Samantha Lee/Business insider
Special purpose acquisition vehicles are emerging as a key way for investors to chase cannabis deals.
- Investors targeting the cannabis industry are turning to special purpose acquisition companies, or SPACs, to chase down cannabis deals.
- Most traditional investors, like pension-backed venture capital or private-equity firms, are reticent to invest the industry since cannabis is federally illegal in the US.
- Investors have poured $2.8 billion into cannabis-focused SPACs since 2019. The entire SPAC market in that time is roughly $17.5 billion.
- Though some of the top banks on Wall Street have advised SPACs, not all are on board, a senior banker told Business Insider.
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As traditional funding sources have dried up for struggling cannabis companies, a new avenue has emerged: special purpose acquisition companies, or SPACs.
SPACs are an increasingly common structure used to invest in cannabis companies as most traditional investors, like pension-backed venture capital or private-equity firms, are reticent to get involved in the industry since cannabis is federally illegal in the US.
SPACs pool money from investors - in a process sometimes known as a blind pool - into a "blank check" public company. Once public, the SPAC can go out and make acquisitions or investments based on a strategy defined by the company's managers.
While SPACs have been around for years, the process is often viewed as a way for a company to go public that couldn't otherwise do so and therefore doesn't hold as much prestige for some as a traditional IPO.
However, the cannabis industry, eager for new ways to raise capital, has embraced SPACs with open arms.
To that end, investors have poured $2.8 billion into cannabis-focused SPACs since the start of 2019 to target opportunities in the cannabis space while remaining onside, at least as much as possible, federal securities regulations.
By comparison, according to SPACInsider, there has been $17.5 billion raised in SPACs overall since the beginning of 2019. And yet, despite cannabis-focused SPACs making up roughly 16% of the entire SPAC market, Wall Street isn't completely sold on the idea.
A 'demographic tsunami'
"The appetite and demand from traditional institutional US investors to get exposure to this demographic tsunami that's taking place in the health and wellness cannabis space is huge," Bill Healy, a partner at the cannabis SPAC Silver Spike Capital, told Business Insider in August 2019.
Silver Spike closed a $250 million fundraise and listed on Nasdaq that month. The deal was led by Credit Suisse, marking the first time a bulge-bracket investment bank led a US cannabis offering Heally, an alum of Deutsche Bank and the blockchain fund Pantera Capital, handled much of Silver Spike's capital raise last year.
Subversive Capital, a $575 million fund, is chasing a different strategy than Silver Spike: It's focusing on real estate, the company's CEO, Richard Acosta, told Business Insider in an interview in February.
The company raised $225 million through a public offering in January on Toronto's NEO Exchange for a SPAC real-estate investment trust or REIT. The fund picked the Canadian market since most cannabis and cannabis-related companies are barred from the major US exchanges, Acosta told Business Insider.
So why a SPAC versus other types of funding strategies?
"It goes back to where the capital markets are," Acosta said in February, noting that cannabis stocks and public debuts had already taken a hit. "You see where the stocks have gone in the last 12 months. There really is no IPO market, right? I don't think you'll see any large-scale IPOs in cannabis for the next couple quarters."
Ruobing Su/Business Insider
That, of course, is doubly true now that the economic fallout from the coronavirus pandemic has sent the global economy teetering on the brink of a major recession.
Advising on SPAC public offerings is also an increasingly lucrative business for Wall Street investment banks, and helps these advisory firms gain exposure - and make important connections - in a brand-new space.
After Business Insider reported on talks high-level Citigroup executives held about working with cannabis companies in March of 2019, the bank made its first foray into cannabis, leading Bespoke Capital Acquisition Corp's $350 million IPO in August, another cannabis-related SPAC.
'This is clearly a gray area'
But not all banks are on board. The risks and federal restrictions around cannabis have given some pause.
The chief psychoactive component of cannabis, THC, is illegal under US federal law despite being legalized in some form in 33 states. Most federally-chartered US investment banks won't raise money or advise on deals for companies that are actively violating federal law, no matter how attractive the growth prospects of the industry are.
A senior investment banker at a bulge-bracket bank said cannabis companies, with uncertain regulatory risks and no comparable companies in the market, fit the mold perfectly for going public through a SPAC.
The banker highlighted two companies that were acquired over the past year by SPACs as examples: DraftKings and space tourism company Virgin Galactic.
The former, a sports betting platform, was acquired by a SPAC in a three-way deal in December 2019 valuing it at $3.3 billion. Just like cannabis companies, DraftKings holds regulatory risk, as newly elected politicians could look to reverse course after the federal ban on sports gambling was lifted in 2018, the banker said.
If DraftKings were to go public via a traditional IPO, the company would be more susceptible to any political announcement being made in the lead-up to it hitting the public markets, the banker said.
REUTERS/Rafael Marchante
A worker checks cannabis plants inside the Tilray factory hothouse in Cantanhede, Portugal April 24, 2019.
"What happens if a politician comes out with some statement a couple hours before that 4:00 p.m. pricing call. If you're going public the regular way you might be in a situation where you have to price your deal poorly," he added. "Versus the SPAC, you're able to go and set up the whole capital structure and the whole deal before you deliver it to the market."
Virgin Galactic is another example of the benefits of a SPAC for a certain type of company. With no revenue and negative cash flow, a traditional IPO was out of the question, the banker said. Further complicating matters was the fact there was no comparable company in the market.
Similar to the DraftKings example, the deal was able to get done because all three parties - buyer, seller, and investors - were all able to get on the same page before announcing the deal publicly, the banker said.
"So some of these assets that couldn't go public by themselves, it's de-risked because of that three-way negotiation," he added. "I think cannabis is the same tact."
However, just because SPACs represent a great fit for cannabis companies doesn't mean big banks will be eager to set them up. The banker said his firm has steered clear of dealing in cannabis SPACs entirely.
According to the banker, the high reputational risk, along with some uncertainty around the legality of the situation make it one the bank is not willing to stomach.
"This is clearly a gray area. ... It's up to Congress to change the federal laws and they haven't yet, so we are not going to get in front of the laws. We have too much to risk," the banker said.
"We've just elected to generally stay away from that right now until we get more guidance from our regulators," he added.
Yeji Jesse Lee contributed reporting for this story
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