By Matt Lamers
Canadian medical marijuana companies are starting to tap debt markets in a big way to fund their explosive growth, which until earlier this year had been financed almost entirely through stock offerings.
Cannabis companies raised $165.9 million via debt instruments – including convertible bonds, debentures and term loans – through August, or about 21% of all capital raised in the marijuana industry.
The year-to-date U.S. dollar funding total – provided to Marijuana Business Daily by New York-based Viridian Capital Advisors, which tracks cannabis-related investments – is in stark contrast to 2016.
The explosion in debt-based deals gives Canadian MJ businesses a new avenue – and thus greater flexibility – to finance growth.
Companies are turning to debt for four reasons:
- Lenders are more comfortable with the cannabis industry. The industry has matured, giving lenders the ability to conduct better due diligence.
- Companies generally prefer debt because issuing stock dilutes the value of the shares held by existing investors.
- There are more businesses, investors and lenders than ever in the MMJ industry – as well as players preparing to tap the recreational market next year.
- Since April, federal and provincial governments have been rolling out tentative plans for how they intend to regulate the sector, which has helped lenders assess risk.
“While equity structures still dominate the capital raised by cannabis companies, debt investments are steadily appearing more often,” said Harrison S. Phillips, vice president of Viridian Capital Advisors. “This shift is primarily being driven by the continued maturation of the industry and the companies therein.”
One year ago, the CEO of Canada’s largest medical marijuana company, Smiths Falls-based Canopy Growth, lamented that “debt financing is the principal absent business instrument for the (regulated cannabis) sector.”
But that has started to change as companies have been able to scale, raise significant capital for growth, develop larger asset pools and log historical operational metrics, such as revenue growth and net profit.
These factors “can potentially increase the companies’ attractiveness when approaching lenders, leading to a slow but steady increase in the number of debt investments in the space,” said Phillips.
Vahan Ajamian, analyst at Beacon Securities in Toronto, said easier access to debt would help fuel corporate growth, and that shareholders would benefit because it’s non-dilutive capital.
“For a long time everybody was talking about it, but no one was able to get any in any size,” he said. “We just saw the biggest one” in Cronos.
‘Total game changer’
The industry took note after Cronos Group secured 40 million Canadian dollars ($32 million) last month through debt financing for the continued construction of one of its production facilities.
“Cronos was a total game-changer,” said Ajamian.
Cronos – based in Toronto and traded as MJN on the TSX Venture Exchange – entered into a commitment letter for CA$40 million in debt financing with Colorado-based Romspen Investment Corp.
Mike Gorenstein, president and CEO of Cronos Group, said the biggest advantage of traditional debt is you’re not diluting ownership of the company.
“We will expand aggressively in Canada and globally, so giving up a share of that future today, when we’re very undervalued, is tough for me to stomach,” he said in explaining why he prefers debt over equity. “So I want to minimize the amount of dilution and take on as much debt as we could.”
Gorenstein expects debt to become more accessible for companies that can prove themselves.
“There’s debt available in the CA$5 million-CA$10 million range, but to get someone to write a bigger check is much harder to find,” he said. “It will probably be more available for the mature part of the industry in six months to a year.”
Some other debt deals announced so far this year include:
- Aphria took out a secured term loan of CA$25 million term loan with WFCU Credit Union. The loan carried an interest rate of 3.95% and a 15-year amortization.
- CannaRoyalty, a fully integrated cannabis investor, closed CA$12 million in a debt financing that carries a three-year term and is secured against its Canadian assets.
Filling the void
In the absence of Canada’s five biggest banks, credit unions have led the way when it comes to lending.
That’s because “the big five” – Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Royal Bank of Canada – mostly abandoned the domestic medical marijuana industry for fear of incurring reputational risk that could have a negative impact on their operations in the United States.
Among the willing lenders is Alterna Savings & Credit Union, based in Ottawa.
Rob Paterson, president and CEO, said debt is harder to get in emerging industries; but as the cannabis industry matures, more companies are putting themselves in a position to be eligible for traditional lending.
“The natural cycle is turning towards (debt financing), and it’s traditional commercial lending that everyone’s looking at for these facilities,” he said.
Alterna provides services for about a dozen cannabis companies across Canada, including industry behemoth Canopy Growth.
“Cannabis companies are now mainstream businesses,” Paterson said, adding that their stable cash flows, growing assets and clearer forecasts are making it easier for them to get loans.
Credit unions’ involvement in the industry goes beyond dollars, he said.
“The whole purpose of the medical marijuana space is to provide a trusted product that’s prescribed to Canadians,” Paterson added. “The credit union system is standing up to say, ‘Why would we not support that industry and the purpose it has, which is to help Canadians?’”
What the future holds
Ben Ward, CEO of Burlington-headquartered producer Maricann Group (Canadian Securities Exchange: MARI), sees the trend opening up for debt.
“The (convertible security) has been a good instrument in the cannabis space, but as the sector matures, debt will open up,” he said. “I think we’ll see much more regular debt so companies won’t have to dilute.”
Ward added a caveat: “But that will only be for a period of time before we reach a million kilos of production capacity in Canada for both the recreational and the medicinal markets. After that point, I think financing will almost completely dry up because there will be no further demand for products.”
He predicted “we’ll see another 18 months of companies raising capital to build capacity.”
Toronto law firm Aird & Berlis, meanwhile, noted that debt is going to become more important for cannabis companies building capacity to meet demand for the medical and recreational markets.
“We encourage policymakers and commentators to think of debt capital as a necessary pillar of a responsible and safe cannabis legalization strategy. Property, plant and equipment improvements – the traditional domain of asset-based lending – are essential to establishing safe and compliant production and distribution facilities,” lawyers Graham Topa and Timothy Jones wrote.
“Regulatory reform that stimulates debt financing could both blaze a trail for economic growth and close the trust gap for this budding industry.”