CBD Opportunities and Risks

Friends, from this lawyer’s perspective*, serious money is about to flow into the (imminently) legal CBD market.  See, e.g.:

https://www.newcannabisventures.com/village-farms-international-to-aggressively-pursue-hemp-and-cbd-opportunities-following-u-s-federal-legalization/

Village Farms (not a client) is a Canadian produce company and they’re viewing this opportunity as a “nutraceutical phenomenon”**.  Anecdotally, other non-cannabis companies (CPG, institutional investors) are scrambling to enter the (imminently) legal CBD market.

This presents yet another whiplash-inducing opportunity and risk for the industry.  For companies that have both CBD products and THC products, do you spin out the (imminently) legal CBD product line, to take advantage of mundane things like bank accounts and lending, tax deductions, traditional institutional capital, and interstate commerce?  Among the many things to consider:

  • Branding – are the two businesses going to share the same brand name?  If so, how does that relationship work to keep the legal CBD business legal?

  • Local Rules – how quickly will local regulations on CBD use (such as those in CA) change to open up how you want to use the product?

  • Taxes – can you split off the legal CBD assets in a tax-efficient manner? (not a 280E question – a traditional tax question)

  • Structure – how is the legal CBD business going to be owned?

  • Strategy – once you’ve got the CBD business separate, what’s your plan to compete?

In other words, yet another day in the Cannabis business.

*As usual, this is definitely not legal advice.

**I don’t know what that means.

Written by: Marc Hauser

Yuppies and Cannabis (and CBD)

Friends, sharing today a recent article from the Washington Post style section about yuppies using cannabis again.  Putting aside the author’s questionable choice to revive the term “yuppie”, this kind of style section article highlights the mainstreaming of cannabis in the US.  I think that the article does a nice job of capturing the cognitive dissonance in the minds of people who grew up during the time when the term “yuppie” was actually used and were subjected to the Just Say No/DARE campaigns of that era. 

https://www.washingtonpost.com/lifestyle/style/i-dont-feel-like-im-doing-something-wrong-yuppies-have-discovered-weed-and-they-like-it/2018/11/30/dd2b7240-e90c-11e8-a939-9469f1166f9d_story.html?utm_term=.ddf204c8d63c

It shows the challenge and the opportunity for the industry at this moment in time. 

Speaking of challenge and opportunity, as you likely know, the Senate signed the 2018 Farm Bill, moving the industry one step closer to finally being able to sell hemp-based CBD fully legally.*  It’ll certainly cause more work for us lawyers as companies move to split out their hemp CBD businesses, which then would be able to take advantage of such quotidian things as tax deductions and bank accounts, and then raise capital on those businesses.  This is because, I suspect that, once CBD is legal, the floodgates will open and US-based CPG companies will start to put CBD in everything to capture market share, and traditional institutional capital will finally start to fund deals.  This will put pressure on the smaller players, who will need to find ways to distinguish themselves into a more niche market, or else consolidate. 

 This isn’t different from other markets**, which is another way that this industry is (almost) like any other consumer product (which is a good thing). This process should provide a good test case for much of what’ll happen when Cannabis is legalized – how large CPG companies react, how the financial system reacts, how the regulatory agencies react, how plaintiffs’ lawyers filing consumer products claims react, how investors react.

 *yes, I know that the CBD industry takes the position that CBD is already fully legal based on the existing Federal agency regulations.  I won’t comment on that because, as the disclaimer says below, this email isn’t legal advice….

**as I’ve noted to many of you, every day, this industry looks like the wine industry to me

Written by Marc Hauser

Cannabis and Securities Law

Friends, sharing a good article from MJBizDaily with further perspective on Aphria. 

 https://mjbizdaily.com/aphria-cannabis-stock-plunging/

The article also points to a recent notice issued by the Canadian Securities Administrators (the Canadian securities regulators) warning against misleading/unsupported promotional activities. This comes on the heels of a recent CSA warning about a lack of sufficient disclosures by public Cannabis companies.  This is all also true for US companies, both public and private – companies and boards have duties to their securityholders* and there are very tight rules about sales and disclosures.

 https://www.securities-administrators.ca/aboutcsa.aspx?id=1752

 These help underlie the point that easy money isn’t easy. 

