Cannabis Capital Podcast

Transcript

Ross O'Brien  00:16

Hi everybody. Welcome back to another episode of Cannabis Capital, the podcast. I'm your host, Ross O'Brien, founder of Bond of Venture Equity venture capital fund author and interested in all things entrepreneurship. These conversations are exciting. We want to share with you the thought leaders who we get to meet in our daily practice and talk about a lot of the current trends and dynamic things that are happening in the world of cannabis. So I'm really excited to welcome today also a founder and fellow financier in the cannabis world, Steve Ham. Steve is the founder of Altmore. Altmore is one of the preeminent Altmore Capital is one of the preeminent lenders in the cannabis space and has been around since 2017 doing some really interesting things. So, Steve, welcome to Cannabis capital the podcast. Thanks for being here today.

Steve Ham     01:03

Ross, thank you so much for having me on. Really excited to share the next 35 40 minutes with you, talk about some interesting topics.

Ross O'Brien  01:12

Great, well, really appreciate you taking the time and I think we'll have a lot in common and a lot of different perspectives on the space which should be exciting to dig into. So maybe the place to start would be steve, tell us a little bit about the firm and your background. And you've been at this for a while. So how did you find your way into the cannabis arena?

Steve Ham     01:30

Yeah, so before I founded Altmore Capital back in 2018 with my partner Patrick Kim, I was in private equity for about two decades. So I cut my teeth in private equity through Carlisle and also founding another private equity fund with one of the owners of an NFL football team. Back in 2017, I actually stumbled upon the cannabis industry really through a person that I know. And it was one of those moments where you rarely walk into a situation where an industry is nascent and you can see the demand side of the equation already pretty much solved. So really through the legalization process, you're really transferring what is an illicit demand into the illicit demand. And obviously that process is long and arduous. But really having one side of the equation solved is a pretty interesting way to invest in what's going to be 100 billion dollar industry. Back in 2018, I teamed up with my partner Patrick Kim and really thought about a way to invest in an industry that's fairly nascent but also very dynamic and somewhat topsy turvy. We thought equity strategy was a little more risk than our risk appetite would allow. So we decided to invest through debt. So we made our first investment early 2018. Since then, we have not looked back and we stuck to our knittings. So we've been doing this now going on our 6th year. We're going to stick to our knittings for the long term.

Ross O'Brien  03:16

Well, I really like that. I find myself saying we're sticking to our knitting a lot as well. It's interesting. I mean, our process was similar and we wanted to stick to the seed series, a arena and healthcare that we've had experience in. So when you were looking at the risk profile of debt versus equity versus late stage versus early stage, I'm sure you looked at public securities as well. What were some of the things that you were seeing six years ago? How did they play out and what did you get right and what did you get wrong?

Steve Ham     03:46

Yeah, so six years ago was still fairly early. I would say that was almost like inning one of a nine inning baseball game. So then very few companies had any revenue, so it was pre revenue investment. So in order for us to get comfortable, we had to collateralize some assets. Maybe they weren't producing any revenues yet, but they still had kind of implicit value attached to them. A good example of that is a limited license that we were structurally able to collateralize. You weren't able to directly UCC those licenses, but you can structurally do that. So we figured that out. That took a while for us to figure that out, but once we figured it out, we felt comfortable enough to move forward with a fairly sizable loan. That investment turned out very well, but I think some of that had to do with luck, some of that had to do with some early due diligence that we did right. But what we learned over the last five, six years is we don't know everything right. So we try to do as much diligence as possible and we have to have our heads on a swivel. So if some things occur that we didn't expect, we have to be nimble and we have to have a team that can respond to that unexpected event. So what Pat and I spend a lot of time on is really building a team that can support in that type of kind of situation. And I think cannabis is unique in that sense that it's not only the most heavily regulated industry in the US. Perhaps in the world, but also it's fast growing as well. And on top of that, it's really working with 40 different markets. Right. Because each state has its own regulatory regime, it has its own state specific regulations that doesn't really transfer at all to any other states. So because of that, it is very complicated, especially if you're underwriting a credit that has multiple geography operations. So we have invested into a company that has ten different state exposure. It's almost like doing ten different diligence for that one credit. So it is very complicated from that perspective. But I think that also gives us a pretty good moat because one of the kind of more frequent questions that we get from our investor base is that, hey, if federal legalization takes place, aren't you going to lose a lot of your potential loans to a bank? My theory on that is, to be honest with you, I think it's just too much of war for a lot of banks to really underwrite. Right. They're great at real estate underwriting and things they know how to do well. But underwriting ten different states, to put out one loan, I think is something that's probably beyond what they want to do. So I think this is really a specialty financing type of situation. So I think as long as we stick to our knitting and then do a great job underwriting, I think we'll still have our moat, even through federal legalization or different types of regulatory changes at the federal level.

