Canadian cannabis companies find funding alternative with debt financing

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Canada’s capital-hungry cannabis companies are increasingly turning to debt financiers to fuel growth as the country marches toward legalization late this summer.

With no marijuana sales yet and lingering regulatory hurdles, some lenders – namely the big banks – have been hesitant to step in.

That has allowed firms like Cannabis Wheaton, CannaRoyalty’s Trichome Yield Corp. and a number of Alberta-based credit unions to provide much-needed capital.

Debt financing – including convertible bonds, debentures and term loans – is a game-changer for the industry, according to Terry Booth, CEO of Alberta-based Aurora Cannabis.

“We’re going to be able to finance our buildings, mortgage them at low rates,” he said. “And then the cash that we free up will go into growth, like a regular business.”

Debt financing has soared since 2015, when almost no debt was available, according to data shared with Marijuana Business Daily by Viridian Capital Advisors, a New York firm that tracks cannabis-related investments.

Debt financing rose to 145.11 million Canadian dollars ($113 million) in 2016 and to CA$662.85 million ($516 million) in 2017.

And debt financing for businesses in the cannabis sector is getting bigger: Globally, the average debt raise in 2017 as of the end of the third quarter was $4.3 million, while the average debt raise in 2016 was $700,000, according to Aird & Berlis, a Toronto law firm.

New entrant

“We see it as an opportunity to step in in advance of the banks,” said Kevin Jarrett, vice president of investments at CannaRoyalty Corp.

Two months ago, CannaRoyalty launched Trichome Yield Corp. to serve as a lending partner specifically for the cannabis industry. Its goal is “to provide a secured yield investment product, with complementary equity exposure to the cannabis industry.”

Trichome Yield will work in tandem with Sprott, a resource and real-asset investor, and Stoic Advisory, an independent cannabis-focused consulting firm.

“We’re carving out our own niche,” Jarrett said.

Until now, companies have largely financed expansion through equity deals. Since the 2015 federal election, more than $1.8 billion in equity has been raised, according to Torys.

Large players, like Canopy, Aurora and Aphria, have been able to access that equity financing easily, says Graham Topa, an associate with Aird & Berlis, because they have more collateral, such as real estate, to support it.

Obstacles remain

Regulatory issues can be obstacles to securing loans for smaller firms, said Amanda Balasubramanian, a partner with Torys and co-author of the report, “Debt Financing Strategies for Tomorrow’s Cannabis Industry.”

For example, Health Canada will grant a growing license only to one licensee and one address – making the permit nontransferable to another location. As a result, it doesn’t make good collateral.

In addition, all directors and officers of a licensed producer, as well as senior staff in charge, must have security clearances from the Royal Canadian Mounted Police.

A lender who does not have this clearance has no ability to obtain the firm’s license in the event the borrower is unable to meet its financial obligations.

Another issue that troubles some lenders is the lack of regulatory guidance on what transpires when the borrower becomes insolvent, according to Balasubramanian.

As it stands, a receiver or trustee-in-bankruptcy has no ability to take over the assets of an insolvent borrower.

A lender can request an insolvent LP to make an application under the Companies’ Creditors Arrangement Act (CCAA) and operate as a debtor-in-possession under court direction. But that process is voluntary.

Alternative financing

While regulators move slowly, cannabis lenders are becoming increasingly creative.

Streaming leads the pack as a debt-financing vehicle, according to Topa.

A nondilutive financing approach, streaming involves issuing debt obligations that are repayable in product or product equivalents, with repayment contingent on actual production.

Cannabis Wheaton has streamed deals with licensed producers Lotus Ventures, Harvest One Cannabis, and IDP Group and HMT Solutions, to name a few. It also signed a debt-obligation-repayable-in-product-equivalent note with Beleave in exchange for $10 million in debt financing.

Meridian Credit Union took another approach, completing a $15 million mortgage financing deal with CannTrust Holdings for its greenhouse facility in Niagara.

And in January, Aurora Cannabis entered an agreement with a syndicate of underwriters, led by Canaccord Genuity Corp., in which Canaccord bought 200,000 convertible debentures in a $200 million offering.

Banks taking an interest

Firms that have a strong business strategy, a facility with sufficient power, water and municipal support, and management with operational expertise are well positioned to receive debt financing, says Sasha Kaplun, vice president of corporate development and stakeholder relations at Cannabis Wheaton.

Traditional banks are starting to test the waters, too. Canopy raised $175 million in a bought-deal financing co-led by the Bank of Montreal (BMO) and boutique investment bank GMP – and Toronto Dominion is “looking at similar deals,” Topa said.

“BMO would not have come in on a bought deal like this two years ago,” Jordan Sinclair, Canopy’s communications manager, said. “But it was a continuous process of, ‘We’re going to demonstrate to you that we’re worth investing in.’”

Topa predicts that with recreational legalization on the horizon, “the big five” banks – Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Royal Bank of Canada – will likely do more traditional loans with equity kickers, where the lender offers a lower interest rate in exchange for an ownership share.

In the meantime, debt financing shows no sign of abating.

“It’s going to increase dramatically in the next year,” Topa said, adding he’s had many clients approach him for guidance on debt financing.

“It’s going to make sense to these companies that debt is the right way to finance going forward. It’s an exciting space to be in.”