Investing In Cannabis During A Crisis: What To Know About Stocks, Debt,  Equity, M&A | Cannabis Culture

Los Angeles Venture Association (LAVA) recently hosted a webinar discussing the recent uptick of merger and acquisition activity over the last six months, and the trends that will impact the future of the market.

Two reasons for the uptick in cannabis industry investments are confidence in the economy and elections which helped legalize cannabis.  Momentum in states like Texas have increased confidence for investors to enter in the cannabis industry.   With increased capital but lack of federal regulations, investors are embracing creative hybrid financing structures, such as convertible debt that might go away through federal legislation or judicial intervention.  While many investors are focusing on regional sales, large companies that can taking higher risks are now moving in and driving the market.

One issue raised that is relevant to cannabis company valuation is the quality of company “housekeeping” – what is the quality of records of the company, what are its outstanding legal issues, and what structuring issues are invoked by having multistate operations?  For the company, this likely means any valuation issue will require experienced M&A counsel.  For investors looking at cannabis businesses, understanding how housekeeping matters can affect valuation is critical.  In addition, when outstanding legal issues can affect valuation having legal counsel who can analyze the underlying issue and determine its valuation impact is critical.

Expert Retention and Discovery: Five Do's and Don'ts » Alameda County Bar Association

Attorneys for the investors in Tesla Inc. will argue that they have the right to use testimony from Elon Musk’s recent deposition in another case involving Musk’s control over Tesla and board conflicts in their action slated to go to trial later this month.  The investors urge that any contradictory testimony could be used to impeach Musk at trial.  But, Musk’s attorneys want to limit the investors’ access to issues involving the SolarCity deal – wherein Tesla purchased the rooftop solar company for $2.6 billion.

The core matter concerns accusations by Tesla investors that Musk led Tesla into a conflicted $2.6 billion purchase of SolarCity.  The investors have described SolarCity—which was struggling financially and of which Musk is the former CEO—as “a company run by Elon Musk’s cousins, intertwined with Tesla in a complex web of familial and business relationships, and in which [Musk] holds approximately $500 million of stock.”

Other Tesla directors previously agreed to settle the action, paying $60 million to escape the case, but Musk continues to fight.

Meanwhile, the Tesla CEO is also still involved in another lawsuit challenging Tesla’s board’s approval of his ten-year, $55 billion compensation package.  Musk’s deposition in that case is what attorneys in the SolarCity case are seeking.

The parties will argue this issue before Vice Chancellor Slights on July 6, 2021,   As Vice Chancellor Slights has previously granted investors’ motion to compel certain communications between Tesla attorneys and Musk while withholding communications with other parties, the argument should make for a unique battle.

For more on the SolarCity matter involving Tesla shareholder rights, see coverage by Law360 here [$$$].

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This newest piece from Law.com [$$] analyzes the most recent appraisal decision from the Delaware Chancery Court, Regal Entertainment Group, in which the court awarded stockholders a 2.6% premium to merger price.  The valuation determination followed from the court’s pegging Regal’s fair value to merger price less synergies, while adding back the increase in value arising between the signing and closing of the merger agreement with Cineworld that resulted from the reduction in the corporate tax rate under the Tax Cuts and Jobs Act.

A full version of the court’s opinion here: Regal Decision

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Global X, an ETF provider, provided this thorough but succinct survey highlighting the progress toward cannabis legalization in U.S. states.; this is part 1 of a 3-part series, so more to come.  As we’ve noted before, cannabis valuation issues are intertwined with regulatory and legalization issues, an interesting, but not necessarily unique aspect of the space.

This recent piece from Forbes provides an interesting look into how Michael Dell scored a huge windfall by opportunistically taking Dell private while the stock was undervalued.  Although the Delaware trial court had acknowledged a valuation much higher than the take-private price, the Supreme Court reversed mainly on policy grounds, on the rationale that public M&A transactions deserved heavy deference to deal price.  As the article shows, Dell internal documents showed it was worth more.