Ross O'Brien  07:25

So, Steve, you mentioned looking at licenses as an asset that you can collateralize. Is it your view then? That a couple of questions on that. So one, is it your view that understanding the value of that asset is nuanced and a sort of bespoke skill set? And the second part of that is what happens? Have you had a situation not on specifics, but are you assuming if you had to assume a license, if somebody was tripped up their covenants and you had to go after assets to recuperate your investment, is it about disposing of the asset to another operator? Is it about taking over operations yourself? One of our perspectives was actually the antithesis of this is that we said early on, as venture investors, we do not want to invest in non operating assets.

Steve Ham     08:16

Right.

Ross O'Brien  08:16

We invest in teams and people. So the licenses don't have value to us from our underwriting process unless there's a team in place that can operate it. So what have you learned in that dynamic, using that as part of your underwriting?

Steve Ham     08:30

Yeah, and I think this is where cannabis investing becomes more complex than perhaps other industries. That license value really depends on the state in which you you know, I think a good example is a cultivation license in, say, Oklahoma has very little value versus a cultivation license in Ohio. For, you know, rather than having a view of collateralizing the license, I think really we take a view that having the license that can be at least collateralized structurally, so that we have some hard assets that we can monetize or at least have some value against as we underwrite these deals. So I think that Ohio is a great example. In Ohio, you're not able to collateralize the license over there, but you can do it in a structural way where we felt we were mitigating enough risk for us to invest into that particular operator against the returns that we were getting. Luckily for us, it actually worked out very well for us. But obviously the license itself really has everything to do with how the regulatory regime is in that particular state. And it's really all about unlimited license versus limited license. There are some in between as well, definitely.

Ross O'Brien  10:07

So one of the things you mentioned as well was being heavily regulated? I would question are we currently heavily regulated or is the heavy regulation yet to come? And from your vantage point, as you've been watching this over the years, what have you seen happen on the regulatory side? What do you think will be happening on the regulatory side? Do you have your lender crystal ball that you're looking at for the next kind of three to five years that you're tracking some signals coming out of the states or at the federal level?

Steve Ham     10:42

Certainly I don't have an answer for you. It's a difficult, loaded question to answer. But what I do think is, at least in the near to medium term, I think there isn't going to be a lot of big changes that's going to know we're based in DC. So we do talk to a lot of lobbyists and people on the Hill. And because of the political kind of climate in the US is such that we don't see a lot of large headline changing changes coming up anytime soon. There might be some regulations that may pass, something like Safe Banking Act and such, so they will perhaps solve some issues around the fringes. But federal legalization really isn't, at least in my perspective, something that's in the near term. So I think that'll take five to ten years perhaps to get through. And I think because there's so many different facets of that federal legalization exist, it's not one thing if you change one thing, there's a lot of knock and effect as well. So the lawmakers are considering all the facets, and this is a very broad legal issue that's going to have to go through a lot of different committees and as well as different discussions before it gets changed.

