Seasoned Executive and CRO
Canada’s cannabis industry is starting to experience growing pains. It is grappling with a lack of capital, a mismatch in supply and demand, and many of the other challenges that can be expected in a nascent industry.
Howard Steinberg, a seasoned executive and CRO focused on change management and who has been in the cannabis industry for many years, recently sat down with us to chat about market conditions and a recently completed restructuring in the space.
1) The CCAA restructuring of James Wagner Cultivation was one of the first in the cannabis space and arguably one of the most successful ones. Can you give a brief overview of the factors leading to the CCAA filing, the key aspects of the restructuring, and how the company has performed since exiting creditor protection?
The need to seek creditor protection was attributable primarily to a lack of capital to support the ongoing operations of the business. Despite raising a significant amount of money since its inception, the business was still nowhere near profitable and was hemorrhaging cash. The company’s major issues were its grow system, the types of strains being produced and the composition of the senior leadership team.
If we take it one step further, the above issues were likely caused by an inexperienced management team that didn’t appreciate JWC’s position in the sector and the resources required to create a successful cannabis company. This is a common problem with companies in the space: managers with little business experience are given vast amounts of capital to spend as they wish in a new sector that few have any real experience in.
Ahead of JWC’s formal CCAA filing, work was done to align the company, management and the company’s senior secured lender, Trichome. I was retained as CRO early in the process. There was agreement among these stakeholders that the business needed to be recapitalized and that the only way to do this was through a formal restructuring process. Trichome agreed to fund the process through a DIP facility, and also stepped up as the stalking horse bidder. The professionals and Trichome believed that a stalking horse process would provide stability to the business during the restructuring process as there was certainty that the business would continue on a going-concern basis upon completion of the transaction. It also allowed discussions to take place at the outset of the process between the Stalking Horse and Health Canada as to how the cannabis licenses could be issued to the purchaser without any disruption in the operations of the business.
Concurrently with addressing the need for new capital, we also used the time under creditor protection to address the company’s operational issues. A team of consultants was brought in to do a deep dive on the viability of the business and determine what steps needed to be taken to turn the business around.
This analysis gave the company a clear picture of its operational issues and a road map of what needed to be immediately addressed upon exiting the CCAA process.
By all accounts, the CCAA process was a success. Thanks to the high degree of cooperation among all the key parties involved we were able to complete the whole sale process within the expected timeline of less than 90 days, and at a reasonable cost. We were also able to begin executing on the operational fixes that were identified in the CCAA process, which provided us with the foundation to complete the restructuring once the sale closed.
Approximately 18 months after exiting the CCAA process, JWC’s products have become the 10th highest selling brands across all sales on the Ontario Cannabis Stores. Our products are now distributed coast to coast and even made their way into the Israeli market, where they sold out in a matter of weeks. We are now one of the leading premium house of brands in Canada and are in the enviable position of needing far more grow capacity than we have available.
2) What does a good team look like to lead a successful restructuring in the space, and what is the role of each?
In our case, the board of directors, the CCAA monitor (KSV), the various lawyers (Bennett Jones, Davies, Torys and Brazeau Seller) and consultants all understood the strategy for the restructuring and the contemporaneous business review. Each party worked together from the outset to give the business the best prospect for long-term success.
Specifically regarding existing management, the goal was for the various departments to act as one under a unified culture and communication based on transparency, openness and intense debate. Creating an environment of that nature is founded on trust, which takes time to build.
Today, senior management fully understands that decisions are team-based and involve members from every department to ensure that the best decisions are made and that the team is accountable for execution. Diversity of opinions is key to making this work. Leadership is comprised of people from different parts of the world, and women occupy a significant percentage of senior management.
3) Reverse vesting orders are being used extensively in insolvency proceedings these days, including many in the cannabis sector to deal with restrictions on license transfers. You’ve mentioned that there are still nuances and sector specific issues that must be dealt with to do an RVO in the cannabis space. Can you expand on this?