*Well, unless they’re waived because they’re a Delaware LLC and they’ve got a good corporate lawyer drafting the documents….

By: Marc Hauser

Level Brands Announcement

Friends, as a corollary to my most recent email, Level Brands announced a deal to acquire cbdMD for stock (~$65mm based on 2018 $3.2mm of revenue and $353,561 loss through August, plus a five-year earnout for an additional 15.525mm shares, but I’m not writing today about valuations).  Level Brands owns a bunch of wellness brands, including a licensing deal for CBD products.

What’s interesting about this deal is that one of the closing conditions is the passage of the 2018 Farm Bill with descheduling of CBD (CBD generally, not just hemp-based CBD).  Although the cannabis industry hasn’t been shy about selling CBD products, now that there’s a possibility of legalization, someone (a lawyer, perhaps?) apparently now sees a risk to the industry and/or the market if the bill passes without CBD legalization.   http://ir.levelbrands.com/node/6901/html

Also, since I have your attention if you’ve made it this far, the Wine & Spirits Wholesalers of America are still in support of cannabis legalization, which is good.  What’s notable about this story, which has a copy of the group’s talking points, is that the group is (unsurprisingly) opposed to vertical integration.  This is, in my opinion, going to be a giant lobbying battle that no one is really focused on yet – whether the three-tier system is replicated in cannabis post-legalization.  It’ll be fun to watch. https://www.marijuanamoment.net/major-alcohol-association-briefs-congress-on-marijuana-legalization/

By: Marc Hauser

Cannabis Musings

Friends, for those of you who’ve been receiving my spammy musings for a while, and for the subset of you who actually read my spammy musings, you may recall that I made a comment a while back about how the Cannabis industry achieved a somewhat dubious milestone when an activist investor targeted a public Cannabis company.  Well, the markets hit another fun milestone today: Ontario-based Aphria is the target of a short seller attack today, which caused Aphria’s stock to plunge (trading down 20% as I write this). 

(Short selling, for the uninitiated, is simply a way for an investor to bet that a stock price will go down.  The short seller is supposed to borrow the shares to make the short, and pays a fee to the lender of the shares.  Generally, the borrow cost has been high for Cannabis stocks, due to, among other things, the demand for these stocks.)

The fund put out a report attacking Aphria’s Latin American transactions.  Aphria responded accordingly that the allegations of the short seller are “false and defamatory”.  In my opinion, this is good news.  Not for Aprhia, perhaps, but for the Cannabis public market, which is looking more and more like the rest of the stock market.

For those of you in California, today’s the day when the BCC is supposed to issue its revised proposed regs.  Something to tide us all over while we await passage of the 2018 Farm Bill.

By: Marc Hauser

Capital Markets Continue to Shift and Develop in The Cannabis Space

Friends, once again, the capital markets continue to shift and develop in the cannabis space.  In other words, it’s a weekday.

 In the past two weeks, we’ve seen a major public company reduce and reprice their offering in response to market movements: https://mjbizdaily.com/marijuana-firm-medmen-scales-back-financing-appoints-interim-cfo/?utm_medium=email&utm_source=mjbiz_daily&utm_campaign=MJD_20181120_NEWS_Daily_11202018&elqTrackId=A25B5812550E3D302DAE5F24E8902F66&elq=caea0b4add5e4b3a8f21e560766efe39&elqaid=834&elqat=1&elqCampaignId=543

We’ve seen one of the larger institutional players announce the upcoming launch of a second fund at US$100 million: https://www.greenmarketreport.com/altitude-investment-closes-30-million-fund/

 We’ve seen a US$14 million PIPE deal by a cannabis-focused hedge fund: https://www.newcannabisventures.com/navy-capital-invests-14-7-million-in-marimed/

 

What does this mean, beyond the fact that I’m pretty good at cutting-and-pasting stories that are based on press releases?  It’s probably too early to call it a trend, since the cannabis markets seem to be evolving by the minute, but these deals appear to confirm what I heard in Vegas a few weeks ago: cash is king (or, as my former boss liked to say, “Liquidity is Value”).  As speculators finally start to recover from their collective hangover and share prices react to broader market trends, operating companies taking on investment are coming to prefer cash over stock. Investors are starting to fill that need for cash by raising bigger funds to write bigger checks (just like in the rest of the private equity world).  Just wait until someone figures out how to place real leverage into these deals…..

