Cannabis

What to expect when getting your cannabis company ready for an IPO

For growing companies in the cannabis sector, doing an initial public offering (IPO) might appear to be a good strategy if you have outgrown your current financing options. IPOs can be an effective way to raise capital for innovation and expansion, especially in a resource-intensive sector such as cannabis. It does come with new requirements, however, as becoming a public company may mean changing corporate governance, and potentially reshaping corporate culture. It also requires an understanding of market conditions, and for the cannabis sector, those conditions are currently exceptionally challenging.

Going public is a major decision that reshapes not only how a company is funded, but how it operates. This is more than just “scaling up” – it is a strategic decision that can bring unexpected advantages and pitfalls. For the cannabis sector, there are unique factors that arise from fast growth and an evolving regulatory environment, as well as investor sentiment and general market conditions. Cannabis businesses that are considering going public should weigh their options carefully before making a decision. At a minimum, leadership should have a very clear understanding of why and how public ownership would bring value to their operations and have a vision for what a successful transition looks like.

Why IPO? Start with what ‘value’ looks like

Going public should be driven by enhancing value – and that value can take different forms. Is the objective to expand operations to new sectors and product lines, to fund operations, or to provide an exit to the company’s investors? All of those are good reasons for going public, but they bring different considerations at the planning stage.

To help ensure a successful IPO, cannabis companies should first determine the longer-term business strategy, and then define their funding milestones. This means they should define what the strategic milestones are, how much funding is required at each stage, and allocate the planned capital raise to specific objectives in a pre-determined timeframe. The purpose is to match the path to growth with the capital being raised in the IPO. If the path is set out in a detailed way, and the planned capital raise is allocated to specific strategic milestones, then the IPO is more likely to be successful.

Investor expectations

If the company is planning an exit because of a pre-existing commitment to investors, the transition to a new corporate structure or funding model should be as smooth as possible and should not impact operations. In this scenario, it is still imperative that leadership articulate a specific and credible plan for how the business is going to be sustained post-IPO.

Have you considered alternatives to an IPO?

Given the current market environment, cannabis companies seeking growth funding might also want to consider other options, such as late-stage venture capital or strategic partnerships. For some, these might provide more favourable conditions and long-term outcomes than going public in this challenging environment.

The cost of public transparency

Public companies must be more transparent than their private counterparts, because they have accepted money from a broad group of retail investors. They are subject to ongoing disclosure requirements and are generally answerable to a larger group of stakeholders than privately-held companies. Business challenges, when they arise, require more time and effort to respond to as there will be a broader group of investors to communicate with and manage. Share prices may become volatile and remain so until they are resolved.

The cannabis market is facing  headwinds, as certain IPOs were met with difficult market conditions in 2019. The high-profile listings of Aurora, Canopy Growth and Tilray have all faced volatility in 2019, partly due to supply and distribution concerns. This was followed by class action litigation in the U.S. involving all three producers, as well as other major cannabis producers in Canada. Each producer is alleged to have overestimated demand for their products, and overstated their revenue projections in regulatory filings.

Another challenge faced by the sector is cautious investor sentiment. Most buyers of cannabis stock have been retail investors who, unlike institutional investors, are more likely to sell their stock in response to short-term market conditions.

The challenging IPO environment isn’t limited to cannabis companies. Although the regulatory environment in the cannabis sector is unique, broader market conditions might also be impacting IPO pricing across all sectors. There have recently been signs of concern across the market at the number of unprofitable companies seeking to IPO, and the valuations of those companies.

Managing the IPO process with minimal disruption

Before filing an IPO in Canada, a company must have a minimum of two years of audited or auditable financial statements under International Financial Reporting Standards (IFRS). Once this information is available, the IPO process typically lasts three to six months.

While this might seem like a short period of time, it is very resource intensive. Total documentation is at least 150 pages of technical financial and legal information, including annual and interim financial statements, management discussion and analysis, a plan for raising capital and a plan for how this capital will be spent. Because of the amount of financial information involved, this is often a CFO-led process, but it also draws upon other C-suite resources.

A strong leadership team is essential

Companies contemplating an IPO should also be prepared for the demands this will place on their whole executive team, and plan for this disruption. If the management team has no direct IPO experience, they will likely work more closely with professionals such as legal counsel and accounting advisors. Even if they have never managed an IPO before, they should have a strong background in financial management, governance and business administration. Entrepreneurs often bring a diverse skillset, such as technology and engineering, however in the context of an IPO, it is imperative that the management team has skills to manage a public company.

Professional advisors help maximize value

As the IPO process can be complex and time-consuming, professional advisors can help you make sense of your financial and market picture, maximize your value proposition and minimize any disruption on operations. Experienced professionals can also help ensure that IPOs support company strategy, while setting achievable objectives for growth.

Although market conditions remain challenging in the cannabis industry, there will be room for growth for companies with a sound value proposition. Your Grant Thornton advisor can help you determine whether an IPO is the right next step for your company and unlock new opportunities.