‘Blank Cheque Boom’ can help take cannabis companies public
Published on April 30, 2021 by Corinne Doan
Cannabis stocks experienced exceptional waves during the first quarter of 2021.
First there was the announcement that American Democrats added cannabis legalization to their agenda. That was followed by a short squeeze market invasion orchestrated by some resourceful online gamers and Reddit.
Next, was the announcement for a US$1.88-billion deal from a guy associated with bubble gum and a Chicago baseball field. Beau Wrigley, heir to the Wrigley Gum family and former CEO, is now the chairman and CEO of Parallel, a cannabis retail company with over 50 stores in a handful of States. Parallel announced a merger with publicly trading company Ceres Acquisition Corp (CERE.U:NEO). Notably, perhaps more than the mega transaction, was the investment vehicle it used, called a Special Purchase Acquisitions Corporation (SPAC).
SPACs are an investment vehicle that were virtually unknown and unfamiliar to most prior to 2020. Until the past year, few investors had SPACs on the radar, yet its momentum is growing at an alarming pace.
A decade ago, an average SPAC capital raise was $70 million. Over the past two years the average SPAC capital raise has been $300 million. During the year 2020, over $83 billion was raised for 248 SPAC listings which was more volume than all the SPACs combined with all the previous years combined. By the end of the first quarter of 2021, 550 SPACs raised $162 billion already outnumbered all from 2020. SPACs are outnumbering traditional Initial Public Offerings (IPO) by a ratio of 4:1. More, 76% of IPOs in US equities are SPACs this year. The escalating trend is a SPAC Boom- also known as a Blank Cheque Boom (more on that later).
What makes a SPAC unique is it is a type of investment vehicle called a ‘shell.’ Like an empty shell missing its turtle, a shell company has no valuable tangible assets other than cash. Although SPACs were relatively unknown prior to 2020, shell vehicles have been a staple of Canada’s junior stock exchanges for decades.
Consider, both Canada’s and the United States’ regulated stock exchanges use a traditional investment vehicle to take companies public, an IPO. The process includes a long-form document called a prospectus that can be onerous and costly. It’s the vehicle commonly used on the senior big board exchanges like the Toronto Stock Exchange (TSX) and New York Stock Exchange (NYSE). Further, both Canada and the US have junior stock exchanges. Canadian primary junior exchanges are the Toronto Stock Exchange—Venture (TSXV), and the Canadian Securities Exchange (CSE). A fundamental difference between Canadian and American junior exchanges is that Canadian exchanges are self-regulated with the same scrutiny as the senior exchanges. This provides a more stable and secure market for business transactions. More, the Canadian junior exchanges provide two additional investment vehicles for ‘go public’ options. One is called a ‘Reverse Take-Over’ (RTO) and the other is a ‘Capital Pool Company’ (CPC). RTOs and CPCs are less costly and less time consuming for a go-public option which can be greatly beneficial to a venture start-up company. Additionally, the security of a regulated exchange provides a safer environment to entice investors. Alternatively, the investment vehicles used on American junior exchanges do not undergo the same scrutiny or regulatory approval. Hence why Canada has had advantage establishing robust junior venture markets.
As mentioned, RTO’s, CPC’s and SPACs have a common theme of all being shells.
To better understand these shells, let’s take a look at what benefits they bring and their similarities and differences.
A reverse take-over (RTO) is an investment vehicle to take a private company public. In Canada, RTOs are used for venture business transactions on the CSE and TSXV. The process is the opposite of what is normally considered a takeover. Generally, when one thinks of a company takeover, the vision is of a large company acquiring a smaller company. With a reverse-takeover, a private company acquires a publicly trading company, hence it is the ‘reverse’ of what one might typically expect.
With any stock exchange listing there is a cost. Once a stock is publicly trading, the stock listing itself becomes an asset because it is a paid-for entity. By virtue of venture stocks being high risk, many do fail. When a company fails, the only company asset it may have left of any value is its stock exchange listing. If the company has enough cash to maintain its listing, it can become a shell. The shell has value because it can be sold like an asset.
