Raising Capital: Cannabis IPOs Explained

Posted July 30, 2018

Originally posted July 26, 2018 by the Cannabis Business Times

Raising capital in the cannabis industry requires a certain level of creativity and innovative thinking.

While launching an initial public offering (IPO) is a common way for corporate entities to access funding, U.S.-based cannabis companies cannot launch an IPO in the United States, as their operations are in violation of federal laws. Often, U.S. cannabis operations will list on Canadian stock exchanges; New York-based Acreage Holdings, for example, recently announced plans to list on the Canadian Securities Exchange (CSE).

Canadian cannabis companies, on the other hand, have generally had no problem listing on U.S. exchanges because they are operating within federal regulations in Canada. Tilray, a Canadian cannabis producer, listed on the Nasdaq earlier this month, while Cronos Group became the first cannabis company to list on the Nasdaq in February.

Budding Equity Asset Management has partnered with ETF Managers Group in its MJ ETF, which launched in December 2017 as the first cannabis exchange-traded fund (ETF)—a marketable security that tracks an index, a commodity, bonds or a basket of assets like an index fund and that trades like a common stock on a stock exchange. MJ consists of 39 individual stocks and has $370 million in assets under management.

Budding Equity originally launched in 2015 on the licensing and distribution side of cannabis-related products, but has since created an index that allows investors to participate in a portfolio of liquid cannabis-related stocks, says President Jason Wilson.

“On the asset management side, it’s coming up with investable strategies and then putting them in a vehicle that can give primarily retail and, in some cases, institutional investors, easy, liquid access to a growing sector,” Wilson tells Cannabis Business Times.

Here, Wilson outlines how cannabis companies can raise capital through IPOs, as well as the legalities and benefits of listing on U.S. versus Canadian stock exchanges.

Cannabis Business Times: What are some of the key benefits of raising capital through an IPO for corporate entities?

Jason Wilson: It’s all about the most efficient means to raise capital. If you’re a corporate [entity], obviously you have a need for capital. It can be for organic growth—i.e., you want to hire more people [or] you want to buy more machinery. In the cannabis space, it’s often we need people that maybe understand cultivation, [or] we need greenhouse space, we need land, we need irrigation equipment. So, you might need capital for that organic growth, to build more production capability. If you’re on the distribution side, it could be more retail space and related fixturing. It could also be for mergers and acquisitions. You’re a cultivator, you want to grow, so you want to buy a competitor because there could be an economy to scale. Obviously, everyone has a fixed cost, so the more volume you have after consolidation, you can split those fixed costs across a larger revenue base, so it increases your margins. You might want to go into a new stream—if you’re growing medicinal marijuana, maybe you want to expand into recreational or maybe you want to get into edibles or drinkables. Obviously, there can be a number of business reasons to raise capital.

When you’re a private company, your only real source of capital is to go to either a bank or a private lender. It’s debt. There’s debt financing costs that come with it, covenants—what you can and cannot do. As you grow a little bit bigger and have a bigger track record, you can bring more equity into the company, but again, it usually comes at a price.

An IPO is the best of all those kinds of worlds. Once you’re a public company and you’re big enough—you have a good enough track record in your business and you have underwriters that are willing to take you to market and offer you shares and debt securities to retail and institutional investors—it’s a very easy and efficient and cost-effective way to bring in more equity capital and/or more debt capital, or a hybrid in between the two. Often it can be issuing debt … that’s convertible, so that one could say, “Oh, instead of getting my $100,000 back, I can convert it into $100,000 … at a certain price.” That’s where going public really gives the management of a company that visibility, and that means to go to the public markets to raise capital outside of your traditional sources, which might be a bank loan or a private lender loan or working with a private equity group to get more capital.

CBT: Tilray, a Canada-based cannabis company, just launched an IPO and listed on the Nasdaq. What is the process like for cannabis companies like Tilray to list on U.S. stock exchanges?

JW: For cannabis companies, it’s a little bit trickier, obviously. For Tilray, they’re treated very similarly to any other company. It’s a function of, are they big enough? Do they meet their basic financial requirements?

At the end of the day, Tilray is a Canadian company that is operating within the Canadian federal regime—what they’re doing is, without question, legal. For Tilray, listing on the Nasdaq wouldn’t be all that much different from listing on the [Toronto Stock Exchange (TSX)], and their decision will be primarily driven by where they feel their institutional investors would rather … see them trade. In many instances, management of a company will have investors that prefer more liquidity, more volume, so they can buy in and out of stocks at a tighter spread. So, the Nasdaq, generally speaking, is going to provide more volume and liquidity than, say, the Toronto Stock Exchange. More investors are going to buy shares on that exchange versus a Canadian exchange. …

Where it gets tricky to do a U.S. listing for say, Acreage Holdings, is they aren’t complying with U.S. federal laws, and that creates a problem. So, if you’re the Nasdaq or the New York Stock Exchange, … when there’s a primary offering and you’re helping a company do their IPO on your exchange, there’s a question of whether you’re actually helping someone violate U.S. federal laws by helping them raise capital. That’s where you’re seeing Tilray not having an issue. … But with Acreage Holdings and other companies that have U.S. operations, there isn’t any federally regulated entity in the U.S. that’s going to be comfortable facilitating the initial listing of those shares—it’s very difficult.

