More Cannabis Debt Is Equity-Linked, Increasing Its Cost

Debt has taken a lead role in financing the Cultivation & Retail sector, accounting for nearly 77% of worldwide capital raised YTD, significantly higher than in any comparable period in history. The prevalence of debt is even higher in the U.S., accounting for over 94% of funds raised.

The rise in debt has a lot to do with the cratering of equity prices over the last year and a half, but it also has to do with a realization that the sector has become more credit-worthy. In 2018-2020, most companies were financed with convertible bonds, frequently with significant additional warrant coverage.

Several trends in cannabis debt financing are reversing:

• The blue line on the graph (measured on the left axis) shows the percent of debt transactions that were equity-linked. As recently as early 2021, over 50% of all debt issues were either convertible or had attached warrants. This number has dropped sharply such that in Q1:22, only about 9% of the deals were equity-linked. This trend reversed sharply in Q2 and Q3, bouncing back to over 50%.

• The Effective cost of debt is a measure that considers the value of the embedded options in equity-linked structures. It is shown in the red line on the graph and measured on the right axis.

• The effective cost of debt had been declining over most of 2021 but has increased sharply in Q3: 22. Whereas the larger, better credit quality MSOs achieved effective costs of around 8% in early-to-mid 2021, they are conspicuously absent from today’s market. The companies in the market have been subject to liquidity pressures and have paid a high price for it. Lowell Farms CSE, for example, raise $6.7M at an effective cost of over 30%.  

We expect this trend to continue through year-end, as liquidity-constrained companies must either complete dilutive equity issues or high effective cost debt. Companies with sufficient cash reserves hold out for the promise of more attractive financing post-SAFE+ Act.

• Investors that do careful credit work will likely find attractive bargains in the balance of 2022.

The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.

The Viridian Cannabis Deal Tracker provides the market intelligence that cannabis companies, investors, and acquirers utilize to make informed decisions regarding capital allocation and M&A strategy. The Deal Tracker is a proprietary information service that monitors capital raise and M&A activity in the legal cannabis, CBD, and psychedelics industries. Each week the Tracker aggregates and analyzes all closed deals and segments each according to key metrics:

• Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors - from Cultivation to Brands to Software)

• Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A) Status of the company announcing the transaction (Public vs. Private)

• Principals to the Transaction (Issuer/Investor/Lender/Acquirer) Key deal terms (Pricing and Valuation)

• Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)

• Deals by Location of Issuer/Buyer/Seller (To Track the Flow of Capital and M&A Deals by State and Country)

• Credit Ratings (Leverage and Liquidity Ratios)

Since its inception in 2015, the Viridian Cannabis Deal Tracker has tracked and analyzed more than 2,500 capital raises and 1,000 M&A transactions totaling over $50 billion in aggregate value.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.