by Jonathan Havens and Marc Adesso
No matter where you get your news, all of the industry (and many of the mainstream press) headlines coming out of the November 2020 elections said essentially the same thing: Weed wins big at the ballot box.
Voters in five states approved medical and/or adult-use cannabis. More specifically:
Arizona voters approved an adult-use measure;
Mississippi voters approved a medical-use measure;
Montana voters approved an adult-use measure;
New Jersey voters approved an adult-use measure; and
South Dakota voters approved both medical-use and adult-use measures (becoming the first state to do so at the same time).
And while there has been significant coverage of these initiatives, it is similarly important to discuss measures adopted or being considered by other states in response to the same. For example, Connecticut enacted an adult-use law in June 2021, likely in direct response to New Jersey voters approving adult use (and in response to New York enacting an adult-use law earlier in the year). It is anticipated that other states in the region (e.g., Maryland and Pennsylvania) will follow suit in the coming years. Speaking of noteworthy mentions, we would be remiss if we did not discuss the successful legal challenges to Mississippi’s medical initiative and South Dakota’s adult-use initiative. As of the date of this article, both measures have been set aside.
Beyond the impact on state cannabis laws, the November 2020 elections resulted in the Democrats controlling the White House, the U.S. Senate, and the U.S. House of Representatives. This caused some to predict that cannabis reform would arrive swiftly in early 2021. However, a 50-50 split in the Senate, plus Senate rules (i.e., the need for 60 votes to thwart a filibuster attempt),[1]plus questions over whether all 50 Senate Democrats would support a legalization measure (plus the 10 Republicans that would also have to support the same) all combine to yield the following result: Federal cannabis reform has stalled. Despite the introduction of sweeping cannabis reform proposals during the 117th Congress (e.g., the Cannabis Administration & Opportunity Act (CAOA), introduced by Sens. Schumer (D-N.Y.), Booker (D-N.J.), and Wyden (D-Ore.), and the States Reform Act, introduced by Representative Nancy Mace (R-S.C.), none have been calendared for debate, let alone passed by either chamber.
Although Senate Democratic leadership has thus far been opposed to enacting incremental cannabis reform (e.g., passing the Secure and Fair Enforcement (SAFE) Banking Act, either as a standalone measure or as a part of must-pass legislation like the National Defense Authorization Act (NDAA) prior to passing comprehensive reform like the CAOA, they could be starting to realize what many others already have: The choice now seems to be incremental reform or no reform at all.
This gridlock in Washington also continues to compress valuations of cannabis enterprises, even in the face of improved operational performance and overall growth of companies in the industry. Without the certainty that full federal legalization would provide, the disconnect in the capital markets seen in 2021 (where cannabis companies reported improved earnings, increased operating leverage allowing for fixed cost containment, and robust mergers and acquisition expansion, but their stock prices actually declined year-over-year) will almost certainly continue in 2022. It is unlikely that incremental change would be enough to significantly ameliorate this disconnect in 2022.
Given the uncertainty around the timeline for ending the federal prohibition on cannabis, most larger, institutional banks are not currently willing to underwrite transactions that involve plant-touching companies. As a result, cannabis companies will, unless and until the prohibition ends, continue to need to pursue alternative capital markets avenues that are largely seen as alternative paths to raising operational capital. In the past few years, many multi-state operators (MSOs), which cultivate, process, and sell cannabis, have sought to raise capital by going public on the Canadian Securities Exchange (CSE) through a reverse-merger-like transaction called a reverse take-over (RTO), whereby a U.S.-based cannabis company purchases and then merges into a Canadian shell company that is already trading on the CSE, in order to gain the public listing of the soon-to-be-former shell company (which survives the merger as the going-forward operating entity). As the number of high-quality, clean shells available on the CSE has dried up as a result of so many U.S. cannabis companies seeking to go public in Canada using the RTO model, a trend that began in 2021 and that will likely continue into 2022 is that U.S. cannabis companies are remaining Delaware corporations, and instead listing directly on the CSE as their primary market. While there is some perception that an RTO is faster than such a direct listing, recent experience has shown that one key difference between a Canadian RTO and a U.S. reverse merger is that RTOs take considerably longer to consummate, such that there may not be much time savings between an RTO and a direct listing on the CSE.