A private company can circumvent the onerous costly IPO process by buying a shell. The private company acquires and takes control of the public company shell, and the transaction is called an RTO. It’s a backdoor approach to gaining access to the exchange. The private company gains a listing on a public exchange and a preexisting shareholder base which can be a benefit to provide liquidity. An RTO typically has a capital finance raise at the same time as its takeover transaction, but that does not have to be the case.
An American Reverse Merger is not the same as a Canadian RTO. The primary difference is the regulatory scrutiny and review process a Canadian RTO goes through. American reverse mergers on over-the-counter exchanges are not put through the same process of due diligence and have a reputation for issues.
A Capital Pool Company (CPC) is another investment vehicle to take a company public. It is a common go-public option on the TSXV and is regulated by the TMX Group. Creating a CPC involves forming a board of experienced directors while doing a simultaneous seed capital raise. The capital raise can be between $100,000 to $1 million. Only experienced or qualified investors can buy a CPC during the seed capital raise. The company is granted a public CPC listing with its only assets being the cash from the capital raise and the experience and credibility of the directors. Hence, a CPC is a publicly trading cash shell. Then, the board is given the mandate to seek out an acquiring transaction. The board’s task is to conduct due diligence on a company to acquire, or to merge. A CPC acquiring transaction is essentially a reverse takeover. Like an RTO, the private company gains a backdoor approach to be a publicly trading company onto a stock exchange. A private company acquired by a CPC gains a stock exchange listing, an experienced board of consultants, a cash pool, and an experienced shareholder base. Experienced shareholders tend to understand investing in a capital financing is a long-term hold commitment which enhances stock price stability due to minimal liquidity.
On Jan. 1, 2021, significant changes were implemented in the CPC program to improve flexibility, minimize regulatory restrictions, and stimulate its economics. Highlights of the changes include removing the 24-month time frame to acquire a private company. (Prior to this change, if a CPC did not complete an acquiring transaction within 24 months, the company would be delisted, and that created time pressure for transactions which may not be beneficial. If possible the company could try to relist on a lesser exchange.) The $500,000 seed capital raise limit has been increased to $1 million. And the aggregate financing limit increase from $5 million to $10 million.
Since its inception decades ago there have been 2,600-plus CPC listings, 85% of those listings completed the qualifying transaction, and $75 billion+ has been raised. (According to TSX website, as of Sept. 20, 2020)
The primary difference between Canadian shell companies and American has been the regulatory checks and balances. During the 1980s there was an American investment vehicle called a ‘Blind Pool.’ They were unregulated penny stocks and riddled with fraud issues and scandal. However, that changed in 1993 when the New York Stock Exchange (NYSE) introduced an investment vehicle called a Special Purchase Acquisition Company (SPAC).
Now available in Canada, US, and internationally, on credible stock exchanges providing regulatory checks and balances, SPACS are gaining efficacy. According to the U.S. Securities and Exchange Commission, “a SPAC is created specifically to pool funds in order to finance a merger or acquisition opportunity within a set timeframe usually 18-24 months.”
The NYSE is the largest lister of companies in the world and in 2020 listed 60% of the world’s SPAC market.
Essentially, A SPAC is an investment vehicle to take a company public.
