“ Responsibility is a heavy responsibility!”
—Cheech Marin, “Cheech and Chong’s Next Movie” (1980)
“ Our intent is to legalize, regulate and restrict. There needs to be reasonable restrictions on making sure that we keep it away from kids…. We also have to ensure that the social and the health harms are properly managed and mitigated, and that can be done through regulation.”
—Bill Blair, former Toronto police chief, Liberal MP and point-man for Bill C-45, legislation governing the legalization of marijuana for sale across Canada, The Globe and Mail (January 2017)
Is it possible that Richard Cheech Marin, who left California in the 1960s for Vancouver, where he met his Canadian “Up in Smoke” partner Tommy Chong, knew in 1980 that many years later marijuana would be legalized with a second-generation police officer leading the charge for the government of the day?
Maybe not. There can be no doubt, however, that Bill Blair would heartily agree with Cheech that responsibility is a heavy responsibility. The government has clearly approached recreational marijuana legalization with much more serious objectives than simply creating an environment for Canadians to enjoy pot.
If we consider the evolution of the current medical marijuana industry, including its financing and use of funds, we can get a sense of what to expect in the recreational space. Since Canada first opened up licences for growing and distributing medical marijuana in 2001, Health Canada, acting as the industry regulator, has granted 50. This is an astonishingly low 3% of the 1,665 applications received. Clearly the bar is high for all involved. Looking ahead, parties with an existing medical marijuana licence will be entitled to participate in the recreational industry industry—and will have an advantage over those that are in the licence queue or hope to be there in the future. We do not expect that Health Canada standards will be relaxed, and in fact there may be additional hurdles added by provinces, municipalities, police forces and other regulators who have yet to have their say following the introduction of the draft federal legislation.
As one would expect in a new industry with unique legal and regulatory concerns, financing for medical marijuana businesses has been challenging. But emerging industry players have successfully used the public markets to tap retail investor interest in both the medical market and for potential expansion into the recreational space. Bank and other institutional investor support is not expected in the short term, although we have seen some limited amount of debt financing from the likes of HSBC Canada, Farm Credit Canada and more recently Whitefish Credit Union. We expect that funding will continue to come primarily from retail investors.
The path to these investors has been interesting. To date, over 40 cannabis sector companies have gone public through reverse takeovers (RTOs). The traditional domain of earlier stage oil and gas and mining players seeking quick access to public markets in Canada, RTOs have been adopted with enthusiasm by cannabis sector participants—ably assisted by underemployed energy and resource bankers. An RTO typically involves a private company acquiring control of a listed shell capital pool corporation, or TSX-Venture orphan company with minimal liabilities. The process is cheaper, faster and less dilutive than the traditional IPO alternative. However, they are subject to some potential drawbacks. The shell company’s operating history may impact the combined business in a negative way with respect to future filings, there may be undiscovered/undisclosed liabilities in the shell company, and existing shareholders of the shell company may see the combination with the new entity as an opportunity to dump their shares post-deal closing which could create downward pressure on share value.
So far investors have had no qualms about this approach to raising funds. Between the 2015 federal election and June 2017, 18 companies raised equity or equity-linked capital through 34 secondary offerings in the public markets amounting to over $913 million. Nearly 71% of this total has been raised by four early participants: Aphria Inc. (TSX:APH), Aurora Cannabis Inc. (TSX:ACB), Canopy Growth Corp. (TSX:WEED pro forma Mettrum) and OrganiGram Inc. (TSX-V:OGI). Each has come to market a minimum of three times within this period (see table), with each successive issue being done at significantly higher. Aurora’s latest round, for example, came out at nearly six times its first round only seven months earlier.
Along with this RTO activity, we’ve seen the beginnings of primary market activity. CanniMed Therapeutics (TSX:CMED) was the first IPO completed in the medical cannabis sector, in December. A second, MedReLeaf (TSX:LEAF), came to market in June, raising over $100 million. Another issue, from CannaRoyalty, is expected this summer.
Private equity funds are starting to emerge as well. Absent the institutional support one would expect in traditional private equity, high-net-worth individuals have largely supported two private equity funds focusing on investments in the marijuana sector. In three rounds of financing, Privateer Holdings of Seattle has raised US$122 million. Backed by high-tech mogul Peter Thiel, Privateer’s portfolio assets include the Marley Natural branded cannabis line; Tilray, a federally licensed commercial producer of medical cannabis, and Leafly, a mobile app for cannabis products and dispensaries. In Canada, the second private equity style fund in the sector, Green Acre Capital, launched in January. Sector heavyweight Aphria and long-time sector investor York Plains Family Office are its backers.
With the pending legalization of recreational marijuana, we expect to see the entry of more traditional bank debt, private equity from institutional sources and other capital from strategic players. Canadian banks and other financial institutions will probably be last to the party—post-legislation and after it is clearer what the recreational industry will really look like. However, it looks like there is enough capital already on the table to get things going. It’s perhaps later than Cheech and Chong might have hoped—but responsibility is a heavy responsibility.