Cannabis-related cross-border transactions have become more creative since the initial wave of transactions that occurred post-legalization in Canada. Changes in the US federal law enforcement policy, coupled with the Toronto Stock Exchange (the TSX) and the TSX Venture Exchange (the TSXV) clarifying their positions on listed issuers that are involved in marijuana-related activities in the US, may have played a part in the transaction structures that we are now seeing.
US Companies Investing in Canada
Deal Structures and Considerations
For US-focused companies looking to invest in Canada, the legalization of cannabis has likely made it easier to access capital as well as sell and distribute cannabis-based products in the Canadian market. However, the ease of doing cannabis-related business does not mean that the decision to enter the Canadian cannabis market is a simple one.
As with entering into any new market, investors should analyze consumer demand and competition prior to making any commitments. Consideration should also be given to what the ideal means for entry would be. An acquisition of, or an investment in, an established Canadian entity offers some potential commercial advantages related to leveraging the target’s customers and suppliers, making this an attractive way to gain foothold in a new market. If the target is a public company, then consider reviewing the legal obligations triggered by Canadian securities laws in relation to early warning reporting, insider reporting and take-over bid rules. In the alternative, if the plan is to start a new Canadian branch of the US company, then a detailed review of tax and legal implications of various business vehicles, such as a partnership or a corporation, should be conducted.
In short, Canada continues to offer a well-regulated legal environment for companies looking for certainty in cannabis-related operations.
Canadian Companies Investing in the US
The federal law in the US maintains marijuana as a Schedule I drug under the Controlled Substances Act, making it federally illegal. However, under various states’ laws, marijuana is legal and regulated in varying degrees. This conflict in laws continues to create legal risks for companies involved in marijuana-related operations in the US.
Despite the uncertainties in the federal legal framework, the US marijuana market size is simply too big to ignore, even for Canadian companies that enjoy a highly regulated and legal cannabis market within Canada. Some Canadian public companies have entered into unique cross-border deal structures to be compliant with the US federal law while also following the restrictions imposed by the exchanges where their shares are listed. As explained in detail here, the TSX and the TSXV effectively prohibited cannabis-related operations in the US for its issuers, and exposed them to the possibility of de-listing for non-compliance with the exchange rules. However, such activities are generally not prohibited under Canadian securities laws as the Canadian Securities Administrators (the CSA) did accept that Canadian issuers may be involved in cannabis-related business activities in the US, and outlined enhanced specific disclosure requirements and expectations related to such activities. Therefore, companies can choose to list on other Canadian exchanges to access the capital markets while also conducting marijuana-related business in the US.
Deal Structures and Considerations
In navigating and complying with the web of legal rules to conduct cannabis-related operations in the US while maintaining listing on the TSX or TSXV, a common theme in some of the deal structures was divestiture by Canadian issuers of their respective investments in the US cannabis market. However, this divestiture was usually replaced with an option to purchase securities or convertible securities that can convert into common shares at some date in the future. In such cases, one of the main conditions was favourable changes in the US federal law in relation to marijuana. For example, in one case from 2021, a major Canadian issuer announced that it was considering investing in a California-based target by creating a special purpose vehicle and structuring options through which, post-legalization in the US, the Canadian issuer would become a major equity holder of the California-based target.
Negotiating these deal structures involve many considerations but one important matter is the length of time for which the options / convertible securities should be valid. It is desirable for the target cannabis company to have a definitive timeframe for expiry of the options / convertible securities; otherwise, the options / convertible securities could potentially remain open in perpetuity if its expiry were based solely on conditions. Depending on how the options / convertible securities are structured, the deal could also have the effect of potentially diluting the outstanding securities of the target.
In addition, when choosing an option-based deal structure, consideration should also be given to the pricing of the options. The price can be determined at the outset based on the target company’s value at the time when the deal is negotiated, or the price can be determined at a later date based on the target company’s future value. As always, whichever route is chosen, a comprehensive tax review should be conducted.
Cross-border cannabis-related transactions can be complex, but they may also be necessary to build or maintain a competitive edge. Canada can offer access to capital and well-regulated markets to sell and distribute cannabis-related products, whereas the US can offer a large and attractive consumer market in legalized states. However, each poses unique challenges that should be considered prior to making any decisions.