The Delaware trial court had indeed recognized that Dell’s value exceed the merger price, by about 28%.  Michael Dell, along with financial sponsor Silver Lake, had acquired Dell in 2013 for $13.75 per share in cash.  In its decision, the trial found the fair value of Dell’s shares as of the merger date to be $17.62, thus implying the deal undervalued Dell by nearly $7 billion.  The Supreme Court reversed that award and reinstated merger price as a proxy for fair value, rejecting the trial court’s analysis that, among other things, “investor myopia” and a focus on short-term profit had caused a “valuation gap” between the market price for Dell’s shares and its intrinsic value.  Based on the deal terms, Michael Dell’s personal stake of 15.6% of the company was worth about $3.6 billion; as the Forbes article shows, he has managed to parlay that stake into a current value of $39 billion, after deploying other financial devices in related M&A activity by Dell.  As Forbes indicates, Michael Dell made a play with a buyout rather than “spending years trying rebuild enthusiasm for the stock.”

The Delaware trial court understood that Dell stock had been experiencing a short-term lull and was prepared to compensate shareholders for losing out on any chance to participate in a longer-term rebound.  Although it had been criticized for identifying a valuation gap as large as $7 billion, it appears that the gap was in fact much larger even than that amount, and yet this enormous transfer of wealth from shareholders to insiders nevertheless took place after the Delaware Supreme Court shut the door on the shareholders’ effort to recoup just some of that value.

 

Cannalaw Conference Wrap-up:  What’s Next for Marijuana?

The conference closed with a look ahead to the future of the cannabis industry, patent issues, and emerging psychedelic market.  What will we see with regards to patent enforcement?  Only two cannabis related lawsuits have been filed to date, one that died.  However, there is speculation that as the industry grows and federal regulation is introduced, there will be a rise in patent lawsuits.  Aside from a few large patent holders, most patents are owned by inventors and small companies which could lead to patent troll activity.  When is the FDA going to regulate hemp products, including consumables?  The FDA has approved certain hemp products, such as hulled hemp, but they are looking into the safety and efficacy of other hemp products.  Steps are being taken, including establishing a CBD working group, but it will be some time before the FDA issues regulations.   What about psychedelics?  Several states have introduced legislation to decriminalize and legalize psychedelics, with Oregon being the first state to pass legislation.  If the industry uses cannabis as a blueprint and learns from their successes and missteps, we could see legalization move quicker than expected.

 

Quickfire Questions:  What’s next?

The panel offered insight and predictions into the future of the cannabis industry, patent issues, and emerging psychedelic market.  When is the FDA going to regulate hemp products, including consumables?  The FDA has approved certain hemp products, such as hulled hemp, but they are looking into the safety and efficacy of other hemp products.  Steps are being taken, including establishing a CBD working group, but it will be some time before the FDA issues regulations.  What will we see with regards to patent enforcement?  Only two cannabis related lawsuits have been filed to date, one that died.  However, there is speculation that as the industry grows and federal regulation is introduced, there will be a rise in patent lawsuits.  Aside from a few large patent holders, most patents are owned by inventors and small companies which could lead to patent troll activity.  What about psychedelics?  Several states have introduced legislation to decriminalize and legalize psychedelics, with Oregon being the first state to pass legislation.  If the industry uses cannabis as a blueprint and learns from their successes and missteps, we could see legalization move quicker than expected.

The M&A panel at yesterday’s Cannalaw conference addressed what valuation techniques are being used to determine the purchase price of a marijuana company.  While in recent years the traditional valuation metrics would normally be utilized – whether multiples of sales, revenues or EBITDA, for instance – the current market is experiencing a supply/demand imbalance, as the scarcity of licensing allows sellers to be more aggressive in testing what the market can bear.  That phenomenon might not normalize any time soon, as legalization trends spur additional M&A activity, with buyers vying for a limited number of licensed operators.

