Cannabis Musings - February 27, 2024
Looking at the Silver Spike-Chicago Atlantic Deal
Friends, first, I’m moderating a panel next week on the State of the Industry at the UNLV Cannabis Policy Institute. The panel includes Can Legal Weed Win? author and economist Dr. Robin Goldstein at UC Davis, Director of the Maine Office of Cannabis Policy Dr. John Hudak, and cultivation owner and Nevada attorney Judah Zakalik. Tuesday, March 5th, at 1pm Pacific Time, you can sign up to watch the livestream here. It’s free, so you have no excuse not to join and learn from this incredible panel of smart people.
Second, a correction. Last week, we talked about legal challenges from the licensed cannabis industry to “intoxicating hemp.” I made the comment that:
“Certainly, the death blow to intoxicating hemp would be if Congress closes the hemp loophole (I recognize this is a divisive term within our industry, so please don’t email me about it) in the 2024 Farm Bill, which is why the licensed cannabis industry has been lobbying on that. Hard.”
In the original, I had linked to two public statements from the Cannabis Regulators Association on the issue, suggesting that CANNRA is lobbying on behalf of the cannabis industry, which it isn’t - CANNRA represents governmental cannabis and hemp regulatory agencies. My linking to those statements (which I’ve removed) conflated the two, which I definitely shouldn’t have done, and so I apologize for the mistake and any confusion that I may have caused.
Last week, we saw some big news that definitely didn’t get the attention that it should have. Two of the most prominent lenders in the industry – Chicago Atlantic and Silver Spike – announced their shidduch (matchmaking). Such a blessing! It’s interesting for a couple of reasons - the transaction is dizzyingly complex, and it speaks further to the state of the industry.
There’s two parts to this deal – Silver Spike is buying a portfolio of (mostly cannabis) loans form Chicago Atlantic through its publicly-traded business development company, and Chicago Atlantic will be jointly running Silver Spike’s investments. Seems simple, but there’s a lot to unpack.
To understand the farkakteh structure of this combination, we first should understand the business development company (BDC). BDC’s are basically investment vehicles – closed-end funds (meaning they raise fixed amounts of investment capital, as opposed to open-end funds, like mutual funds, which take unlimited capital on a continuing basis) that invest primarily in smaller companies. Its typically listed on a stock exchange, raises money in an IPO, dividends out at least 90% of its net income on a tax-advantaged basis (like a REIT), and pays a fee to its manager. Think a publicly-traded venture capital fund with a yield. Kinda weird.
Silver Spike, which has been a cannabis-focused lender to the industry for some time through private credit funds, IPO’ed its BDC in February 2022 with a focus on making loans to smaller cannabis companies. This was an interesting choice because one of the quirkier requirements to qualify as a BDC (under federal securities law) is that the BDC has to provide “significant managerial assistance” to the companies in which it invests. That’s tricky to do as a lender, because creditors can have different interests from management and equityholders, particularly when the borrower is in trouble.
What was the benefit then for Silver Spike? What asset managers always long for – the vaunted “permanent capital vehicle.” An entity that raises money from investors and isn’t required to give it back – investors instead get their liquidity by selling their stock in the BDC immediately on an exchange, rather than having to withdraw their money from a private fund (which is usually very restricted). The manager then gets to charge management fees on assets and carry/vigorish (more fees) on profits for eternity. Such a deal!
Chicago Atlantic also has been in the cannabis lending business for a while (full disclosure: Chicago Atlantic was a client of mine when I was practicing law), mainly lending through private credit funds, but also through its own publicly-traded mortgage REIT (a real estate investment trust that makes real estate loans). An mREIT is also a permanent capital vehicle with yield and tax advantage similar to the BDC, but more narrowly-focused on real estate. They also pulled it off.
So, how do you combine two similar business with very unusual structures? Very carefully.
Fortunately, Silver Spike’s BDC, being a public company, filed (as its required to by law) a fair amount of information and detail about the transaction, particularly the loan portfolio purchase. Chicago Atlantic is selling at least 24 of its loans (primarily cannabis), worth about $130 million, to the BDC, in exchange for a majority of the stock of the BDC. The stock will be registered, allowing it to be sold or transferred eventually without restriction. The BDC will change its name to Chicago Atlantic, chugging along with a large, diverse loan portfolio that it can also lever up to juice returns (basically, the BDC borrows from another lender, using its own loans as leverage, sometimes referred to deliciously as “back leverage”).
We don’t know as much about the joint venture between Chicago Atlantic and Silver Spike, but the filing tells us that Silver Spike’s company that manages the BDC will also take on the Chicago Atlantic name, and the two groups will jointly manage the loan assets.
In short, I read this as they’ve found a way to join their similar, yet disparate vehicles into one, sort of like Voltron. Chicago Atlantic gets the benefit of additional permanent capital through the BDC in exchange for liquid stock (which it may presumably also be able to distribute out to its investors at some point), while Silver Spike gets the benefit of Chicago Atlantic’s scale, larger asset base, and resources.
At the same time as this is strengthening Chicago Atlantic I also read this as another data point in the continuing overall weakness in the industry. After the schmaltz-fueled binge on equity ended in mid-2019, lenders (and REITs, in the form of sale-leasebacks, which are kind of like loans) stepped into the fold to provide debt capital to the industry. That leverage cycle is now also coming around, a combination of there being simply less debt capital to lend (lenders have to raise money from investors who want to put capital to work in the industry), and fewer quality credits (borrowers that aren’t distressed). If the industry were going gangbusters (or if cannabis were fully legal), we’d see the space flush with easy credit available from a plethora of lenders. But it’s not, so we don’t.
I’m not suggesting that either Chicago Atlantic or Silver Spike are themselves distressed – I think this transaction is more just reflective of the need to adapt to the continued challenge of an industry that unfortunately doesn’t have a lot going for it right now (a recent report from CRB Monitor that active cannabis business licenses actually dropped nationally in 2023 underscores that fact). When it finally does turn around, those with the experience, the connections, the reputation, and the capital will be the ones to succeed.
Be seeing you!
© 2024 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form.