CBT: For companies like Acreage Holdings that plan to list on the CSE, what is the process like for them? Is the process much different from listing in the U.S.?

JW: It’s very much the same. Every exchange has its basic requirements of, how long have you been in operation? They want to make sure it’s a real, viable company—that there’s an actual, real business behind it with some form of track record, that they have appropriate auditing and … that they’re in compliance with accounting laws. …

The Canadian Securities Exchange has … obviously done their homework and they’re comfortable with the regulatory risk, that they’re not facilitating in providing capital to a U.S.-illegal business. … In the past, they’ve let a lot of junior-minors on their exchange—these are companies that do want to become public, but they’re probably not going to be widely held by big pension funds of big institutional investors like BlackRock. … It’s going to be smaller asset managers and high net worth retail investors—things of that nature. Their criteria will be sized appropriately. But at the end of the day, all of these companies have to be legitimate, full-fledged reporting, operating companies.

CBT: What are the benefits of listing on the U.S. stock exchanges versus listing in Canada?

JW: It’s easier access. The Canadian market—call it just shy of 40 million people in Canada. And in the U.S., it’s 370 million people, so it’s possibly ten times the size of Canada. … With a lot of brokerages, they just don’t have access, or if they do, it’s not easy, it’s not clean, and/or it’s expensive to trade on a foreign exchange. One of the things that really helps facilitate raising more capital in the public markets is having a stock that trades well. And when I say it trades well, I mean it trades frequently, it trades at a tight bid-ask between buyers and sellers, and there are enough investors that come in that create enough interest that your stock will trade at a premium above book. If you ever raise more capital … in the equity markets at a price on the exchange that is above your book value, then issuing more capital is creative to the initial investors in the fund. So, that’s the key thing.

People look at the U.S. and say, “Hey, if I’m on the Nasdaq, it’s going to be pretty easy for almost 400 million people and all the intuitional assets around those 400 million people to trade my stock,” versus in Canada, it’s only going to be 37-38 million people and their related intuitional investors. It’s really that extra exposure, which should help your stock trade better [and] make it easier for people to buy and sell it, which should help with the price of your company.

CBT: Are there any U.S.-based cannabis companies that are listed in the U.S. right now? Will any of the exchanges serve them since cannabis is illegal at the federal level?

JW: If you have U.S. operations that are in violation of U.S. federal laws, you’re not going to be able to get a U.S. listing. It’s also going to be questionable to be held in any U.S.-regulated entity.

Even with MJ, for example, we had to go through this process that’s quite interesting. MJ is an SEC-regulated fund. It’s an exchange-traded fund, and the SEC had to review our investment criteria and our process. … [We had to get] them comfortable with our strategy. Even though, on its face, cannabis is illegal in the U.S., … we will not invest in any company that is in non-compliance with U.S. federal laws.

Aphria is a good example. Aphria is a Canadian producer. Almost all the revenues come from the production of cannabis in Canada, but they do have some cultivation activities in the U.S. So even though Aphria is a Canadian company listed on a Canadian stock exchange and it looks like we should be holding them, we don’t, because they are actually carrying on activities in the U.S.

Maybe it sounds like a shade of gray, but it’s how the regulators look at it, especially given today’s political environment—given [Attorney General Jeff] Sessions. After the Cole Memo was revoked, there’s [been] heightened awareness of this issue. There are some people who are from outside the U.S. who are involved in the cannabis space. They could be supplying capital, lending money to or own part of a cannabis facility in the U.S.—like Acreage, for example. If the immigration services get wind of that, … they have … prevented them from entering the U.S. for life. … You [then] have to go and apply for a waiver to be able to enter the country again. So, there’s a lot of sensitivity around it because on a pure technical basis, having anything to do with funding a cannabis operation in the U.S. is illegal at the federal level, even though it’s not at the state level.

CBT: The MJ ETF is traded on the New York Stock Exchange (NYSE.). What was the process to list this ETF in the U.S.?

JW: They had to be comfortable with our strategy. … If you’re an investor in the U.S. and you really want to get involved in this space, you go on your computer or you talk to your adviser and there are really only three or four companies that you have visibility to. They’re the only ones that are trading on the U.S. exchange, and in U.S. dollars, so you don’t have to deal with currency and … this extra layer of complexity, [which is] also substantial for withholding tax. … Generally speaking, Americans, or any domestic investor, will shy away from foreign investments because they’re more complicated and a little bit harder to understand.

With MJ, … we deal with all that madness. We … deal with trading on all these other exchanges through our custodian group, which has a global reach, so it’s very easy for us to do, and we manage that whole process, but we bring one U.S. dollar-denominated, U.S.-listed security with high-volume, good liquidity [and] tight bid-ask spread in one little bundle to investors. We … do securities lending in the fund, which allows us to offset effectively all of the cost associated with compiling all these assets in one place—management fees, custody fees and all that. We generate enough revenue through securities lending and the fund that it offsets the administrative costs, management costs, of putting this together. It keeps it simple, keeps it clean.

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