As featured in Benzinga.
Public cannabis equity fell in excess of 50% in 2018 and has lost another 35% this year, with the peak-to-trough decline exceeding 75% on an index basis. Going public has traditionally offered significant advantages to companies in the form of cash infusion, shareholder liquidity, access to future capital and an increase in stature. Investors, however, may be surprised to learn that the number of public companies in the United States has fallen over 50% since peaking at 7,322 in 1996. This phenomenon is also seen across other developed nations such as Germany, Canada, Singapore, Switzerland and the UK; each of which has seen a 20-60% decline in public listings over the same timeframe.
While public companies have enjoyed many advantages since the listing of the Dutch East-India company in 1602, disadvantages to a public listing abound and include increased costs, regulatory compliance, structural changes and the inevitable myopia created by stock price hyper focus. The latter may explain why a number of visionary cannabis founders have recently been replaced by financial professionals charged with stabilizing and raising company stock prices.
Permanently under construction: road to success.
Advantages of going public include:
Cash Infusion: Going public often results in an immediate and significant infusion of cash that can be used for a variety of reasons. We witnessed a significant rise in M&A activity as cannabis companies flush with cash and rich equity were able to boost growth via acquisition.
Shareholder Liquidity: Founders, employees and pre-IPO investors can sell shares (usually after a lock-up period) in the public markets, providing liquidity and the potential for outsized returns to early risk-takers. The delta between public and private equity values makes pre-IPO investing attractive, and the cannabis space afforded large returns until the recent public market revaluation.
Established Value: Daily trading establishes real-time value for companies, value that can be used to make stock-based acquisitions as well as to attract and retain top talent.
Capital Markets Access: After twelve months of being public, companies in the U.S. can engage in follow-on offerings using a short-form registration process and thus access capital markets with reduced time and expense.
Improved Stature: Public companies are perceived as a better credit risk and enjoy greater recognition in the marketplace. These qualities often provide a competitive advantage. While fewer than 1% of cannabis companies are public, they cast a long shadow evidenced by the capital hangover driven by their stock price malaise.
While these advantages are significant and merit careful consideration, there are also several disadvantages to a public listing that in the past two decades have led to a meaningful reduction in listings as witnessed across several developed markets around the world. These disadvantages primarily include cost and time along with the loss of confidentiality, flexibility and control.
Disadvantages of going public include:
Direct Cost: The average cost of going public in the U.S. can exceed $1,000,000 in one-time expenses. Initial costs include legal and accounting fees, FINRA filing fees, exchange fees and underwriting commissions which average 6% of company value on the day of listing. The annual cost of remaining public hovers around $1,500,000 and is comprised of fees related to accounting, legal, compliance, insurance, director compensation and investor relations. Non-U.S. listings and reverse take-overs (RTOs) can often be far cheaper, a factor that has driven much of the public listing decision-making in the cannabis industry.
Indirect Cost: A public listing can take anywhere from 6-24 months with a significant amount of management time consumed in the process. This is a large distraction from running company operations and an indirect cost to corporate health. Public company management can easily spend 25% of its time on activities related to being public, which itself represents a large and ongoing indirect cost to the business.
Corporate Governance: Major exchanges require that boards be comprised of a majority of independent directors who have oversight on auditors, set executive compensation and oversee litigation issues. Company founders often have a difficult time answering to independent directors, and recent cannabis management turnover is emblematic of this commonly experienced corporate friction.
Loss of Confidentiality: Public companies are required to release all operational details to the public. These releases often contain sensitive information related to profit margins and future plans, and can lead to untold issues as employees, investors and competitors alike become privy to a company’s inner workings. In the public cannabis space, the large delta between projections and realizations has contributed to equity valuation rationalization.
Stock Price Focus: This is perhaps the biggest cost of being public as management becomes judged and rewarded by its stock price. This is justified as falling stock prices often lead to hostile takeovers, shareholder lawsuits, loss of confidence and management turnover. We have seen much of this in the cannabis industry, and the inevitable sacrifice of macro vision and long-term strategy for decision myopia and quarterly results can pose a significant drag to long-term value creation.
Going public can have many positive effects on corporate balance sheets and competitive positioning, and can also drastically change corporate culture with ongoing impact to business operations. The decision to go public is a major one and must only be made after carefully weighing the pros and cons as well as reviewing private financing options. The advantages of cost savings, confidentiality and long-term focus often outweigh the difficulty in obtaining growth capital in private markets, and the cannabis industry is no different. While the federal-state conflict does create temporary financial constraint, increased participation from family offices and venture capital funds will continue to help fill this capital gap. Cannabis is a classic emerging market and will emerge stronger and more resilient as it traverses the rocky trail to maturity.