Ross O'Brien  12:10

From our perspective, we tend to just dismiss federal legalization as kind of ever being a thing. We're much more on the healthcare side, life sciences side, as opposed to recreational. So for us, rescheduling versus legalization is meaningful. One of the concerns we had early on was how high these valuations were for a lot of these companies and this sort of like exuberance of the green rush a few years ago, and we're still seeing it today. And a lot of that took on this tenor of pricing in the inevitability of federal legalization, meaning that you're already adding that into the valuation of the company today. So if it was to happen, where's the arbitrage? Right? So from an investment standpoint, we're like, okay, it would be nice to have, but not a need to have if you underwrite. And underwriting is different for you as for us. But we use the same terminology, right? So when you think about the things like Safe Banking Act and 280 E from a tax standpoint, it would appear and tell me if this is still the way things are shaking out, but it would appear that banks are still reluctant to bank on a broad scale, certainly to anything that touches the plant. 280 e has a massive drag on net income. I e paying your taxes versus acquiring through growth or reinvesting to grow an organization. And so are you seeing more competition or more competitive terms coming in? Are more banks coming in on a more traditional basis, or is this still pretty wide open for you guys to kind of pick the cream of the crop?

Steve Ham     13:43

Yeah, I don't see a lot of banks coming in at all. I think this was my hypothesis, call it three, four years ago. If the banks were to come in, I think they will come in at a local real estate level. So 30 year mortgages and whatnot.

Ross O'Brien  14:00

And I think over the last two.

Steve Ham     14:03

Years that's basically proven to be right. There are very few, if any, banks doing a cash flow loan. And that's kind of where we thrive and that's kind of our bailey wick. So our typical borrowers are minimum, call it $30 million in revenue with typically 20% EBITDA margin. And they have cash flow to grow their business, but not enough to expand and have a transformative expansion. So that's where they come to us for that transformative capital. So typically the loan proceeds are used to double their size, whether it's cultivation or retail footprint. And over the next twelve to 24 months, they typically deleverage significantly through the growth. So that's kind of how we look at it. And we really don't see a lot of banks coming in and competing with us or providing term sheets to our prospective borrowers. Even over the last quarter or so, we've seen other cannabis focused lenders actually leaving the space. Right. So we've seen a few of those happen over just over the last month and a half. So I think the competition actually has gone down and the industry is still growing. So I think from kind of how we look at the space, there are still seven to $8 billion worth of projects that can be financed. And I'm just talking about the middle market of the cannabis industry. Perhaps call it maybe a billion dollar, maybe a little bit more has been funded. So people ask what happens to those six to $7 billion that are not being funded? Well, they're just waiting. Right. So a great example was Missouri, for example, during the pandemic, obviously the capital did not flow to this industry as quickly as people anticipated. So a lot of the Missouri operators were not able to open their cultivation as well as retail as quickly as the regulators wanted. So as a result of that, a lot of them, their licenses were either revoked or were transferred to other people who were opening them. So that is typically kind of flavored du jour in cannabis. Hopefully some regulation or some catalyst happens in the cannabis industry with regard to regulation, so that more capital comes in. I think that'll help everybody in the.

Ross O'Brien  16:46

Industry, including us that makes a ton of sense. And with respect to the types of founders and teams that you work with, we always talk about how important it is that we back people as much as anything. For those folks that may be hearing this and just being introduced to you for the first time, a, what sort of advice do you have for founders that are out there or folks that are operating in this space if they're looking for alternative sources of financing? And who are the types of teams and what does a relationship look like with you and your firm over time if you have somebody in your portfolio?

Steve Ham     17:21

Yeah, I can't emphasize this enough. I've seen so many companies that start off with the capital structure being upside down. And what I mean by that is because the capital in the cannabis industry is so hard to come by, they actually over leverage. And because of kind of the dynamic nature of the market, things move very fast here. So the expected cash flow to support the debt may or may not be there. Call it three, four quarters from now. So it is hard to raise equity. But I tell everybody, if you're going to start a cannabis company, come with enough equity to really operate your business. And if only if you need debt capital to really expand a business, that's where you would want to come to us and talk to us to get our capital. But to start your business and take on debt is really not a great way to start a business, really in any industry, but especially in cannabis.

