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A year ago, a business plan scribbled on the back of a napkin was virtually all you needed to raise money for a Canadian cannabis company. There were plenty of hedge funds willing to pump money into the market and flip the stocks to retail investors, eager to ride the green wave.

Things have changed over the past 12 months, as industry hype has met poor financial results, product shortages and a slow roll-out of retail stores. It is becoming increasingly difficult for private cannabis companies, or small-to-mid size publicly traded firms to raise the capital.

Trichome Financial Corp., which will begin trading on the TSX Venture Exchange next month, is hoping to step in where the equity markets are leaving off, offering private loans to LPs, retailers, and ancillary companies desperate for the capital needed for expansion.

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Marc Lustig of Origin House (formerly called CannaRoyalty Corp.), and Aaron Salz of Stoic Advisory, launched the company in early 2018 out of the Origin House offices. Today it has its own offices and is led by Michael Ruscetta, who used to run private investment fund RCM Partners Inc.

Trichome raised $15 million last fall and has made loans to four companies: 180 Smoke Vape Store, James E. Wagner Cultivation Corp., Ganjika House (a dispensary in Brampton, Ont.) and Blissco Cannabis Corp. It’s looking to raise a further $15 million to $30 million in conjunction with the upcoming RTO.

Cannabis Professional spoke with Michael Ruscetta about Tricombe’s investment thesis and where the cannabis capital markets may be headed. The interview has been edited and condensed.

Cannabis Professional: What is Trichome’s business model?

Michael Ruscetta: It’s a combination of using our own balance sheet capital, which we are doing today, and launching a private credit fund, which will be owned by Trichome, managed by Trichome and will pay fees to Trichome. Ideally, we'll have multiple pools of capital. We'll invest alongside the fund, so investors in Trichome will benefit by the economics of transactions, plus benefit in the fee income associated from the fund, and we'll look at other businesses that we can put on our platform to leverage our intellectual capital.

The nice thing about our business model is we can make money in a range of different ways that isn’t predicated on picking stocks. We don’t have to pick winners. We have to underwrite well to ensure our money comes back to us, and charge appropriately for it.

CP: What’s your central investment thesis?

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MR: Our view was that there would be a normalization in the equity markets; that the best opportunities had largely been priced accurately, that there would be a shift in capital from everybody that had a business plan, to people that actually could execute on a business plan. Also, that there would be a migration of capital flows to the largest companies. Part of that is an ETF effect; if you want exposure to the cannabis sector, you buy Canopy, because it’s large and liquid.

The retail market gets a little bit tired after a while. The hedge fund space gets a little bit tired because the retail market gets a little bit tired, because hedge funds require retail investors to mark up their portfolios. The private-to-public arbitrage has largely dissipated, so it's crunch time.

All these cannabis companies are consumers of capital, for developing products, for working capital, for expansion, for M&A, for a variety of different needs. Then you’ve got the expansion of the industry itself, so retail, services, there’s just a multiplication of needs for capital to execute on business plans.

CP: So the thesis is based on the idea that companies won’t be able to continue raising money using equity?

MR: It’s not so much we were making a bet that markets would not be welcoming to everybody, because that’s kind of a mugs game. The bet was that there was so much demand for capital, that equity markets were not always the best option to satisfy those demands.

Trichome has two particularly big drivers. One is the structural growth opportunity in the market. It has another big tailwind: it’s amplified in any adverse market scenario, whether that’s a broad market scenario or whether that’s a cannabis-related scenario. We have events like CannTrust that spook the market, and the window shuts for guys to finance. If the S&P 500 is down 10 per cent, the market shuts for high-beta stocks.

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CP: How have you seen cannabis capital markets evolve over the last year?

MR: Private companies are finding it exceedingly difficult to raise equity capital, because that was premised on, ‘I’ll invest in this private company, they’re going to go public, I’m going to sell my stock and two or three times my money.’ If you are public in Canada and say have a market cap of less than $500 million, it’s also not super easy. There’s been a big bifurcation in the market into haves and have nots – and there’s a lot of have nots.