While RVOs can facilitate the licensing process with Health Canada, in fact, at best it may only marginally shorten the process while creating other potential problems, not the least of which is the limited ability of licensed producers to bring in new strains of cannabis.
Health Canada requires directors, officers, partners, key personnel and anyone that exercises or is in a position to exercise direct control over the corporation to be security cleared. Once clearance is complete, Health Canada reviews the individual’s application. None of this can be avoided by a RVO.
Putting aside any legal issues related to RVOs, the insolvency process provides licensed producers a one-time ability at the time of the application process to bring in new strains from non-licensed entities. Once the license has been granted, producers are limited to obtaining strains from other licensed producers who have little interest in selling their top strains to their competitors. Pursuing a RVO prevents augmentation of the strains, and therefore, a purchaser who uses the RVO process is limited to the strains of the acquiree or to acquiring strains from other licensed producers. New strains are a key for success, as they allow producers the flexibility to grow what the market wants today and into the future.
While the stalking horse process did result in a delayed closing until the licenses could be issued to the new entity, it did not derail the transaction, and using an RVO process would likely have had the same issues, particularly concerning the diligence performed by Health Canada on the new board members in the context of security clearances.
We engaged with Health Canada early in the process through counsel specifically retained for this purpose so that Health Canada would be able to work cooperatively with us to effect timely issuance of new licenses and related approvals.
4) Was there any aspect of the insolvency process that was unexpected to you? Or frustrating / inefficient?
The licensing process for the new entity and inventory transfer, both overseen by Health Canada, was complicated as we were the first to use a stalking horse process to effect the license transfer process. As a result, Health Canada appropriately had several questions. Ultimately, working hand in hand with them, we completed the transactions, on a relatively timely basis. Because we had anticipated this risk in advance, we had a transition plan in place, and accordingly, the delays securing the licenses did not affect our business and operational plan.
5) What shape is the Canadian cannabis sector in right now? What type of companies in the sector are facing headwinds and what are the common issues?
The growth in the Canadian cannabis market is expected to continue over the next 5 years from 2021 levels of $4.4 billion to 2027 levels of $8.8 billion. While a rising tide lifts all boats, domestic producers are burdened with significant excise tax, provincial mark ups and an inability to grow premium product.
This is leading many to sell below their cost of goods sold. For those that can produce premium products (loosely defined today as products containing a minimum of 24% THC), getting to market is a daunting and costly affair. First they have to convince the provinces to list their product, and then they have to convince consumers to purchase it. This has pushed many to sell on a B2B basis while exploring ways to export to countries like Israel, the UK and Germany. Exporting product has its own set of challenges. The biggest hurdle is the time it takes to land the product in the destined country. The lengthy shipping times create working capital issues, as most payment terms are linked to landing the product.
There is no easy answer. Over capacity/supply exists in the value or lower price segment of the market while limited capacity/supply exists in the premium or higher price segment of the market. And this all assumes that producers have won the battle against viroids, viruses, pathogens and pests. The adage that growing marijuana, especially indoor, is as easy as growing weeds in your garden is proving not to be accurate!
Retailers are not faring much better. Competition continues to heat up, especially in urban areas. Larger chains and provincial online listings dominate retail sales and are only getting further entrenched as consumers better define their preferences and no longer explore retail locations owned by mom and pops.
6) What do you predict for the industry in the next 18 months?
As in any new and growing market, consolidation is at play in the cannabis market. In recent months, we have seen companies like Canopy Growth Corp. snapping up Supreme Cannabis Inc. and Aurora Cannabis buying Terrafarma Inc. (parent to Thrive Cannabis), both in an effort to revitalize the purchasers’ premium offerings. We have also seen Sundial purchasing Spiritleaf in an effort to vertically integrate into the retail sector.
Many more will face an even more difficult road than the past as the capital markets have lost faith in the industry, making raising fresh money a difficult endeavor even for those that are executing successfully. The industry is in for a rocky road over the next 18 months as it tries to find a balanced state. This will undoubtedly lead to busy times for restructuring professionals.