Ross O'Brien  18:29

And are you talking about types of debt that's equity and debt sort of hybrids or shareholder loans and investor loans, founder loans, those types of things?

Steve Ham     18:40

No, the convertible loans are, I think, perfectly fine as long as they're structured right so, or others. But I think the types of loan that we provide, which is senior secure loans, so you need to start servicing the loan and amortize a loan after X number of months or X number of years. And if construction or licensing or permit process takes longer, which it always does, so let's say that that gets delayed three quarters or a year, then you're going to have to start worry about how to take care or rebalance your capital structure. And that type of activity takes a lot of time for the management. And from my perspective, management should be 100% focused on growing the business, not how to service their loan. So in the early days of the cannabis company growing, it really should be fully capitalized with equity. And once it's grown up and has an opportunity to expand, I think that's a great time to come take on some debt and be able to potentially double your business. But on a foundation of great business.

Ross O'Brien  20:02

That they've already started with equity, that makes a ton of sense. And clearly, Steve having the time and discipline to stay in the space. I want to go back to something you said just for a moment about other folks sort of falling to the wayside. Certainly our observation early on was a lot of people got really excited about this as an emerging sector and emerging industry and a lot of folks so one of my mentors early on in venture capital said, never forget that. It's not get rich quick, it's get rich slow. And a lot of folks sort of rushed in this way. I hate using that Green rush phrasing, but it was a thing, right? There were all these premature IPOs and everybody could you could raise anything you wanted for a period of time if had the word cannabis in it. And at the end of the day, the folks that brought years of experience from other markets and combined that then with building a knowledge base within cannabis seem to be the ones who are sticking around. Right. So it's great to see that being proven out yet again. When you think about I love that you talked about management and where you'd like to see their focus. Is your approach to be at all hands on with management? Do you take board seats where something is so the value is so intrinsic to successfully managing these businesses that have a lot of opacity to them? Is that something that you do?

Steve Ham     21:22

Management team is number one in our underwriting and because we're not an equity investor, we're a debt investor, it's even more important to us. We do very rarely take a board seat, but that is not our mo. We're really a debt passive investor, but we have a very frequent contact with management team. I think a lot of our borrowers reach out to us for advice or just be a sounding board to discuss what's happening in their businesses and at least getting some feedback from us with regards to what's happening with their capital stack and whatnot. So I'm happy to get on the phone with them anytime they need. But certainly we're not an equity investor, so we typically shy away from taking board seats but happy to engage with them and provide any kind of feedback that they're seeking. Yeah, so management team is number one. I think with regard to the management team, we've seen, I think, a couple of different rounds of management team shifting into or coming into the industry. I think what we call inside of Altmore is Management 2.0. I think great example is a lot of the professional managers that were successful in CPG, other industries that are able to transfer their professional management to cannabis have been very successful. So we try to back those teams and we've been very successful with those types of credits. It's difficult for us to underwrite anything other than that type of management team who can really fine tune their businesses and be able to be very nimble as well. So number one is management team. No question about it.

Ross O'Brien  23:23

Well, we're very much aligned there as well, Steve. And I think it's proving out, especially in the choppiness of the cannabis markets that seem to move very quickly, sometimes correlated a lot of times uncorrelated, to what's happening on a macroeconomic scale. And time and time again it seems that the disciplined, long term focused professional management teams are surviving and thriving. When you think about what's coming, obviously the regulatory market is a key driver. However, we're also starting to see some trends emerging around the stickiness and strength of brands. The changing of licenses from limited to unlimited, the multistate interstate commerce issues. Are there areas, waves of momentum that you're seeing in any of those buckets sort of either direction right now?

