Options for buying a cannabis business in a dry capital market

At the Benzinga Capital Conference just a few months ago, everyone was saying that “the capital markets are dry.” This was a phrase as popular as “cowabunga” was at the height of Bart Simpson’s popularity.

But what does it mean to say “the capital markets are dry?” What are the implications of a dry market? And what options does one have for acquiring or even selling their business in a “dry market?”

What is a “dry market?”

When someone says that capital markets are “dry,” it typically means that there’s a scarcity of available funds or a lack of liquidity in the financial markets. This situation can occur for various reasons, such as:

Reduced investment activity
Limited access to funds
Economic downturn
Regulatory changes or uncertainty
Global events, such as geopolitical tensions or natural disasters

Unfortunately for those of us in mergers and acquisitions, all the above factors are very much present right now. We have seen a noticeable reduction in investment activity, capital raises have all but stopped, we are in the midst of a market correction, the federal government is reliably uncertain as to what they will do regarding cannabis, and the world is fraught with geopolitical tensions.

We are facing the perfect storm of factors that create a dry market.

What are the implications of a “dry market”?

A “dry” capital market can have several implications across various financial aspects.

Investment opportunities

Limited options: Investors might find fewer investment opportunities due to a lack of available assets or securities in the market. This scarcity can limit diversification and potentially reduce potential returns.

Reduced liquidity: With fewer buyers and sellers participating, securities become less liquid. This lack of liquidity can lead to wider bid-ask spreads and increased price volatility.

Borrowing and lending

Difficulty in raising funds: Companies seeking capital for expansion or operations might find it challenging to secure loans or issue bonds. This limitation can hinder growth and business development.

Higher borrowing costs: When the market is dry, lenders might demand higher interest rates or impose stricter terms due to the scarcity of available funds. This can increase the cost of borrowing for businesses and individuals.

Economic impact

Slowdown in economic activity: A dry capital market can lead to decreased investments in projects and businesses, resulting in a slowdown in economic growth and development.

Employment effects: Companies might delay hiring or even resort to layoffs if they can’t access funds for expansion, potentially impacting employment rates.

Regulatory and policy implications

Policy response: Governments and central banks might intervene by implementing policies to stimulate the economy, such as lowering interest rates, providing liquidity injections, or introducing fiscal stimulus measures.

Regulatory adjustments: Regulators might review and revise policies to encourage lending or investment, aiming to improve market liquidity and alleviate the dryness.

Investor sentiment

Risk aversion: Investors may become more risk-averse during periods of dry markets, preferring safer assets or keeping funds in cash or low-risk instruments until market conditions improve.

Long-term consequences

Market confidence: Prolonged dryness can erode market confidence, affecting not only current transactions but also future investments and the overall stability of the financial system.

Unfortunately, addressing a dry capital market often involves a combination of policy interventions, market adjustments, and shifts in investor sentiment. But this isn’t happening right now, so we have to deal with the market as it is.

Navigating acquisitions

The last question to be answered is: How does one sail in these unfamiliar waters? Navigating an acquisition in a dry capital market can be challenging, but several strategies can help structure a deal:

Alternative Financing

Explore nontraditional sources of funding such as:

Private equity/venture capital
Mezzanine financing: Use a combination of debt and equity financing to bridge the gap between senior debt and equity.

Seller financing

Negotiate with the seller for financing options. They might agree to accept payments over time (deferred payments) or provide seller financing, where they act as the lender to facilitate the acquisition.

Earn-outs and contingent payments

Structure the deal with earn-out provisions tied to the future performance of the acquired business. This ensures the seller receives additional payments if certain milestones or targets are met post-acquisition.

Joint ventures or partnerships

Consider forming partnerships or joint ventures with other companies to pool resources and share the financial burden of the acquisition.

Asset-based lending

Leverage the assets of the target company or your existing assets as collateral to secure loans. This tactic might be more attractive to lenders during dry market conditions.

Flexible terms

In a dry market, flexibility in deal terms becomes crucial. Negotiate flexible terms regarding price adjustments, payment schedules, or contingencies to accommodate the market conditions.

Strategic alliances

Explore alliances with strategic partners who might have access to different funding sources or who can bring synergies to the acquisition that make it more appealing to investors or lenders.

Seller consideration

Discuss with the seller the possibility of them retaining an equity stake in the acquiring company. This demonstrates confidence in the business and aligns their interests with the success of the acquisition.

Creative structuring

Consider creative deal structures that involve combinations of equity, debt, and other financial instruments to meet the funding requirements while addressing the risks associated with a dry market.

Adaptability and agility

Remain flexible and adaptable in your approach, considering the evolving market conditions. Being able to pivot your acquisition strategy based on market changes can be advantageous.

Acquiring companies in a dry capital market demands creativity, flexibility, and often a willingness to explore unconventional financing options. When considering how you and your team are going to survive in uncharted waters, it is best to have an advisor that knows how to navigate them.

Gordon Sattro has served as the Director of Nationwide Mergers and Acquisitions for Green Life Business Group since 2020.

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