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/

Excelsior!

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/

Excelsior!

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. 

Excelsior!

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