How do you see the relative lack of liquidity and capital resources in this space affecting cannabis mergers and acquisitions in the coming year?
Slaughter: Lack of access to capital resources will present opportunities for mergers and acquisitions in this capital-intensive industry. Until the SAFE Banking Act or similar legislation is passed, cannabis companies will continue to rely on alternative financing (with rates of up to 15%) to finance the construction of their operations and /or their expansion. While lenders are increasingly comfortable with the financial viability of large cannabis companies, which translates into better terms, smaller companies are still struggling to secure financing.
Zeoli: There is definitely a lack of readily available funding in this industry. Some of the smaller players may have a harder time finding profitable capital to support expansion, perhaps leading them to look for an exit altogether. That said, I believe there are a decent amount of cost-effective private funding alternatives available to big players. Over the next year, I expect to see a significant influx of additional private capital flowing into the cannabis markets, whether through direct investments or lending vehicles.
Are there specific lending considerations for cannabis mergers and acquisitions? Is it relatively difficult for buyers to obtain a loan for financing an M&A?
Doran: Access to traditional banks and traditional bank capital is a major issue facing the cannabis industry. This is symptomatic of a larger problem: the sector does not have consistent or meaningful access to financial products and the plumbing of the traditional financial system in general. Cannibis industry regulations make it difficult to provide executives with traditional cannabis loan collateral sources and structures. Many traditional lenders do not yet offer loans or banking services to the cannabis industry. There is a growing pool of non-traditional private lending sources, but access to debt capital remains expensive and access is generally skewed in favor of larger players. This disparity in access to debt capital will tend to fuel consolidation.
ZeoliFirst, given the highly regulated nature of the target entity, the overall cost and level of due diligence involved is significantly increased as the lender will need to be assured of regulatory compliance by both the borrower and the target entity. Second, the lender must consider what the collateral for the loan will be and how to properly secure its collateral interests. A target company’s most valuable assets will be its license, inventory, and cash. Each of these assets is highly regulated in one way or another, and it can be complex to properly secure the lender’s interest in such collateral. Given the relative lack of funding sources in this market today, lenders are very selective about the transactions they finance. This makes it difficult for some borrowers, especially smaller players, to obtain acquisition financing.
Interstate commerce could potentially generate economies of scale in some areas. But the timing – or even the reality – of that remains unclear. Do you think long-term possibility has a short-term influence on buyers’ M&A strategies?
Slaughter: Most market participants are not expecting legislation that will enable interstate commerce anytime soon and are preparing for a relatively static regulatory environment. As a result, I expect companies to continue to look to mergers and acquisitions as a primary means of increasing market share, entering new markets, and growing ahead of federal legalization and prosecution. consolidation that is expected to occur as traditional industries enter the market.
Doran: Even with rapid federal legislative breakthrough, the era of true interstate cannabis trade is likely still a long way off. For example, just look at how long the liquor industry remained regionally Balkanized after the repeal of Prohibition. That said, long-term investments are planned, particularly around cultivation and logistics, for the eventual opening of the cannabis trade across state lines.
Rules around cannabis delivery vary by state – it’s not allowed in Illinois, for example, but it’s well established in California. How do buyers view delivery-focused assets as part of their M&A and growth strategy?
Zeoli: Some states are behind in allowing the delivery of cannabis, but I believe that eventually all states that allow the sale of cannabis will also allow its delivery. As an example, there are at least three Illinois bills currently pending focused on cannabis delivery. Interestingly, the existence of COVID-19 has accelerated legislative action to allow delivery in many states. Many states have moved to open delivery as in-person sales have been dampened by the pandemic.
Doran: I agree that delivery will likely expand to be present in many, if not most, legal markets in the medium term. Not everyone will focus on investment and M&A activity in delivery assets, licensing and logistics technology, but a select subset of cannabis industry investors will continue to explore and to exploit opportunities to establish themselves in what will eventually become a vital part of the industry.