Mergers & Acquisitions in the Cannabis Industry

Posted by Tiffany Carrari on January 18, 2019

As the cannabis industry grows, businesses at every level are participating in mergers and acquisitions, despite regulatory hurdles. Some of the biggest players in cannabis are continuing to consolidate their holdings, while smaller operations and entrepreneurs are also seeking a way forward.

2018 saw massive expansion in the cannabis industry, led by both U.S. and Canadian industry frontrunners such as Cronos Group, MedMen, and Aurora Cannabis.

  • Aurora Cannabis

Canada’s Aurora Cannabis is now the largest producer of cannabis following its acquisitions of CanniMed and MedReleaf in 2018, as well as funding construction projects to expand production facilities. Aurora is one of many companies funding consolidation and infrastructure development projects by raising funds from investors through publicly traded securities  and bought-deal offerings.

Aurora became one of the first cannabis companies listed on a stock exchange after completing a reverse takeover to join the Canadian Securities Exchange (CSE) in 2014 and started trading on the Toronto Stock Exchange (TSX) in 2017 before having its shares listed on the New York Stock Exchange (NYSE) in October 2018. Canadian firms like Aurora Cannabis that do not have cannabis assets within the U.S. are able to list on the TSX and NYSE – both of which have restrictions against listing cannabis companies operating in the U.S. for as long marijuana remains federally illegal. Meanwhile, cannabis companies with U.S. operations such as MedMen have been listing on the more receptive CSE which does not restrict firms with U.S. operations.

In a world where traditional financing methods remain scarce, the reverse takeover model (RTO) has been a popular vehicle for both Canadian and U.S. cannabis companies looking to tap into public markets to raise capital. A reverse takeover is an attractive alternative to an initial public offering (IPO) because it allows a private company to bypass the lengthy and complex process of going public by taking control of and merging with a dormant company that is already publicly traded.

  • MedMen 

MedMen is one of several U.S. based companies now listed on the CSE following a reverse takeover last May. MedMen’s CSE listing was the company’s quickest route to access liquid capital– a move that has inspired droves of U.S. firms to seek out reverse takeover deals as a way to raise money. MedMen was steady in its efforts to raise money and consolidate throughout 2018, entering into a $120 million bought-deal financing and making the largest ever U.S. cannabis acquisition when it purchased medical-marijuana retailer PharmaCann in a $682 million all-stock transaction  that gave the firm access to 79 retail and cultivation licenses in 12 states. The acquisition of PharmaCann effectively doubled MedMen’s footprint, now the largest U.S. cannabis company.

Bought-deal financings occur when a company sells common stock, convertible debt, stock options, and/or warrants to an investor or group of investors to raise cash. Stock options, warrants and convertible debt allow an investor to purchase shares for a certain price at a later date. For instance, MedMen’s $120 million bought-deal financing deal saw the Company sell Units comprised of Class B Shares and Class B Share Purchase Warrants. Each warrant entitles the holder of such warrant to purchase one Class B Share for $10.00 for a period of three (3) years following the deal’s closing.

MedMen’s expansion sees no signs of stopping in 2019. Just this month, the company announced a new plan to raise capital by spinning its real estate out into a newly formed Real Estate Investment Trust (REIT) created in partnership with Venice, CA investment firm Stable Road Capital. The REIT has raised $133 million dollars to purchase cannabis real estate owned by MedMen and others. The REIT will then lease back retail stores, production and cultivation facilities to MedMen who will use sale proceeds for funding the company’s continued growth.

  • Cronos Group

In addition to mergers and acquisitions, we are seeing partnerships and joint ventures between companies such as Canadian cannabis producer Cronos Group, Inc. (Cronos) and MedMen. The two companies intend to form a jointly-owned third company (MedMen Canada Inc.) to bring Cronos cannabis to Canada’s retail market via MedMen branded stores.

Last month, Cronos announced that it has entered into a subscription agreement with Altria Group, Inc. pursuant to which Altria will make a $2.4 billion equity investment in exchange for common shares and warrants, resulting in Altria holding a 45% ownership interest and a total potential ownership position of 55% dependent on exercise of the warrants. Marlboro maker parent Altria’s investment in Cronos marks the dawn of big business entering the cannabis space in 2018.

Growing Pains

With so many mergers and acquisitions, both at home and abroad, there is much conjecture about which “pot stocks,” if any, are an investor’s best bet going into 2019. U.S. federal illegality has created an interesting situation where cannabis companies with U.S. based operations cannot list on NASDAQ so instead list on the CSE. Conversely, Cannabis companies with Canada based operations are able to list on the TSX and NASDAQ. Therefore, companies like MedMen have the advantage of developing operations in both countries and still list on the CSE, despite not having access to mainstream securities exchanges. While companies like Cronos and Aurora have the advantage of listing on the TSX and NASDAQ, they cannot expand operations into the U.S. – where consumer spending on legal cannabis  is expected to climb to nearly $21 billion by 2021 as compared to only $4.5 billion in Canada.