By: Marc Hauser

Juul, Cannabis, Then an Even Bigger Deal for Big Tobacco?

Friends, a report in Bloomberg today about Altria potentially investing in JUUL.  Who knows how real this is*, but if it’s true, it’s yet another example of how US companies are finding ways to establish a foothold and get exposure to the Cannabis industry (however indirect)** without causing their boards or general counsels to have a conniption.

 Excelsior!

 *(yes, some folks at Altria and JUUL know, but it’s a rhetorical question posed for editorial emphasis)

**(yes, I know that JUUL is for tobacco, not Cannabis)

Juul, Cannabis, Then an Even Bigger Deal for Big Tobacco?

By: Marc Hauser

Cannabis Musings

Friends, it was good to see many of you in Vegas for the lollapalooza that was MJBizCon.  A number of thoughts and observations from my trip:

  • Just about everyone I talked to is still mystified at the current state of the capital markets in the cannabis industry, particularly the public markets.  I heard the word "bubble" used a lot, but then I heard a lot more people counter that argument.  There did seem to be general consensus that the strategy of issuing more stock to get another all-stock deal done to issue more stock to get another all-stock deal done etc. is probably not sustainable.  What seems to me to be more sustainable is tapping the public markets for truly strategic and measured growth, not just relentless roll-ups.

  • Then again, Acreage Holdings just listed with a $2bn+ valuation.  

  • But what's interesting is that, even if this first real wave of public markets activity does correct, the industry itself is strong and growing like crazy and likely won't care, so it'll be a case study to watch how investors and buy/sell side activities adjust if/when that happens.

  • To paraphrase Rick Ross, everyday we're hustin'.  Everyone who wasn't there to look at all of the equipment on the expo floor (if you didn't go, this was a real, honest-to-goodness trade show, and the expo was mostly equipment and services, with relatively few brands) was making connections and finding deals.  Even the investor luncheon - there had to be 1000 people in the room listening to industry folks talking about investment opportunities in the industry.

  • Cash is back.  More vehicles are being formed and raised to put cash out the door, as operators are coming to realize that stock consideration comes with risk, and as more traditional (non-Cannabis) PE investors come into the market and want to write bigger checks and don't want to hold SAFEs (because, why would they?).

  • That's also because Series A/B rounds are on fire.  Operators in the industry are now large enough that they've grown past the seed capital stage and hitting up friends and family. (hence the real need for sophisticated/experienced charming deal/capital markets counsel such as yours truly to help them develop, structure, and make that pitch...)

  • PE funds being raised are still being funded by individual investors, not really yet with any traditional institutional investors (unsurprisingly).  One fund I spoke with noted that they've got 99 people in their new fund - they have to stop at 99 for boring securities law purposes - and the average check isn't relatively (to traditional PE funds) large.

  • Lots of focus on Senator McConnell and the 2018 Farm Bill, which (if you believe what a politician says before they actually do it) is now almost certain to include industrial hemp. Investors are very much eyeing the potential in hemp-based CBD with the anticipated passage of the Farm Bill, particularly if it really does, once and for all, clarify that it's legal (few operators seem to appreciate and/or care that the legality of hemp-based CBD is not as certain as they think it is).

  • Lori Ajax, Chief of the CA Bureau of Cannabis Control, finally gave some public guidance (after relentless public questioning) that the newly-proposed regulations weren't intended to eliminate white label products. We'll see what happens there, but she suggested that no one should change their current practices yet (this is not legal advice).