The model is similar to a CPC, in that, a company is formed by an experienced board of directors with a seed capital raise. However, the capital raises are much greater for a SPAC than a CPC. A Canadian SPAC must raise a minimum of $30 million with a listing price of $2 per share or unit. A NYSE SPAC must raise a minimum of $100 million with a listing price of $10 per share or unit. Once listed, a SPAC becomes a publicly trading company with no assets other than an experienced board and a cash pool — a shell. The board of the SPAC is tasked with conducting due diligence to acquire or merge with a private company within a time frame (36 months in Canada and 24 months in the US.) When the acquisition transaction is announced it is the beginning of a process called a ‘D-SPAC.’ Shareholders are given a timeframe to consider the transaction, which must be approved by their vote. If approved, the SPAC does its acquiring transaction, and the private company gains a backdoor access to be a publicly trading stock. If the board does not successfully complete an acquiring transaction within the pre-stipulated timeframe, the seed capital is returned to the original investors. For the reason of the cash pool benefit, a SPAC is shell company commonly referred as a ‘Blank Cheque.’ And because of its meteoric frenzy over the past two years, it is being called the ‘Blank Cheque Boom.’
Why is all this important for cannabis stocks?
Cannabis is an emerging industry. All emerging industries are unknown. And the unknown is high risk. High risk speculative business ventures require vision and entrepreneurial spirit. Bankers and business acumen detest hearing this, but it all really comes down to one word… faith.
Speculative ventures require innovative platforms to raise capital. Entrepreneurs and investors desire a less risky platform to conduct business transactions. In Canada, the speculative venture platform was created for the oil and gas and mining industries. Hence why Canada developed prosperous venture stock exchanges with unique shell investment vehicles decades ago. Other speculative industries such as the technology sector also found Canada’s venture markets to be beneficial. It seems a natural fit for the cannabis industry to originate on Canada’s junior exchanges.
Not only did Canada have the platforms to support the speculative ventures, but the country legalized medicinal cannabis two decades ago (in 2001). Having cannabis federally legal fostered a hospitable climate for Canada to be the nucleus of the emerging cannabis industry. For almost a decade cannabis companies have been relying almost exclusively on Canadian stock exchanges to go public. This is an advantage over the US where cannabis remains federally illegal. Since cannabis is not legalized federally in the United States, American regulated stock exchanges have prohibited American cannabis companies from going public. Only Canadian cannabis companies can trade on regulated American exchanges. Conversely, American cannabis companies can go public in Canada. However, that advantage is waning.
Since many States have legalized cannabis and with the indication from the Democrats to legalize federally, American stock exchanges are softening their stance on prohibition. It’s an ‘iffy’ grey area but they are now allowing ancillary cannabis businesses a place on the exchange as long as the company has no direct touching with plant production. This has caught the attention of SPAC entrepreneurs. With the possibility of federal legalization, speculators can venture a SPAC can go public now, and hope it will be able to have a fully legal cannabis acquiring transaction in a few years.
Not unlike the Canadian junior exchanges and its shells with origins in venture oil and gas and mining sectors, SPACs too are finding a home with emerging industries. This is because the shell investment offers a less risky option for venture capitalism. In the United States, the emergence of the SPAC’s has given a business platform for speculative entrepreneurs developing electric vehicles, environmentally sustainable technology, sports/ media/ entertainment platforms, and of course cannabis.
It’s important to note, the cannabis sector is still emerging, and any new industry is high risk. Shell investment vehicles have inherent risk because they are an unknown business entity and must transpire to survive. Although they are now booming and reviewed by credible stock exchanges, as a shell, a SPAC too comes with built-in risk. However, there is a saying in the investment industry, “the higher the risk, the higher the reward could be.” When choosing any shell investment, the crucial component to consider is always the leadership. Other considerations should be investment vehicle add-ons such as a unit with a warrant. If you don’t understand a warrant, that’s ok, because it’s another article.
Corinne Doan is Canada’s first published author with a book regarding Canadian cannabis investments titled Canadian Cannabis Stocks Simplified: A How-To Guide for the Budding Investor. She was a licensed investment advisor with a focus on venture capital markets and held investment industry (IIROC) relevant licenses with the Canadian Securities Course (CSC), options and branch managers. Also, Cori has an MBA with specialty disciplines in public relations and communications. Any data or Information that is not directly cited in this report is believed to come from reliable sources. All dollar values are CAD unless otherwise specified.