A general criticism applicable to pot stocks using bought-deal financing to fuel growth is that the continued issuance of new stock, convertible debt, stock options and warrants can result in long-lasting share dilution. Shares are diluted when outstanding share counts balloon leading to a substantial reduction in  per-share profit. The impact of dilution isn’t always immediate since convertible debt, stock options and warrants can build up for years, leading to unanticipated increases in share counts down the road. However, until access to non-dilutive forms of financing and basic banking services for cannabis companies becomes readily available, bought-deal offerings will continue as the preferred method for raising capital.

M&A Locally

Meanwhile, smaller industry players and hopeful investors are jockeying for position at the local level, focused on securing licenses, building out facilities, expanding operations and developing brands - presumably in a bid to position themselves as acquisition or partner targets for larger groups like MedMen.

Like most jurisdictions throughout California, the City of Los Angeles is still in the process of reviewing commercial cannabis license applications for cultivation, manufacturing, distribution and retail operations within the City. Many of the applicants are persons and pre-existing businesses already in operation, having been “grandfathered” in and protected as part of LA’s Social Equity Program which also mandates priority consideration in favor of applicants who meet certain criteria.

Investors are chomping at the bit to acquire existing cannabis businesses and take advantage of the priority consideration afforded to social equity applicants in Los Angeles. Likewise, applicant-operators and social equity applicants are enthusiastic about the prospect of cashing in on their advantageous position. However, investors and applicants face challenging regulatory hurdles because applicants (even those already in operation) are just that – applicants.

So long as an application for licensure is pending at the local or state level, there is no “asset” to transfer because no license has issued. The local authorizations and state temporary licenses issued by licensing authorities are not “transferable” and neither is any pending application or the right to pursue licensure as a social equity candidate. Despite these roadblocks, investors, applicant operators and social equity candidates are looking to negotiate pre-licensing agreements to bring investor capital and management support to ‘authorized’ operations, as well as financial and business development support while applicants await final licensure and until those licenses become transferable.

Furthermore, LA’s Social Equity Program mandates that some social equity candidates are required to retain certain ownership percentages in a licensee business. While these regulations are intended to protect the interests of social equity candidates, practical business considerations related to capital contributions and operating capital are more likely to dictate profit distributions among investors and social equity owners in a licensee business. Further, such regulations could inhibit social equity candidates from selling their ownership stake in a business license. Until permanent licenses are issued and become transferable, investors and applicants negotiating pre-licensing deals will need to exercise high-risk tolerance and accept that all parties will be obligated to participate in the business and license application process until the licenses become transferable assets.

Peculiarities associated with license transferability issues are giving rise to various work-around solutions and complex deal structures emphasizing the rights and obligations of investors and applicants during the period of non-transferability. For instance, in the case of an investor who desires to purchase the assets and pending license of an applicant-operator’s business, a deal may involve an initial ‘closing’ and the parties’ execution of ancillary agreements setting forth terms associated with transferring the license at a later date. Such ancillary agreements generally require an applicant to continue directing business operations, as well as remain engaged in prosecution of license applications. The applicant is then required to cooperate in transferring permanent license(s) once they become transferable. Obligations of the investor(s) include financial and management obligations during the interim period between the closing and ultimate transfer of the license. One tricky issue to deal with is how payments are made to managing parties. Such payments must be reasonably related to the work being performed and any payments based on a percentage of profits must be disclosed to both local and state authorities. Furthermore, only an applicant/licensee can direct or control the licensed activity and therefore must remain in charge of business operations pending transfer of the license(s).

Not only is the enforceability of these agreements questionable, but they also require investors and applicants to perform obligations and remain “in bed” with one another for an indeterminable amount of time. Despite inherent risks, investors are more than willing to engage in pre-licensing deals as a way to get in at the ground floor in California – the world’s largest cannabis market.

DEA Reschedules CBD to Schedule 5

Posted by Margolin & Lawrence on September 28, 2018

By Raza Lawrence and Allison Margolin

On September 28, 2018, the DEA issued a rule announcing that drugs including CBD with THC content below 0.1%  will be taken off of Schedule 1 of the controlled substances schedules, and moved to Schedule 5, which allows CBD products to be sold through traditional pharmacies with a doctor’s prescription, so long as the particular product is first approved by the FDA.  The order also disallows any importing or exporting of CBD products without a permit. 

