“Since Justin Trudeau was elected in 2015, the legal framework for medical and recreational marijuana has been loosening at a rapid pace, fuelling remarkable growth for what is still a nascent sector,” says Andrew Powers of Borden Ladner Gervais LLP in Toronto. “But the details of the regulatory environment are unclear, so investors should proceed with caution.”
In Canada alone there are more than 130,000 registered medical cannabis patients. Licensed producers (LPs) are projecting sales approaching $400 million in 2017, with Canaccord Genuity reporting that sales could hit $1.5 billion by 2024.
As it turns out, the domestic outlook pales beside the potential in the international market. Brendan Kennedy, CEO of Seattle-based Privateer Holdings, which has invested heavily in Canadian LPs, predicts that the international market could attain $100 billion in retail sales between 2022 and 2027. What’s remarkable is that these forecasts don’t even take recreational sales into account.
Operators scrambling to get in on the action need financing to support growing capacity by building structures and making acquisitions. But there appears to be no shortage of capital.
“There is a significant influx of capital from everywhere, including China and the US, for this new industry,” says Jonathan Sherman of Cassels Brock & Blackwell LLP in Toronto.
Encouraging this influx, says Sherman’s colleague Jacqueline Richards, is the way in which Canada has structured its legal cannabis licensing process.
“Our system has encouraged the development of more sophisticated and better capitalized players than in other areas of the world,” she says. “Canada currently limits the number of licenses available for producers [only 38 have been issued to date] and the licenses are tied to specific pieces of production property, which incentivizes companies to license large pieces of property and build big, early.”
Still, the shape of the investing environment is uncertain, particularly with regard to recreational cannabis. Key issues relating to marketing, distribution and enforcement that will shape the adult use industry remain murky. Until the Liberals’ marijuana liberalization legislation, introduced in April, receives royal assent, clarity is not likely to emerge. Even then, consequential amendments to criminal law and provincial law must be put in place before a full picture forms.
Even more risk emanates from the US.
“The Americans have smelled the smoke and want to crash the party,” Powers says. “But there’s an anomalous regulatory environment in the US that creates risk for producers and other companies in the cannabis ecosystem.”
While an increasing number of US states are legalizing marijuana, cannabis remains a controlled substance under federal law.
“The businesses involved in cannabis have to be careful not to run afoul of interstate commerce complications because plants, seeds, other products and even cash relating to the industry can’t cross state lines without significant exposure to federal liability,” Powers says. “With a number of American companies coming here for capital, investors should take account of the legal risks that these companies face at home.”
It’s not just private investors, however, who need be cautious. Collective investment in various forms, including labour-sponsored funds such as Saskatchewan’s Golden Opportunities Fund, are investing in the industry. Private equity funds such as Toronto-based Green Acre Capital Fund are becoming players, too.
“The collective investment funds are focusing on earlier stage private companies, particularly LPs, so they’re not insulated from the risks we’re talking about,” Powers says.
But there may be opportunities for investment in other vehicles, such as REITs and royalty funds, that might insulate investors from some of the risks.
REITs, for example, may consider acquiring real property that could be leased to LPs.
“In this industry, property is king, because producers need space and square footage to grow capacity,” says Powers.
Royalty funds are already in the space. Ottawa-based CannaRoyalty, for example, provides upfront capital to licensed cannabis businesses in exchange for a royalty on their revenues.
All this aside, there’s no doubt that surprises are on the horizon. For example, stakeholders expected that the legislation currently before Parliament would allow export of recreational cannabis; it doesn’t, though that could change.
For the time being, however, investors appear undaunted. Risk, after all, is part of their daily menu. What they’re banking on is that cannabis will soon be fit for general consumption.
Borden Ladner Gervais LLP,Cassels Brock & Blackwell LLP