  • I personally didn't see any dreadlocks or tie dyes at the expo, and instead saw lots of khakis and sensible shoes. Another example of the fact that cannabis is moving towards being like any other business with a giant trade show and people doing regular business things. (not a judgment on dreadlocks or tie dyes - more likely to be found at The Emerald Cup)

  • That being said, Vegas brings out some odd ones.  Waiting for coffee at a stand at NYNY, an older gentleman in front of me asked if they could grill his bagel. No, not toast it (that was an option he declined) - grill it.  I'm 99.99% certain this was a sincere request.  

Looking forward to seeing you all there next year, and definitely sooner than that.  

By: Marc Hauser

Cannabis Professionals

Friends, passing along an article from Bloomberg this morning as another sign of the professionalization of the cannabis industry.  The trend that the article discusses, of bankers and other financial professionals moving into cannabis up in Canada, looks a lot like what happened with the first dot-com boom, when investment banks (and then law firms, accounting firms etc.) couldn’t compete with startups for talent. 

My point isn’t that cannabis is in a dot-com-like bubble, though – instead, my point is that cannabis companies know that they need expertise in multiple disciplines to grow and survive (finance, marketing, sales, distribution, etc.), and certainly to position themselves to succeed through legalization.  This certainly isn’t news for those following the industry, and it isn’t just happening in Canada. 

Yet another sign that running a cannabis business is like running any other business (well, almost), and that’s a good thing.      

Bankers Are Flocking to Canadian Cannabis Startups

By: Marc Hauser

Cannabis SPACs

Friends – so yesterday, I made a comment in my email that exits are getting done these days with paper.  Well, that’s not totally true. Another short, fun lesson in capital markets.

https://www.newcannabisventures.com/5-u-s-cannabis-companies-with-projected-c261-million-sales-in-2019-join-forces-to-go-public-in-canada/

Cannabis Strategies Acquisition Corp. just announced a roll-up of five different cannabis assets, closing simultaneously.  Cannabis Strategies is a SPAC, an acronym that’s fun to say and stands for “special purpose acquisition company”.  SPACs are publicly-traded companies that are formed to raise money in an IPO without any assets, and a mandate to acquire assets within a specific period of time and (sometimes) with a specific industry focus.  It’s a blind pool, and the investor is betting to get in early at a discount in exchange for tying up their capital, in exchange for the hope that the sponsor managing the SPAC will find good assets.  It’s sort of a publicly-traded private equity fund, sort of.

Here, Cannabis Strategies raised a pile of money in December 2017 on the Canadian Stock Exchange, and has now put together a parcel of somewhat different assets to spend some of that money.  I did some quick searching, and didn’t seen any other cannabis-focused SPACs out there. It’ll be interesting to watch how Cannabis Strategies integrates these differing assets, and also if anyone follows suit with raising capital and buying up assets this way for cash.

By: Marc Hauser

Cannabis and the Capital Markets

Friends, another dive into the world of complex capital markets transactions.  This time, an analysis of Tilray’s announced $450 million convertible bond offering, noting that the annual interest payment is more than 2017 revenues (although the author sort of elides over the fact that the company will now be sitting on nearly half a billion more of cash to pay that coupon), and the 15% premium to the (then) current stock price. 

In my opinion (which, by the way, is not the opinion of Gaw Van Male, LLP or its employees), the author’s breathless concern about this offering seems to have less to do with the bond itself and more with how the market has been bidding up Tilray’s stock price. https://ftalphaville.ft.com/2018/10/08/1538971201000/Tilray-s--450m-game-of-chicken/

By: Marc Hauser

Cannabis - The Pains of Going Public

Friends - passing along a noteworthy review by the Canadian Securities Administrators (which coordinates securities regs across the provinces) about the general lack of appropriately sufficient disclosures by cannabis companies in their public filings.