It is important to note that the ruling is narrow in that it only applies to CBD products with less than 0.1% THC.  However, products with higher THC content could continue to be sold under state law and without federal FDA or DOJ regulation under the Rohrabacher–Farr amendment.  Ironically, the new federal policy is to tolerate sales of CBD products with high levels of THC, but to restrict sales of CBD products with low levels of THC by requiring FDA approval, a huge task in itself. Some sources indicate that it can cost more than $1 billion to bring one FDA-approved product to the market, including approximately $50-840 million to bring treatments through the stages of Basic Research/Drug Development and Pre-Clinical/Translational Research, and approximately $50-970 million to complete the Clinical Trials (Phases 1, 2, and 3).

The new ruling is bad news for anyone hoping to sell CBD with no or low levels of THC and without FDA approval.  Already, in July 2018, the California Department of Public Health ruled that hemp-derived CBD would not be allowed in food or drinks for humans or pets in California. 

CBD products could potentially be sold as edible cannabis products under California state law if the producers obtain commercial cannabis manufacturing licenses from the state and local government, and the products are distributed and sold through outlets with state and local commercial cannabis licenses.  Even if everyone involved complied with California state cannabis laws, they would still be subject to enforcement, punishment and being shut down by the FDA, unless they contain over 0.1% THC, in which case they could be sold under state law with no federal interference.

The Rohrabacher–Farr Amendment would not protect any low- or no-THC CBD distributors, even those who strictly complied with state law, from enforcement actions from the FDA, as Rohrabacher–Farr only restricts the DOJ from interfering with state regulation of medical marijuana.  The FDA is part of the Department of Health and Human Services, not the DOJ, and thus retains the ability to regulate CBD – its regulations trump any state laws relating to CBD under the supremacy clause of the US Constitution. 

It is possible that today’s DEA ruling could later lead to reclassification of all cannabis from a Schedule 1 to Schedule 5 substance, which would mean that all cannabis could fall under the jurisdiction of the FDA and could only be sold through pharmacies with doctor’s prescriptions and must be produced by companies with FDA approval (i.e., large drug companies). 

Since 2009, the FDA has had the authority to regulate tobacco products, which are now controlled by only a few large corporations, as are many other drugs regulated by the FDA.  The same could happen to cannabis.  Individuals and organizations in the cannabis community should lobby the government to prevent this monopolization by ensuring that cannabis is descheduled as a controlled substance.

Earlier this year, the FDA's parent agency stated that CBD has little potential for abuse – hopefully the government's future approach to CBD will follow this lead and remove CBD's schedule 1 classification.

Massachusetts Cannabis Regulators: 36 Watts will be the limit for cannabis cultivators

Posted by Margolin & Lawrence on May 8, 2018

Compared to the farming of most other crops, commercial cannabis cultivation’s impact on the environment is minimal – except when it comes to power use. A large proportion of cannabis cultivation takes place on indoor grow sites, using man-made lighting arrays as a substitute for daylight. These setups and their accessories, including the fans and HVAC systems that prevent the plants from overheating in proximity to the lights, can demand large amounts of power. Unsurprisingly, areas which have legalized cannabis cultivation have seen corresponding increases in energy use: In Colorado, cannabis grow facilities used 200 million kilowatt hours of electricity in 2014, with cannabis cultivation accounting for almost half of Denver’s yearly increase in energy use. For cities and states planning to legalize cannabis while still limiting their use of electricity, regulating the power used by cannabis cultivation is a must.

The History of Cannabis by Margolin & Lawrence

Posted by Margolin & Lawrence on April 20, 2018

News: Ninth Circuit Hears Medical Cannabis Case

Posted by Margolin & Lawrence on April 17, 2018

Just last week, on March 29th, a three-judge panel for the Ninth Circuit Court of Appeals held a special setting at the University of Idaho College of Law. Judges Richard Tallman, N. Randy Smith, and Morgan Christen considered the case of Michael Assenberg v. Whitman County (Case No. 15-35757). Assenberg was appealing the district court’s summary judgment in an action against Whitman County, the Sheriff’s Office, Sheriff Brett Myers, and the Quad Cities Drug Task Force. Assenberg alleged that the search of his Colfax home for marijuana and his subsequent arrest violated his rights under the Fourth Amendment of the U.S. Constitution.

In 2011, law enforcement conducted a raid on his home, where Assenberg was running a medical marijuana dispensary. According to Assenberg, the raid came about after a confidential informant posing as a medical marijuana patient visited his dispensary. The Whitman County sheriff and Quad Cities Task Force seized approximately one hundred marijuana plants and Assenberg was charged with four felonies. However, the charges were later dropped in Whitman County Superior Court after it became clear the marijuana was stored incorrectly by the county.

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This blog is not intended as legal advice and should not be taken as such. The possession, use, and/or sale of marijuana is illegal under federal law.