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Executive Summaries Jan 22, 2019

Public funding in the cannabis industry

For some time, we have seen the emergence of financial markets in the cannabis industry, particularly due to the legalisation of cannabis for recreational use adopted last fall.

Indeed, 145 Canadian companies (with approximately 10 from Quebec) currently hold a licence issued by Health Canada to grow, process or sell cannabis and, of these, a large proportion have financed their projects and capital needs through the sale of shares to the general public through an initial public offering (IPO), i.e. listing on a stock exchange. 

To this end, in Canada, during the first quarter of 2018, $1.2B in capital was linked to the cannabis industry and obtained by stock-exchange listed cannabis licensees[1].

Major Canadian cannabis producers authorised by Health Canada, such as Aurora Cannabis, Hexo, Canopy Growth Corporation, Apria or CanTrust Holdings, are listed on the Toronto Stock Exchange (TSX). Some producers are listed on the New York Stock Exchange (NYSE) and others, such as Cronos Group Inc. seeking access to U.S. capital, have recently registered with the National Association of Securities Dealers Automated Quotations (NASDAQ), although the regulatory environment in the United States remains uncertain for cannabis companies. Cannabis is still illegal in the United States at a federal level, as well as in 40 states that have not legalised cannabis for recreational purposes, and 33 of these have, however, accepted legalisation for medical purposes.

Several Canadian companies in this sector - currently totalling more than 60, including American companies such as Green Thumb Industries Inc., for whom capital is still difficult to access in the United States - are turning to the Canadian Securities Exchange (CSE). This exchange accepts registration requests from companies that do not yet hold a licence, but which have submitted their applications to Health Canada. The CSE is an alternative market whose reporting requirements for issuers are simplified and the barriers relating to registration easier to overcome for start-ups in the cannabis sector.

Capital contributions enabling the funding of companies within the cannabis industry are very high, in particular due to the costs of preparing a licence application (accounting fees, consultants, legal fees, etc.), land acquisition costs, greenhouse construction, equipment purchases, retention of qualified personnel and the implementation of security systems. However, it is still difficult to obtain this type of capital for these companies for a variety of reasons, including the ongoing reluctance of several traditional lenders to finance this sector of activity due to concerns regarding negative public perception of financial institutions that support the cannabis industry. Also, as mentioned above, regulatory uncertainty in the United States is a barrier to many investors buying shares in a company operating in the sector. This is related to the risk of being considered by the American authorities as an inadmissible foreigner and therefore banned for life from the U.S. border due to their financial interests in the industry.

Thus, since legalisation, cannabis companies have relied mainly on the public market as a financing strategy given the lack of private capital, thereby bypassing the unlikelihood of borrowing from traditional lenders.

Initial public offering of securities (IPO)

This method of financing has enabled many companies in the medical cannabis industry to raise public capital since the legalisation of cannabis for medical reasons in Canada in 2001. However, this means that a company that goes public then becomes an issuer, subject to the requirements of the applicable securities commissions. In addition to raising capital, a public offering (IPO) can be advantageous as it allows companies to attract media and public attention, enabling them to better promote themselves and potentially strengthen their brands. However, it should be noted that the Cannabis Act is rather restrictive with regards to brand choice and it is important to be well-informed in advance. Becoming a public company can also be a financial leverage strategy, as the company must demonstrate its financial strength and provide continuous disclosure of its performance, which can facilitate mergers and acquisitions.

Although attractive to companies in the cannabis industry, this method of financing can be long, risky and expensive, and also requires preparation as well as strong and structured governance. The admission rules, ongoing requirements, regulatory context, market access and the conditions for admission to the stock exchange are not the same for each of the exchanges: a significant amount of work is required in advance in order to analyse these various elements. Also, when a company becomes public, officers are subject to public scrutiny by shareholders and securities regulators. This includes the provision and filing of quarterly reports, financial statements, management reports, an annual information form, a change report, etc., all of which must be in accordance with applicable regulations. Several steps must be taken to set up a public offering (IPO), including the preparation and filing of a prospectus with securities regulators to provide potential investors with detailed information about the company. This includes risk factors related to the company and its industry and the filing of an application for listing on an exchange, all of which require considerable resources.

The preparation of a prospectus takes a significant amount of time and, once completed, it must be filed with a stock exchange, the securities regulatory authority in the relevant province and the authorities where the equities may be offered. Following analysis of the prospectus and any corrections required to satisfy the securities regulators, the company may file the prospectus and then sell its shares in the provinces where the company is authorised.

Although it is a significant and highly valued source of funding due to the particular context of the cannabis industry, listing is a costly process both in terms of energy and financial resources, and accountability to investors, brokers and securities regulators is mandatory and ongoing. It is therefore essential for a company operating in the cannabis sector to ensure it has the competent resources for the implementation of this financing method, in order to meet the high requirements to which public companies are subject, and this, within the legal framework applicable to cannabis.

 

To learn more about IPOs, sign up for our Strategic Forum on Public Financing, which will be held on Tuesday, February 19, 2019 in Montreal and Quebec City.

[1] Alan Brochstein « Canadian Cannabis Stocks Wieghted Down By Capital Raises And New Issues » Forbes.com.