparent communication about the company’s performance. Company management and leadership must understand what that means and the time commitment involved.
“I spent a career doing this, and even I was caught surprised,” Ford says. “I love getting on the road and telling our story, but it’s a lot of work. Half a typical day is consumed with ‘public stuff,’ such as calls with investors and the media.”
“It’s not your company anymore,” Ford adds. It’s owned by shareholders. “That’s a very hard concept for an entrepreneur to accept.”
CHECKLIST ITEM #3: Gird for volatility
Canada’s legalization of adult-use marijuana generated an enormous amount of excitement for the sector, bidding up share prices. But the stocks crashed just weeks later, with short-sellers raking in almost half a billion dollars in profits in just two days alone. (Short-selling is “when an investor borrows shares and immediately sells them, hoping he or she can scoop them up later at a lower price, return them to the lender and pocket the difference,” according to MarketWatch.)
“At the moment, there is a large concentration of short-selling in the sector,” Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, noted in an October 2018 report.
This should not be surprising. Cannabis is a small-cap stock, which means it is more growth-oriented and there is more upside for investors. Also, significantly more volatility (a wide range of price fluctuations and large trading volumes) exists. Consider that from 1997 through 2012, the Russell 2000 small-cap index returned 8.6 percent on an annualized basis, compared with 4.8 percent for the S&P 500 stock index. But over that same period, the Russell 2000 had about one-third higher volatility.
“The volatility could be a real stressor on the business,” says John R. Downs, director of business development for The Arcview Group, a marijuana investment network based in San Francisco. “Executives can often find themselves spending more time managing the stock and worrying about the share price than actually running the business.”
Even without short-selling to worry about, a change of course for a business or an underwhelming earnings report can lead to sharp selloffs that could be devastating. “Pivots can be very painful for a public company,” Downs said. “There is so much more pressure. The stakes are much higher.”
On the other hand, he said, cannabis stocks have the characteristics of “sin stocks”—stocks that deal in tobacco, alcohol or other products deemed harmful, which tend to fare better during broader stock-market swoons.
In the end, the most recession-resistant company could be a privately held cannabis company, Downs said.
CHECKLIST ITEM #4: Button-up your corporate governance
As with every public company, all management decisions must be reviewed by a board of directors representing the interest of shareholders. And that board would have to create an audit committee, compensation committee and nominating committee, at the very least.
“The requirements to successfully go public can be overwhelming, including the time commitment from management and the length of time the process can take, particularly if certain items, such as audits of historical financial statements, are not already available,” says Scott Hammon, COO of MGO | ELLO National Cannabis Alliance. “The process can distract what are frequently smaller management teams from the operations of the core business.”
Many companies are also unprepared for the increased reporting and disclosure requirements post public offering, which can necessitate additional resources and changes in processes and governance procedures, Hammon says. “We normally recommend that companies start to operate like a public company before the go-public transaction is completed as that makes for a more streamlined transition,” he says.
CHECKLIST ITEM #5: Become an expert at navigating anti-cannabis tax laws
When a company goes public, it must be diligent and savvy about how it handles its tax obligations. For cannabis companies in the U.S., that means working harder to maximize deductions. Investors will put your tax accounting under a microscope.
Under 26 U.S. Code Section 280E, for example, any business engaging in the trafficking of a Schedule I or II controlled substance is prohibited from taking tax deductions or credits (except for the cost of goods sold (COGS)). In other words, cannabis companies must pay taxes on all their revenue without using otherwise legitimate business expenses to reduce their taxable income (again, excluding COGS deductions).
There are ways around 280E, however, and public companies must become artful about navigating those ways, like separating cannabis activities from the rest of the business’s activities to claim at least some federal deductions.
CHECKLIST ITEM #6: Disclose, disclose, disclose
In Canada, every public cannabis company must meet the quarterly and annual disclosure and reporting requirements per securities regulations.
Here’s a rundown of some of what’s required by National Instrument 51-102—the securities’ commissions’ “Continuous Disclosure Obligations”:
- Comparative annual financial statements: Document(s) comparing the company’s performance with another business.
- Management discussion and analysis (MD&A): Where the company’s management and executives analyze the company’s performance with qualitative and quantitative measures.
- Interim financial report: Conveying the performance of a company before the end of normal full-year financial reporting cycles.
- Material change report: Detailing a change in the business that could have a significant impact on the stock-market price.
- Business acquisition report (BAR): Detailing a “significant” acquisition of a “business.” An acquisition is considered significant where the acquisition meets one of the following significance tests: investment, assets, or profit or loss. (If an acquisition qualifies as a reverse takeover, the company may not be required to file a BAR.)
- Information circular: Information about a company’s annual meeting of shareholders. Each exchange and country has its own set of requirements and laws governing financial disclosures and reporting requirements, meaning companies typically can’t take a cookie-cutter approach to going public on different exchanges.
CHECKLIST ITEM #7: Get out the checkbook
Deciding whether to go public may come down to a simple question: Can you afford it?
Cannabis companies must pay accountants to pore over financial details; legal fees to lawyers to prepare contracts; marketers to get the word out to investors and the media; and tax advisers to help navigate tricky tax laws in multiple jurisdictions. There is also an underwriter’s commission, which can run anywhere from 5 percent to 7 percent of the offering.
“For any company, regardless of where it is in its life cycle, the decision to go public should always be made as part of its larger strategy,” Hammon says. “It’s less about going too soon, in terms of maturity, but whether the company has a clear understanding as to how going public helps it accomplish its strategy.”
The decision to go public, and when, may be the biggest you will make as an entrepreneur. But proceeding cautiously, with the right tools, will minimize risk and put you in the best position to prevail on the open market.