Managing Cannabis Debt and Equity in a Volatile Market
Raising investment has always been one of the most challenging aspects of doing business in cannabis. Large banks continue to be wary of lending money to companies selling a federally illegal drug, but as the industry evolves and matures, companies are finding new and more creative ways to fund their operations—and slowly but surely convincing bigger lenders to play ball. In 2021, the industry saw an unprecedented influx of cash as more banks and institutional investors started working with the industry, offering loans at lower rates than ever before.
Total debt and capital raises in 2021 as of December 15 topped $12 billion, according to Viridian Capital Advisors. Equity raises amounted to about $7.1 billion—a significant jump from the 2020 total of $2.7 billion, but still $2 billion short of the industry peak in 2018, when Constellation Brands put a whopping $4 billion into Canada’s Canopy Growth Corp all by itself. The more significant trend in 2021 was debt raises, which allowed companies to take advantage of lower interest rates on their loans. In the United States, debt raises amounted to $5.3 billion, up from $1.6 billion in 2020. The average debt raise of $48.1 million in 2021 was more than double 2020’s average.
Two major factors contributed to the increase in cash infusions: acquisitions and historically low interest rates. As larger companies expanded their operations and territory via acquisitions, they needed more cash to complete deals. Banks and other lenders saw this as a prime opportunity to take advantage of low interest rates and offer more attractive loans to cannabis companies—a win-win scenario. One of the most high-profile examples was Curaleaf’s $425-million debt financing at an 8-percent interest rate late last year.
“There were multiple factors that drove the increase in equity and debt raises, particularly debt,” said Scott Hammon, a partner at public accounting and consulting firm Macias Gini & O’Connell LLP, where he specializes in public and private equity and debt financing in cannabis and other industries. “Last year  was unique in that the amount of debt raised increased at a much higher rate than the increase in equity financing.”
While equity raises via the stock market have been significant over the past few years, cannabis stocks have seen a precipitous drop since their peak in early 2021. Consequently, equity raises are a less attractive vehicle for raising investment, at least at the moment. The increase in debt financing reflects the increased number of institutional funds and banks willing to lend to the industry, Hammon noted. Increasing comfort with the industry (due to increased social acceptance and improved operating metrics) and a desire for higher rates of return amidst the low interest rates of 2021 drove the increase in number of lenders. Cannabis borrowers traditionally have been subject to a risk premium, providing lenders an attractive spread even as interest rates for the industry continued to decrease.
As a result of lower interest rates, multistate operators and other large cannabis companies have been able to restructure their debt at rates as low as 8 to 9 percent—a significant drop from the 15 percent to 30 percent companies paid in 2015.
Larger transactions attract institutional investors seeking liquidity. An increase in the number of institutional investors willing to enter the pool is a good sign for the industry, Hammon said. “One of the things that’s changed in the past several years is, each year, there’s more institutional investor interest and a handful of institutional funds that are willing to come into the space,” he said. “That matters, because if you go from five to ten or fifteen to twenty funds, it may not sound like a lot, but if you get a double-digit increase every year, that trend helps support the industry’s growth. However, institutional investors still supply a much smaller percentage of capital in cannabis than other industries.”
Another popular vehicle for raising investment capital over the past few years has been special purpose acquisition companies, or SPACs. These “blank-check” vehicles allow entrepreneurs to raise hundreds of millions of dollars on spec following a prescribed format: A leadership team outlines a general plan to acquire an unspecified private company (or companies) and transition the acquisition(s) to the public market through an initial public offering within a specified period of time. GreenWave Advisors, which provides financial research and consulting services to the cannabis industry, counted twenty-two cannabis SPACs seeking a total of about $3.9 billion in October 2021 alone. While many SPACs have not been successful, there is reason to believe they have a promising future.
“One of the challenges for SPACs trying to complete transactions with cannabis companies is there wasn’t a culture of obtaining audits and, in some cases, the inability to get audited historical financial statements covering multiple years caused SPACs to look outside the industry for other targets,” Hammon said. “That issue is changing as more and more companies are getting audits.”
As promising as the past few years have been for companies looking to raise money, 2022 is not looking so bullish. With interest rates creeping up and inflation at a forty-year high in the United States, it’s unlikely the cannabis industry will see a continued upswing in either capital raises or debt restructuring. That stocks are down across the board, even among companies posting impressive revenues and profits, doesn’t help matters. As sagging share prices dilute existing shareholders, equity raises have become a last resort for companies in need of cash. For the first three weeks of 2022, the value of equity raised by U.S. cannabis companies was down 85 percent compared to the same period last year, according to Viridian Capital Advisors.
“This may not be the opportune time to raise funds,” said Hammon. “I’ll be surprised if the level of capital raising this year hits the same levels as last year. But it’s a volatile industry, and I could be proven wrong if there is significant movement with federal legislation or a significant state like Texas passes recreational legislation. Not likely, but the industry moves significantly in those types of events.”