 

Financial Inclusion:  Banking in the Legal Cannabis Industry

The panel focused on the challenges of cannabis banking, including availability, compliance issues and whether the proposed Safe Banking Act will pass.  The major problem that large banks face is not with the illegality of cannabis, but with the compliance costs.  Large banks must file a Suspicious Activity Report (SAR) with each deposit from cannabis companies since they are considered high risk deposits, leading to significant increases in administrative cost.   State-chartered banks are mostly regulated by state, but still must comply with federal law.  While the Safe Banking Act, introduced last year, is a step in the right direction, it does not address the SAR compliance issue, so banks will still be reluctant.  

 

Emerging Focusses in Cannabis Law: Fintech and Cannabis – An Evolving Industry Within an Evolving Industry

This discussion focused on the intersection between Fintech and the cannabis industry, which are both highly regulated and complicated.  Major credit card companies do not permit cards to be used for transaction purposes, so cannabis companies must rely on cash, which is inconvenient for the consumer and a burden for the retailer.  Fintech has stepped in to fill the void by helping to facilitate the transactions and provide compliance related services. The payment related companies provide processing and online ordering services,  allowing customers to pay using apps to withdrawal directly.  They also track spending, which helps tailor products and services to consumers.

RKS is covering the the Cannalaw Summit, a conference covering a range of topics including cannabis valuation.  Beyond the newest US states to legalize recreational cannabis use, Mexico is proceeding with legalization steps in what observers said could become “the world’s largest cannabis market.”  The summit kicked off yesterday covering an industry “with projections of $35 billion by 2024 for the US market, and upwards of $100 billion worldwide.”

Panels yesterday covered:

The Evolving Relationship Between IP Law and the Cannabis Supply Chain

The panel focused on a wide range of IP issues and risks associated facing cannabis companies, including legal requirements to protect IP of plants and interstate regulation issues.  Companies must take a strategic approach to determine the scope of protection needed for the plant: utility patents, plant patents or PVPC protection.  They can protect IP by filing state trademark applications, registering non-cannabis related goods, and file on an “intent to use” basis.  Once federal regulations are loosened, those who take steps to protect their IP will benefit the most. Other risks specific to this industry are the inability to transport the goods across state lines and dealing with state specific manufacturing/distribution.  To mitigate these risks, companies can create separate IP licensing companies, separate manufacturing in each state, and structure payment terms to comply with laws of all jurisdictions.

Collaboration in Cannabis Law: Utilizing Firm Resources to Provide Holistic Client Services

This discussion focused on challenges and strengths for both the boutique cannabis-driven firms and “big law”  firms, and how they can work together to maximize benefits for their clients.  Boutique cannabis firms have a unique understanding of the nuances of cannabis law and the risks associated with them, , while “big law”  can provide IP, M&A, federal and commercial advice.   Boutique law firms also understand the organizational structures of multi-state clients, while “big law” can handle unforeseen issues that could result in class action litigation, like unknown health or environmental issues.

A Review of Client Engagement, Intake and Risk Best Practices

The panel laid out issues surrounding the emerging cannabis industry – federal illegality, inconsistent state regulations, conflict issues, unsophisticated clients – and the need for law firms to protect themselves from ongoing risk management issues.  Conflict checks, waivers, retainers and scope of work must be written down in detail and define the end or your representation in writing.  To mitigate risks, firms can consider running background checks, offer flat fee arrangements, replenish retainer fees, and inform malpractice insurance carriers of cannabis representation.

We look forward to covering the next day’s events.

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The Governor of Delaware has nominated Vice Chancellor Kathaleen McCormick to the post of Chancellor (the ‘chief judge’ of the Delaware Chancery Court).  The nomination is to replace retiring Chancellor Andre Bouchard.

Steve Hecht of Rolnick Kramer Sadighi LLP said of the nomination “VC McCormick has been a welcome addition to the bench since her appointment in 2018.  This was a great choice and I am sure she will continue to transform the Delaware Chancery Court as Chancellor.”