By Amith Arcot, Associate
According to recent estimates, the size of the global legal cannabis market may exceed $110 billion by 2028. Despite significant progress towards the legalization of cannabis at the state and local level in the United States, legalization efforts still face a variety of hurdles at the federal level. Due to cannabis’ status as a federally controlled substance, U.S.-based companies that are directly involved with marijuana by way of “touching” the cannabis plant through cultivation, processing, or the sale of cannabis and cannabis-infused products, are still unable to list their shares on U.S. public markets such as the New York Stock Exchange or NASDAQ. As a result, many major players in the cannabis space have continued to look to our neighbors to the north for an opportunity to dispense their shares to a wider audience.
Canada legalized the recreational use of cannabis in October 2018 through Bill C-45, the Cannabis Act, which was followed by a flurry of new cannabis company additions to Canada’s stock exchanges. While a traditional IPO on a Canadian market remains an option, many of these green companies have opted for a non-traditional approach to offer their shares out to the general public through a reverse takeover or RTO.
An RTO is a process by which typically a smaller private company can list their shares on an exchange by taking over a larger publicly traded company already listed on a stock exchange. Often confused with SPACs, RTOs do not involve a shell company going public with the goal of later acquiring a private company. Generally, during an RTO, the private company will approach a public company, buy up enough shares to control that company, and then exchange its own shares for shares in the public company. Following this exchange of shares, while not required, the public company typically changes its name to its new acquirer and the private company has effectively listed itself on a public market. Unlike a traditional IPO where the primary purpose is capital raising, an RTO does not generally include an equity financing component and thus is primarily used as a vehicle to provide shareholders with greater liquidity. To date, a number of U.S.-based cannabis companies have used RTO mergers to go public in Canada, including Curaleaf, Green Thumb Industries, Verano Holdings, Nextleaf, and MedMen.
Benefits of an RTO
In addition to providing shareholders increased liquidity, there are a variety of other advantages associated with RTOs as opposed to traditional IPOs. On average, an RTO is a much cheaper, faster, and more efficient method of providing public access to and liquidity for your company’s shares. Additionally, because RTOs generally lack an equity financing component there is less need to continually monitor market volatility, thus lowering overall execution risk. Notably, regulatory review of an RTO typically involves oversight solely by the stock exchange rather than a securities commission.
Moreover, because going public generally accelerates company growth and compliance considerations, companies that choose to use RTOs as their vehicle for public offering can take advantage of preexisting vendor, business, employment, and compliance relationships their target company has already cultivated, thus lowering barriers to entry and greatly reducing friction associated with taking a company public. Furthermore, unlike a traditional IPO which requires filing a prospectus, an RTO typically does not, shielding directors and officers from potential prospectus liability relating to misinterpretation of information contained in an investment prospectus. Lastly, since no equity needs to be raised for an RTO, shareholder dilution can be kept to a minimum.
Important Factors Private Cannabis Companies Should Consider
While there are a number of benefits that cannabis companies can enjoy via a public offering by RTO, there are certain factors that savvy cannabis companies must keep in mind in order to flourish. Private cannabis companies that perform inadequate due diligence beforehand can become subject to a variety of liabilities. Ensuring that a target company is free of legal, environmental, government, labor, and other liabilities is a prerequisite for any cannabis company craving a public offering.
Additionally, instituting a lock-up period can also protect cannabis companies from a material share price decrease in the event that the target company’s shareholders sell their shares following the merger. Furthermore, because RTOs involve merging two separate entities, a plan for corporate restructuring post-closing for tax purposes is something private companies should bear in mind as they take a plunge into a public market. Because RTOs in the cannabis space involve cross border mergers, cannabis companies must consider how their corporate structure will interact with a foreign tax jurisdiction and therefore may need to contemplate restructuring in order to decrease their tax burden and other costs while increasing overall efficiency. Lastly, as noted above, cannabis companies looking to go public in order to raise funds should consider alternative options as the primary purpose of an RTO is share liquidity rather than capital raising.
Barton LLP’s stable of experienced attorneys has broad-based experience in the areas of reverse mergers and alternative public offering transactions. Engaging experienced legal counsel at the outset can allow your cannabis company the opportunity to confidently navigate around many of the pitfalls a company may find themselves falling into when offering their shares to the public. Should you have any questions or require additional information relating to RTOs, mergers and acquisitions of any other type, alternative public offerings, the tax implications thereto, or any other issues related to cannabis legalization, regulation, licensing, sale, or other ancillary services, please feel free to contact our Cannabis Law Team.
