Cannabis offers budding opportunities for credit lenders in Canada

Canada's recently legalised Cannabis market could be a major opportunity for debt funds looking to diversify.

Canada has turned a former black market into a potential gold mine for international debt investors.

The country legalised the medicinal use of marijuana in 2001 and its recreational use at the end of 2018. This opened the floodgates for investors to safely enter the market. Debt lenders raised more than $2.48 billion globally for the strategy in 2018, according to Viridian Capital Advisors.

Most of the funding so far has been from banks and private equity firms. But as the market continues to expand, companies are looking to scale and debt lenders are revving their engines.

“This market was traditionally funded by retail and equity investors and that has created a lot of dilution,” says Eric Foster, co-head of the cannabis practice at Dentons Canada. “Some of that has been by design but much of it has been by necessity.”

Debt capital made up 31 percent of fundraising for cannabis during Q1 2019 compared with 17 percent for the same quarter in 2018, according to Viridian. More than $1.79 billion had been raised in 2019 as of 17 May.

“It’s a pretty small club [of lenders],” says Michael Ruscetta, chief executive at Trichome Financial Corporation. “Having the first flag in the ground is helpful in terms of being ahead of the curve.” Trichome, which has Sprott Asset Management as a founding partner, typically focuses on lending first-lien loans of between C$2 million ($1.49 million; €1.33 million) and C$40 million to companies backed by strong assets.

Ruscetta thinks the industry is full of interesting opportunities involving companies that add value to the cultivation and distribution of cannabis, including in the process of extraction, as well as services and retail.

He says Trichome is gearing up to launch its first cannabis debt fund in the next few months and is looking to target somewhere between C$50 million and C$75 million.

Canopy Rivers, the venture arm of publicly traded Canopy Growth, is another player building a stake in the market. Daniel Pearlstein, executive vice-president of strategy, says Canopy Rivers looks at companies in a variety of sectors within cannabis and focuses on those with intellectual property or strong brands that could easily scale as the market continues to grow globally.

Successful track record

He adds that the firm looks for companies with founders that have succeeded in other industries and will lend tickets from C$1 million to C$30 million. “It’s not really until recently that the market is rewarding companies that are real businesses rather than companies that happen to be in the cannabis industry,” Pearlstein says.

The main investor base so far has been family offices and wealthy individuals, Foster says. However, he adds that institutional investor appetite is growing: “The number of institutions that are active is significantly greater than six months ago.”

Although the market continues to grow, it remains heavily regulated and operates through a licensing model. Foster says firms should make sure their portfolio companies are following the proper licensing requirements and frequently monitor compliance to avoid complications.

The opportunities expand far beyond Canada. Canopy Rivers and Trichome are global players and Foster says he is working on deals in more than 20 countries.

As regulations change across the globe, the debt opportunity will continue to grow.

“We are starting to see a new wave of capital, new kinds of companies and really accomplished individuals looking to take a jump into the industry,” Pearlstein says. “It could be one of the best opportunities in this generation.”