CP: I understand there has also been a shift of capital towards U.S.-focused cannabis companies. Is that correct?

MR: We’ve seen that for the last six to nine months. There was a little bit of an arbitrage opportunity, so the capital flowed to that, and retail investors have certainly become more attuned to the U.S. opportunity. Capital has absolutely flowed, and deservedly so. There are bigger market opportunities, and in many cases companies are generating real EBITDA and real cash flow, which very few here have been able to do. So where would you rather be? I’d actually like to apply a multiple to real EBITDA, not EBITDA that’s two years in the future.

CP: Where are the commercial bank lenders?

MR: We’ve seen some traditional bank financing in the sector, but the banks are being skittish. They’re prepared to lend to perceived good corporate clients, where there’s additional revenue streams, underwriting M&A, cash management. But they’re not really prepared to take a lot of risk in order to do that.

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Many of these cannabis companies covet that bank facility at 5 or 6 per cent. But there’s only been a handful, and if you read the credit agreements, they come with pretty significant limitations to doing business. It’s great that you can articulate to the world that you have a bank as a lender at 5 or 6 per cent, but if you don’t have access to the capital, or it’s limiting what you can do with that capital, it’s not very value-added.

I think that many of these companies will fail. But I want to make a distinction: some will fail because they deserve to fail, some could fail without access to capital. That’s where we come in.

— Michael Ruscetta

CP: What kind of limitations are we talking about?

MR: We’ve seen everything from loans having to be cash-collateralized. In one case we’ve seen a mortgage on a property where all the payments are paid up front for like five years. We’ve see highly restrictive covenants in terms of expansion abilities. This is an industry that requires a great deal of flexibility, because things shift so rapidly. If you can’t adapt to that because you have constraints around you, it’s not very valuable.

CP: Are you competing with banks?

MR: Our business case was always predicated on the banks being a larger share of the market, and we weren’t formed to compete with the banks. We see in the U.S. and globally, the credit markets have evolved to one where non-bank lenders are providing a significant amount of junior capital on a balance sheet. So we’re working on a transaction today where there’s already a lender, and we’re working on a second lien piece. As the industry matures and the credit markets mature, and if there’s more bank presence, we’ll be a second lien lender or a first lien lender, whatever the case may be. We’re a little bit agnostic.

CP: I understand securing loans to cannabis companies can be challenging. How do you manage this?

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MR: It’s a hybrid between looking at lending on hard-money metrics, real estate, building, equipment – the realizable value of all those things, not what people say they’re worth, because there’s a big difference. We often see appraisals for real estate, where highest and best use is a cannabis facility: they paid $2 million for it and as a cannabis facility its worth $10. No it’s worth $2 million.

If there’s real estate, we want to know where that real estate is, how good is that real estate? Is it in the middle of the province with no economic activity around it? If it is, it’s probably not interesting to us. If it’s in an industrial building outside of Vancouver or southwestern Ontario it’s a different story.

We do look at the value of a license, but we look at the value of where a company is positioned in the market. Let’s say it’s a licensed producer. What are they producing? Why are they producing it? Our view is the growing will ultimately be a commodity business, so you’re positioned one of two ways: you’re either a large-scale low-cost producer that can compete with commodity grade products, or you’re positioned with more niche products that have brand value, command market adoption, and have pricing that can be protected.

CP: How do you manage risk in an industry where many companies may fail?

MR: I think that many of these companies will fail. But I want to make a distinction: some will fail because they deserve to fail, some could fail without access to capital. That’s where we come in. We are seeing distressed companies. Some companies are distressed because they made poor capital allocation decisions in the past, but might have some good assets. So there is a lot of sifting through opportunities to see, ‘ok is it a bad business? Or is it a bad balance sheet?’ A bad balance sheet we can fix.

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