Cannabis companies face capital crunch

Detailed corporate books and negotiating strategies key to snagging investment and financing

Some cannabis companies are merging with others to stay afloat. Others are facing bankruptcy or liquidation | Cascade Creatives/Shutterstock

This article was originally published in BIV Magazine's March 2020 issue.

The slight bump in share prices for Canadian cannabis companies in early 2020 was a welcome respite from the plunge in corporate valuations that happened throughout 2019.

While few believe that the sector is out of the woods, entrepreneurs who structure their companies in ways demanded by investors can still secure venture capital.

Gone are the giddy days of 2018, when investors were infected with a cannabis fever that drove up share prices ahead of legalized recreational marijuana sales in Canada.

Instead of securing loans, getting equity financing and navigating initial public offerings, corporate CEOs today tend to be facing more dismal prospects, which have forced layoffs at a number of cannabis companies, including B.C.’s Emerald Health Therapeutics, which announced last October that it had laid off 65 employees, or about one-third of its workforce, since August 1, 2019.

Personnel changes have also included the exits of key executives who were once the public faces of large cannabis companies, including former Aurora Cannabis Inc. chief corporate officer Cam Battley and former Canopy Growth Corp. CEO Bruce Linton.

For every Hexo Corp., which recently closed a production facility, there is an Aurora Cannabis, which postponed construction on two production facilities. Some companies are merging with others to stay afloat, or, in a worst-case scenario, are facing bankruptcy or liquidation.

There was even a reported case in January of California-based retail chain MedMen Enterprises Inc. trying to pay suppliers in full with shares, or a one-time payment of half the outstanding bill. 

“The financing side seems to be slowing down significantly, and what we’re preparing for is a restructuring of the industry in the sense of being ready for mergers and acquisitions and consolidation – expecting some of the bigger players who have equity on their books to make moves and try to acquire some of the juniors,” Borden Ladner Gervais LLP partner Stephen Robertson tells BIV Magazine. “That and getting ready for bankruptcies, and allowing companies to restructure.”

Ventures such as Ontario-based Wayland Group Corp. and Ascent Industries Corp. in Maple Ridge have filed for creditor protection as they try to restructure and stay solvent. CannTrust Holdings Inc. could follow suit. At the time of publication it was under a cease-trade order imposed after losing its Health Canada licence for growing cannabis in unlicensed rooms. 

“We’re going to continue to see, in the next couple quarters at least, some material writedowns and writeoffs, and more challenges ahead,” warned Altitude Capital partner Roderick Stephan while on a panel at the Lift & Co. Cannabis Business Conference in Vancouver this January.

The mood in the room was far more subdued than at the same conference in 2019, when panellists and attendees exuded a sense of excitement – that the cannabis sector was on the verge of explosive sales and early entrants would enjoy untold fortunes.

Panellists in 2020, by contrast, provided cautionary tales along with tips for how to structure businesses and negotiate for capital.

Keeping accurate corporate books – including a detailed account of everyone who has stock options, how many and at what price – is vital, says Narbe Alexandrian, CEO of Canopy Rivers, which has investments in more than a dozen cannabis companies.

Remarkably, he adds, some ventures do not have that information ready.

Large investors, who today have time to weed through every aspect of a company’s business, are far less likely to be swayed by an idea or a story, or any personal fear of missing out if they wait, says Alexandrian. The tables have turned.

“What we are seeing now is companies that are really cash hungry,” he says. “They need money. They’re putting their hand up and asking for any structure whatsoever.”

Alexandrian sees the current climate as one in which investors can get royalties in addition to high interest rates for providing capital because so many companies are focused on getting to profitability. They need cash to become profitable and in many cases they are willing to dilute their equity stake to get there.

Providing too much equity to investors, however, can be a dangerous thing.

“The No. 1 advice I’d give is to not screw up your cap table,” Alexandrian says, referring to the chart that shows the percentages of ownership, equity dilution and value of equity in each round of investment in a company.

“If you screw up your cap table and if the founders and operators of the business don’t have enough ownership in the company, you will shoot yourself in the foot for future financing.”

If a sizable stake in the company is provided to unknown people or entities with representatives who are hard to reach, that will kill the prospect of any new investment, Alexandrian says.

Other advice from Alexandrian and Matthew Nordgren, founder and CEO of California’s Arcadian Fund, is that entrepreneurs should seek key investors who are willing to tough it out for the long term.

If they meet investors who appear to be out for a quick buck, it is best to walk way, Nordgren says.

“You better have investors who are willing to go down that dark alley with you, because, right now, I can promise you, we’re not doing much else other than being down that dark alley with all of our companies, and we’re going to find our ways out,” he says. “You’re going to want us with you. You want real investors who are here for the long term because we’re building resources and portfolios that are going to benefit your business for years to come.”

Alexandrian suggests that an affinity with a long-term investor is much like a marriage – and it lasts about as long, too.  

“The average marriage in North America is about 10 years,” he says. “The average length of time – investment to exit – in the tech space is 9.6 years in Canada, and in the U.S., with a huge flow of capital, is 9.2 years.”

A final tip from Alexandrian is to let investors come up with valuations and make offers, which entrepreneurs can always decline.

“We had a company come to us recently and tell us what they were developing, and they gave us a valuation of $25 million,” he says. “We thought it was grossly high but we politely said, ‘This isn’t the right investment for us. Let’s keep in touch.’ They emailed us back and said, ‘We’ve revised our valuation. Now it’s $10 million.’”

That revision killed trust, Alexandrian says.

“It’s not Black Friday, when I get a great Black Friday deal,” he says. “The huge gap goes to show that, if you’re not confident of the $25 million value, how can I be confident about your $10 million valuation? Leave the valuation work to investors because that is what we do. If you don’t like [our assessment], you can pass.”

This article was originally published in the March 2020 issue of BIV Magazine. The digital magazine can be read in full here.

gkorstrom@biv.com

@glenkorstrom