Steve Ham     24:17

Yeah, we're beginning to see some really interesting brands emerge and they're beginning to cash flow beautifully. So we are looking at a few deals. Brands are by nature fairly light asset model, but they are proving to have brand value as they move from their original state where they started to multiple states. So we're looking at a few brands that have really struck a chord with the end users and diligencing a few of those opportunities. Right now, with regard to MSO and Verticalization, I think number one, they're really, really hard. Like MSO is really, really hard. Managing multiple different states with multiple different compliances and regulatory regimes, super hard to do. On top of that, trying to verticalize in states, that makes it exponentially hard. So we like operators that really kind of focus and really stick to their knitting just like we do. So we tend to not always, but we tend to seek out a company that really has found its niche and has done really well. They do one thing better than everybody else in that one single state. And the reason we like that is they've kind of built a moat around either their brand or their proprietary business model. And on top of that, these types of companies are becoming a very interesting and invaluable potential acquisition targets. So I think that's kind of where we're really kind of honing in on. I think vertical companies are great when they figure it out, but man, it's so hard to have a management team that has skill sets to manage a full vertical. Managing a cultivation and manufacturing company versus managing a retail is so different and it's so hard to perfect. We do have a couple of companies that have figured it out though. So once you have figured it out, it's a real moat, right? Because having to figure out how to grow the best cannabis, how to manufacture the best cannabis product, and then learning how to distribute that product to a very wide geography and then selling them through your own retail chain is really hard to do. But once you figure it out, it's very hard to replicate so we like those businesses too.

Ross O'Brien  26:45

That's so interesting. We always talk a lot about how we think vertical integration is the Achilles heel of the regulatory momentum. And it's funny, we literally say the same things when we look at the founders that we invest in. It's nigh impossible to find somebody who really understands cultivation and agriculture, who really understands logistics and supply chain, who really understands retail and managing people and point of sales and inventory management, who really understands brands. And the risk, we think, is significant. Right. If one of those pieces falls down. Right. If you have something go wrong from the cultivation side, it ripples through the entire organization and has a higher risk impact on what could otherwise be a standalone successful business. And we just don't see that in other sectors. So we're not sure why it should ring true in this business versus others. Right. Which is also why, much like yourself, the professional quality of the management teams, where you can bring experience from other sectors, I think is really important. So this has been really exciting, Steve. I think you guys are clearly setting the standard out there for a much needed service and alternative sources of financing. So tell us a little bit more where folks can find you. Just reiterate again, I know you said sort of 30 million is the benchmark in terms of top line revenue for companies that would be interested in connecting with you. But tell us how that process goes and what they should be thinking about.

Steve Ham     28:15

Yeah, typically our lower end of borrowers look something like call it $25 to $30 million in revenue. They're generating positive EBITDA. Typically we like to see about 20% EBITDA margin. It can be a little bit lower or certainly can be higher. But we like to invest into already cash flowing businesses. And typically these borrowers come to us because they have a great project or expansion plan that could potentially double the size of the business. Right. So a good example is Maryland, for example. So as the state of Maryland is looking to go adult use legal in January, some operators are looking to expand their cultivation to max out their allowed square footage. They're looking to get some leverage to get that accomplished. So that type of situation is pretty often. We also work with companies that are looking to potentially consolidate a certain state or a certain supply chain. So let's say that they are a dominant player in XYZ supply chain, part of the supply chain, and they have a potential acquisition target that they want to acquire. They'll come to us for some of the acquisition financing as well. So we like to see that type of situations where the company can come in, acquire that business for a fairly low multiple. They can synergize the operations between the two, and some of those two operations are greater than the parts. So we like to finance that type of situation. And third thing is brands, that is something that is slightly little bit newer for us because it is obviously an asset light business model. But as I said before, these companies are beginning to cash flow beautifully and to the extent that we can really kind of see a clear path to increasing their cash flow over the next two to three years, we like to be part of that type of situation as well.

Ross O'Brien  30:50

Steve, that's awesome. Thank you very much for joining us today. I didn't even get a plug in for my book, you know, Cannabis Capital. The book is sending copy your way. So thanks for joining us, love to read it.

Steve Ham     31:03

Thank you so much. I really am very excited to read.

Ross O'Brien  31:07

Oh, thank you, Steve. Everybody, Steve Ham from Altmore Capital. Thanks for listening.

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