CANNAINVESTOR Magazine September / October 2016 - Page 16

In 2015 there was a general correction in publicly traded cannabis companies that we attribute to:

Unsustainable Valuations: A “return to fundamentals” as unsustainable valuations, along with more institutional money coming into private placements, are driving down investor terms and valuations.

Lack of Liquidity: The lack of liquidity for most public cannabis companies hurts their ability to close common stock financings, instead relying on highly dilutive convertible debt and equity line structures.

Weak Balance Sheets/Cap Tables: The fact that many companies became public via reverse mergers and rely on dilutive structures to finance operations has created weak capital structures and balance sheets.

Why do you think cannabis biotechnology/pharmaceutical firms make up the majority of cannabis companies listed on exchanges other than OTC?

Uplisting to a more senior exchange such as the NASDAQ involves a company meeting specific exchange requirements, such as market capitalization, liquidity, net equity, and filing requirements, so it is a quantitative decision on the part of the exchange. The biotech companies that trade on the Nasdaq exchange have met these requirements. Of the more than 250 public cannabis companies, five have warranted a listing on a NASDAQ exchange, which include Arena Pharmaceuticals, Cara Therapeutics, GW Pharmaceuticals, Insys Therapeutics, and Zynerba Pharmaceuticals. Another firm, 22nd Century Group, trades on the NYSE. The cannabis biotech sector was also the sector that realized the industry’s first true IPO, with Zynerba Pharmaceuticals completing its IPO on August 10, 2015.

It seems that many publicly-traded cannabis companies have a significant amount of convertible debt on their balance sheets. What effect does this have on these companies?

The explosion in public cannabis companies occurred in the beginning of 2014, when Colorado and Washington State implemented the first legalized recreational programs in the country. The number of public cannabis companies increased from about 35 at the beginning of 2014 to over 170 by the end of that year.

Approximately 25% of the companies in the chart to the right went public through reverse mergers. Early-stage companies, which almost all of the public cannabis companies are, that went public via reverse mergers tend to attract straight or convertible debt rather than equity investors as they are perceived to be riskier ventures. Debt provides to the investor the security of seniority on the balance sheet, while convertible debt provisions provide optionality to capture additional upside through equity.