Most IPOs are of young, fast growing companies. As such, going public demonstrates a meaningful milestone in the development of a business and prospects of even greater future success.
The business equivalent, if you will, of a Bar Mitzvah.
Okay, maybe on the day I became accepted among my co-religionists as a “man” I wasn’t yet able to drive myself home from the party or order a drink at a bar, but the path from age 13 to adulthood was at least discernible. The child is, after all, the father of the man, as Wordsworth first said (and the Beach Boy’s Brian Wilson covered).
Same too, with most companies when they reach the IPO stage. Generally, up until the Internet bubble, enterprises seeking to go public needed to convince investors that they were on a clear trajectory to over $100 million in revenues, and if not currently profitable, at least getting close.
Then a massive slew of money-losing dotcoms came along, with a message to sceptics, who wondered why they didn’t generate any profits and had no immediate plans for doing so: “you just don’t get it”, which could be regarded as the “OK, boomer” slogan of tech entrepreneurs circa 1999. Delivering positive net income was your grandfather’s quaint idea of success. The world had moved on to a more sophisticated level of valuation: clicks, not profits.
Then the tech bubble popped. While tech valuations eventually recovered and then some, higher standards for IPOs remain (see: WeWork). Newly minted public companies are still smaller and represent greater risk than members of the S&P 500, but on balance they are bigger and further along in their development than their late 1990’s brethren.
With one glaring exception: cannabis.
There always was a backdoor to going public, the “RTO”, or reverse takeover. RTO’s, when I started my career at a big Wall Street firm, were regarded as a gimmicky type of transaction, a shortcut for companies who couldn’t “really” go public via the conventional route, and the transaction never lost that stigma (at least among mainstream businesses).
What makes RTOs possible? Once a company succeeds in completing an IPO, even it if eventually fails, there may be economic value to maintaining its public registrant status as an empty “shell” company. Rather than file for bankruptcy and liquidate, the board might decide to keep a little bit of cash on hand, pay some modest accounting and filing fees every year (maintaining the books isn’t that hard when there isn’t an underlying business to keep track of), and retain the option that someday, in the fashion of Dr. Frankenstein, they might someday inject new life into an otherwise dead body.
Then a few years ago cannabis deregulation gained footing. A new type of investor-backed company emerged, with urgent funding requirements, but which leading Wall Street firms wouldn’t be caught in the same conference room with.
RTO: meet cannabis.
The business logic was compelling. Buy a mining shell listed on the Canadian Stock Exchange for a couple of million dollars, lift up its lid, deposit a cannabis company into it, and then go out and raise as much money as you can, as fast as you can.
The investors in the first raises for these cannabis RTOs, typically private placements of around $2-3 million, were individual angels. These intrepid souls made a fast return, which they used to cycle into the more private placements, which again made them a fast return, and much joy ensued.
Then starting in about mid-2019, economic reality hit. In business, the wheels of finance may grind slowly, but they grind exceedingly fine. Most of the cannabis companies who took the RTO route to the public markets have proved to be unprofitable, even if managements lifted revenues up to otherwise impressive levels. As of this writing, the vast majority of actively traded RTO cannabis companies have yet to convince investors they are on a path to near-term profitability.
But hope remains. The Bar Mitzvah boy in those Kodachrome photos with the faint wisp of a mustache did indeed become a man (of sorts).
However, it took a while.
Cannabis is in the early stages of a generational transformation into a trillion-dollar industry. Eventually, regulations will catch up with economic reality.
As cannabis companies become regarded as more conventional, then conventional financing mechanisms will become more available.
Just like today I can walk into a bar and order a drink.
Like a real man.
Ed Harris is the CEO and co-founder of Pacific Growth Capital, which operates the Spark® Deal Room. Originally from New York, Ed now lives in Seattle with his family, where he enjoys the scenic beauty and slower pace of life that the Pacific Northwest offers. He does, however, forbid his children to root for any professional football team other than the NY Giants, and misses the pizza.