Remembering that cannabis companies have really only been going public on the CSE for not very long, eventually I imagine this will shake out and investors will demand disclosures that are more in line with market expectations and customs (see, for example, WeWork’s very-short-lived attempt to report “community-adjusted EBITDA” (which isn’t a thing)).  Nonetheless, it does remind companies that, even when listing on a smaller exchange like the CSE, getting access to public capital means comes at a price.

https://www.bcsc.bc.ca/Securities_Law/Policies/Policy5/PDF/51-357__CSA_Staff_Notice___October_10__2018/

By: Marc Hauser

Cannabis Meets the Public Markets

Friends, an interesting article today from Bloomberg about public cannabis company Hexo Corp. (f/k/a The Hydropothecary Corp.)  They’re the ones that announced the deal with Molson Coors in Canada a few months back.

What I love about this story is that it’s showing how quickly the public cannabis markets are maturing.  They’ve now got activist investors!   As the story notes, Hexo is up 95% since mid-August and is trading 13x enterprise value to forecast (!), but because that lags the 26x EV to forecast of the rest of the industry (minus Tilray, which skews the results!), an activist investor sees blood in the water.  Another sign that finance is treating cannabis like any other industry (see, also, Goldman and BofA lending into the Constellation deal).

Welcome, cannabis, to the public markets. 

By: Marc Hauser

Material Adverse Effect in M&A Transactions

One of the major deal negotiation points in mergers and acquisitions transactions is whether the buyer can walk if something happens that causes a “material adverse effect” (MAE) on in the target’s business.  The MAE closing condition shows up in deals where the buyer is locked up for a period of time between signing the agreement and closing (say, for regulatory approvals or financing).

 

From the buyer’s perspective, it seems logical and fair that it should be able to terminate and get its deposit back if the target’s business declines materially.  From the target’s perspective, MAE is vague and subjective – what does “materially” even mean?  Deal lawyers and well-meaning law professors have tried to solve this problem over the years by trying to tie “materiality” to objective tests, such as a specific decline in EBITDA, but even those tests are somewhat unsatisfying.  The meaning of MAE is such an unknown that even the Delaware Court of Chancery (which is, nationally, the key court for M&A law) had never found a case where the buyer was justified in terminating because of a material adverse change in the target’s business.  Until now.

 

On October 1, 2018, the Delaware Court of Chancery ruled in Akorn, Inc. v. Fresenius Kabi AG et al. that Fresenius properly terminated its merger agreement to acquire Akorn because of a material adverse change in Akorn’s business.  This case is noteworthy because it is the first time, after many prior cases considering the question, that the Delaware Court of Chancery has allowed a buyer to terminate an acquisition because of an MAE.  The Court makes it very clear that the MAE was very fact-specific and company-specific.  In particular, the target’s EBITDA had fallen 86% year-over-year, the stock price had plummeted, the target had materially breached its regulatory and compliance obligations, eroding value, and, after signing, the target did nothing to resolve its serious compliance problems, breaching its covenant to operate in the ordinary course of business between signing and closing.

 

This decision most likely will not change the deal landscape – indeed, the Delaware Court of Chancery declined to find an MAE in landmark cases coming out of the 2008 recession.  However, it will likely affect the negotiation of closing conditions in transaction documents – no longer can deal lawyers argue that “the Delaware courts have never found an MAE, so it doesn’t matter” – with MAE definitions more specifically tied to the target’s business and operations.  Akorn also serves as a reminder to targets that the pre-closing obligation to keep operating the business in the ordinary course is a real one.  Finally, this case could result in more buyers testing the limits of the Akorn decision in the courts, but, as the Delaware Court of Chancery seems to have made clear – those limits are still fairly narrow.

 

If you have any questions, please feel free to reach out to your GVM lawyer.

This information is only a summary and provides only general information about fiduciary duties and corporate law.  It does not constitute legal advice, and you may not and should not rely on it.

By: Marc Hauser

Control Rights and Fiduciary Risk

Don’t overplay your hand – that’s what the Delaware Court of Chancery is suggesting in a recent and important case for investors. If you own equity with control rights, “hardball” tactics like forcing “oppressive” financing terms could expose you to a breach of fiduciary duties.

