AFC Gamma, a Florida-based real estate investment trust (or “REIT”) that provides debt financing to cannabis cultivators, processors, dispensaries, and related operations, filed an S-11 with the SEC on December 29, 2020, to allow the company’s stock to be listed on the Nasdaq. REITs own, operate, or finance income-producing real estate and typically specialize in a specific market sector. Although the S-11 form is unique to REITs, AFC Gamma’s filing includes risk disclosures that are similar to those often included in the periodic reports of cannabis companies listed on US securities exchanges.
Disclosing Legal and Regulatory Shifts
Consistent with disclosure statements filed by several cannabis producers and processing companies, AFC Gamma’s S-11 identified potential changes in the cannabis sector’s legal and regulatory environment as a major risk factor that investors should consider. AFC Gamma identified operations in Arizona, Arkansas, California, Connecticut, Florida, Maryland, Massachusetts, Michigan, Nevada, New Jersey, Ohio, and Pennsylvania, as being especially susceptible to “social, political, and economic risks” related to local laws and regulations. In contrast, major cannabis producer Aphria, Inc. in its July 2020 annual SEC filing, more broadly disclosed legal and regulatory shifts as a risk of operating in its home country, Canada, and abroad.
A Highly Leveraged Industry
AFC Gamma’s S-11 also includes a risk disclosure that “[s]ome of our borrowers may be highly leveraged” and identified potential restrictive covenants as impairing their ability to finance future operations. A December 14, 2020, Seeking Alpha article notes that over a third of publically-traded U.S. cannabis companies have negative tangible equity, including MedMen whose negative tangible equity is estimated to exceed $364 Million. When commercial leases such as those provided through AFC Gamma are added to the debts of listed cannabis companies, their leverage rises drastically. Aphria Inc.’s most recent annual SEC filing also mentions potential undercapitalization as a material risk.
Reliance of Government Licensing
Another risk addressed in AFC Gamma’s S-11 is its and its borrowers’ reliance on various government licenses in order to fund operations and sell products and services, which licenses may not be renewed or extended by regulators . A similar risk factor appears in Hexo Corp.’s annual SEC statement from October 2020, which mentions that Hexo depends on regulatory approvals and licenses along each step of the supply line, from manufacturing, to storage, selling, and even disposal of cannabis. Hexo Corp is a Canada-based producer of retail cannabis goods listed on the New York Stock Exchange.
Public Perception of Cannabis Products and Investments
AFC Gamma’s S-11 did not explicitly address the risk of a potential negative perception shift regarding the cannabis industry and cannabis products, per the annual statements of some public cannabis companies. In contrast, medical cannabis producers Aphria, Inc. and Tilray, Inc., both included detailed risk disclosures concerning the potential for consumer and investor perceptions surrounding cannabis to shift in a manner that would devalue their shares in their most recent annual SEC statements, filed in March and July of 2020. These companies are both major players in the cannabis sector, and reached a merger agreement to form the world’s largest cannabis company valued at roughly $3.9 Billion, on December 16, 2020.
AFC Gamma’s business is somewhat unique in that only one other cannabis REIT’s shares are publically-listed in the US: Innovative Industrial Properties. But AFC Gamma’s risk disclosures parallel those of many publically-traded cannabis companies regarding their borrowers’ dependence on highly-regulated licenses, a rapidly shifting legal environment, and an industry with unique capitalization concerns. This provides broader guidance to all securities issuers: particular attention must be paid to the regulatory challenges that are specific to the issuer’s business. Those challenges should be carefully assessed so that the disclosures are effective, thorough, accurate, and forward-thinking, based on the issuer’s business plan.