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05 Sep Getting High on Marijuana RTOs

There have been an overabundance of marijuana RTOs in the news lately. So much so that the SEC has even issued a warning regarding investing in these securities. Additionally, many of the shells (both manufactured and otherwise) are explicitly restricting investment in marijuana or cannabis-related businesses. We ourselves will not get into this arena–for numerous reasons. Here are a few reasons marijuana-related reverse mergers represent a high risk for investors and the public at large.

Legality Outside the SEC 

Some pot-centric businesses are not even legal. The SEC may issue the green light on a reverse merger with a business focused on Mary Jane, but that doesn’t mean the business has the green light from other laws. The issuance and dealings of securities is what the SEC is for. They don’t enforce other laws (e.g. The Controlled Substances Abuse Act) with which any cannabis company may be required to comply. And because the market penetration or acceptance in other states may be slower and less rapid than many marijuana companies hope, we may actually see a great deal of money move out of such investments in the short term only to come back later when the recreational use of pot becomes more widespread and across many more jurisdictions.

Typical Reverse Takeover Schemes & Microcap Issues

Two things trouble me about the rise of marijuana business operators. Like cigarettes or alcohol, there could be questionable morality issues in general relating to such deals, combine that with the typical taints of reverse mergers and you’ve a very gasoline and fire combination. For instance:

  •  Pump-n-dump schemes have already been reported with promotion outside what is considered clean and legal in the eyes of the SEC.
  • The public float is low and insiders own large amounts of stock. The millions raised in such RTOs is typically going to a very small block of shareholders.
  • Untested business models and roll-ups of businesses have large amounts of risks involved. That also means much more volatility in the price of the stock.
  • If the company is on the Pinks or the OTC, it may be more difficult to get enough investment information to make a truly informed decision about the character of the business and its performance.
  • In some cases, the stories of such companies are over-touted by their own internal Investor Relations and marketing. This is by design as it will typically lead to more investment and a higher valuation.

 

Risk/Return Tradeoff

No doubt this is a growth industry with nothing but upside potential. Consequently, there will be many who’ll be “flying very high” (pun intended) for their investment risk in pot companies. The CannLabs, Inc. deal saw substantial returns for the new owners who ended up with roughly 85% of the stock. In particular, the convertible preferred shareholders made out very well. When the stock peaked a small original investment before the company went public would have been worth about 40x. Not bad, but that reward comes with a substantial increase in risk.

My personal feeling is that, some shells are dirty enough with litigation and liability that sticking a cannabis business into the shell only makes things more tainted.

Big bets are being played in this space as a land grab ensues–the assumption being that now that Colorado and Washington have legalized that a more ubiquitous and widespread acceptance of the recreational use of pot will soon ensue. If you’re going to drink the Kool Aid–or in this case–take a hit be sure you know the risks before you get high on something that may already be overly inflated.

 

 

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.