Georgetown Basho Investors LLC, a fund led by Chester Davenport, began investing in data company Basho Technologies, Inc., in 2010. After a series of preferred stock financings, Georgetown gained the right to block outside capital raises. In 2014, Georgetown and Davenport forced a final preferred round that gave them control over the company and fairly egregious economics (including a 3x liquidation preference). Georgetown and Davenport took active steps to thwart outside financing pitches (including offers that the investment bankers found were more favorable to the company), controlled the negotiations with potential investors, and pushed aside management who opposed their terms. The Board of Directors rejected Georgetown’s offer, but then Georgetown refused to further fund a bridge loan, throwing the company into a liquidity crisis, and Georgetown gave the company one day to accept its final preferred round terms. After three board members resigned, Georgetown appointed a majority of the board and moved forward with the financing. Needless to say, this didn’t end well – the company later ran out of money and liquidated in 2017.

The Delaware Court of Chancery (which is, nationally, the key court for corporate governance issues) found that Georgetown and Davenport breached their fiduciary duties for self-dealing both in the preferred round and afterwards – Davenport as a board member and Georgetown as a shareholder.

Notably, and an important point for investors to remember, even though Georgetown didn’t own a majority of the stock, the Court reminded that a shareholder still owes a fiduciary duty if it exercises “control over the business affairs” of the issuer.

So is this the end of private equity investing? Well, the Court took pains to make it clear that this case is very fact-specific, pointing out that its decision doesn’t mean that there’s a “heightened risk for venture capital firms who exercise their consent rights over equity financings. … If Georgetown only had exercised its consent right, that fact alone would not have supported a finding of control. … Georgetown and Davenport did far more.”

This decision shouldn’t chill investing activity or the ability of investors to exercise their well-negotiated blocking rights. But, like in other areas of law (e.g, equitable subordination, lender liability), courts don’t like it when investors take too much advantage of their rights for their own benefit, to the exclusion of other stakeholders.

If you have any questions, please feel free to reach out to your GVM lawyer.

This information is only a summary and provides only general information about fiduciary duties and corporate law. It does not constitute legal advice, and you may not and should not rely on it.

By: Marc Hauser

Proposition 65 and You

As you may already be aware, new rules under Proposition 65 take effect on August 30, 2018 that significantly change the warnings that must be displayed to retail customers on many products sold in California.  If you have not done so already, we strongly recommend that you evaluate and, if necessary, change the warnings you’re currently providing to your customers.  Failure to comply could expose you to monetary risk and attorney’s fees.

In short, Prop 65 prohibits retailers and manufacturers from “knowingly and intentionally” exposing California consumers to chemicals “known by the State to cause cancer or reproductive toxicity”, regardless of where the product was made, unless a “clear and reasonable warning” is provided.  The state provides example warnings that are “clear and reasonable” under the new regulations, meaning that, although a retailer or manufacturer may create their own warning, use of the “safe harbor” examples provided by the state satisfies the new requirements.  Alcohol beverage and cannabis products have their own, particular warnings. 

As noted, the new rules apply to producers, importers, and distributors and certain retailers may also be required to provide warning notices.  In particular, alcohol retailers with more than 9 employees must post the new alcohol warnings, including notices about BPA (which is found in some synthetic corks).  So, retailers, restaurants, bars, hotels, DTC sales, tasting rooms, and even internet commerce sites selling to a buyer with a California address should all evaluate whether they’re required to label.

Significantly, Prop 65 provides a private right of action.  This means that a private citizen may serve a notice of violation, with penalties of up to $2,500 per day and the plaintiff’s lawyer being able to recover attorney’s fees.  The private right of action significantly increases the chances of being caught for non-compliance.

If you have not yet educated yourself about Proposition 65’s requirements and how they might affect you and your business, please feel free to reach out to your GVM lawyer for more information.

This information is only a summary and provides only general information about Proposition 65. It does not constitute legal advice, and you may not and should not rely on it.

By: Marc Hauser