Like RTOs, another trend from 2021 that may not continue in force in 2022 is the rise of cannabis Special Purpose Acquisition Companies (SPACs). SPACs are blank check companies that raise capital through an initial public offering (IPO), with the stated goal of merging with an existing private business. By merging with the SPAC, the private company then gains a public listing, often more quickly than a traditional IPO. In line with the global SPAC boom, no fewer than 18 cannabis-focused SPACs had launched by August 2021, raising a total of $3.3 billion.[2] However, these SPACs may have raised too much money – due to all the regulatory, legal, and operational challenges discussed above, cannabis companies’ valuations have been depressed such that sizes of many of these companies would not qualify them as merger targets for many of the cannabis-focused SPACs launched in 2021. As a result of this scarcity, several of the 18 aforementioned SPACs have announced that they will pursue merger targets in industries other than cannabis. Some other of these SPACs have had to attempt an acquisition of several companies to meet their merger size requirements, often with mixed results. Given the uncertain future of the pre-existing SPACs in the market, it is unlikely that one will see many new cannabis-focused SPACs launching in 2022.
Once public, cannabis companies often seek to raise funds using alternative methods, as traditional banking products are often too expensive or not available, for the same regulatory, legal, and operational reasons discussed above. Especially in an environment where capital markets financing has become relatively challenging, it would not be surprising if the proliferation of alternative financing companies servicing the cannabis continues into 2022. One example of this trend is an increase in real estate investment trusts (REITs) offering real estate-focused financing to the cannabis industry. Equity REITS like Innovative Industrial Properties, Inc. (NYSE: IIPR), NewLake Capital Partners, Inc. (OTCQX: NLCP), and Power REIT, Inc. (NYSE: PW) continue to offer sale-leaseback financing to cannabis operators. There are also a number of privately-held equity REITs serving the cannabis space, such as Pelorus Equity Group’s REIT, and a small handful of Canada-based equity REITs, such as Nova Net Lease REIT, which is seeking to go public on the CSE, but will acquire U.S.-based cannabis real estate. A new trend in 2021 was the rise of mortgage REITS offering debt-side real estate financing to cannabis companies. AFC Gamma Inc. (NASDAQ: AFCG), Chicago Atlantic Real Estate Finance, Inc. (NASDAQ: REFI), and Freehold Properties, Inc. (Nasdaq: FHP) all filed Form S-11s with the U.S. Securities and Exchange Commission for their IPOs. Unlike plant-touching cannabis operators, these ancillary financing companies have charted a path to listing on a national exchange so that they can access larger pools of capital at favorable rates that are not otherwise available to cannabis operators. Since several cannabis REITs are privately-held, it is difficult to say how many cannabis REITs are in existence, currently, but the total is probably close to 15 such entities, with that number likely to increase in 2022.
Despite regulatory and valuation challenges in 2021, the U.S. cannabis industry continued to thrive and expand. Although we expect some challenges to remain in 2022, incremental changes in the legal and regulatory landscapes (both federal and state) combined with entrepreneurial and innovative ancillary financing sources will result in continued industry growth.
[1] While U.S. Senate rules are beyond the scope of this article, we recommend the following PBS piece: Lisa Desjardins, “How does the filibuster work?,” PBS News, Jan. 27, 2021, https://www.pbs.org/newshour/politics/how-does-the-filibuster-work.
[2] Shariq Khan, “Cannabis SPAC deals hit nadir after investors snub sector,” Reuters, Sept. 24, 2021, https://www.reuters.com/business/cannabis-spac-deals-hit-nadir-after-investors-snub-sector-2021-09-23/.
About the Authors
Marc Adesso is a partner in Saul Ewing Arnstein & Lehr’s Cannabis Law and Capital Markets practice. Clients in the cannabis and capital markets industries, among others, rely on Marc for advice in a multitude of corporate and securities matters to create long- and short-term financial solutions focused on maximizing shareholder value, including real estate investment trusts (REITs).
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