Trends Watch: Cannabis Private Credit
- Mar 23, 2023
By Elana Margulies-Snyderman
EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.
This week, Elana talks with Bill Healy, Co-Founder, Silver Spike Capital.
What is your outlook for investing in cannabis?
We are bullish on cannabis senior-secured private credit. The risk-adjusted gross unlevered returns of ~18% are very attractive. The industry is growing rapidly (15-30% compound annual growth rate [CAGR] for the last five years and it is expected to retain this trajectory) and could become one of the largest consumer categories in the United States over the next decade. The cannabis industry has limited access to traditional sources of capital. While raising equity capital is highly dilutive at prevailing market valuations, operators are more receptive to borrowing at current levels to expand and, in some cases, make strategic acquisitions of distressed competitors.
Where do you see the greatest opportunities and why?
Given the industry’s lack of access to traditional sources of capital, lenders can demand senior-secured, first-lien terms with strong covenant packages and amortizations.
We favor vertically integrated, multi-state operators and companies with strong management teams and leading competitive positions in their respective markets. Efficient and well-capitalized operators are likely to thrive at the expense of smaller, inefficient, or failing operators in a competitive environment with reduced profit margins and expected consolidation.
Although the current imbalance in the supply and demand for capital is not expected to dissipate any time soon, even the most established operators need to secure funding for their working capital and expansion to meet industry demand.
What are the greatest challenges you face and why?
Operating management teams, as in any nascent and rapidly growing industry, are key to success. We spend considerable time and energy building partnerships with borrowers, educating them on the market cost of capital and how to interact with institutional-level capital providers. A main challenge for both operators and investors is the continued regulatory divergence between federal and state laws. Given the federal illegal status of cannabis, the industry is regulated at the state and, in some cases, local level. However, this regulatory complexity and fragmentation creates barrier to entry for new investors and contributes to a “cannabis risk premium” for lenders.
What keeps you up at night?
Given the considerable confusion and lack of understanding of the cannabis industry, educating prospective investors on why risk-adjusted returns in the sector are more attractive than traditional private credit and PE buyout strategies remains challenging.
The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.
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Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.
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