The legal cannabis (marijuana) investment sector in Europe and the UK has been much slower to get off the ground than it has been in North America – by far the largest in the world. The situation has been complicated by the myriad of variations between national and regional laws and regulations that control the use and sale of cannabis, both medical and recreational, in Europe.
Regulators in the EU, and UK, have been slow to clarify rules around the conditions under which companies in the legal cannabis industry either can list publicly, or offer investment vehicles whose capital, all or in part, is invested in the sector. That lack of clarity has largely put institutional investors off the sector, making it difficult for companies and investment vehicles to raise significant capital.
But with London-based investment company Chrystal Capital recently launching its Guernsey-regulated Verdite Capital Fund, there are signs UK and Europe-based investors may soon have options for sector exposure closer to home. Until now, British investors keen to pursue returns in the new sector, have mainly been restricted to investing in legal cannabis stocks and indices listed in either the USA or Canada. Does the launch of a UK-domiciled fund, albeit a private equity fund rather than a publicly traded company, suggest that will imminently change?
The Verdite Capital Fund – UK-Based Exposure To The Legal Cannabis Sector
Chrystal Capital Partners launched their Verdite Capital Fund, intended to invest in companies in the medical cannabis sector, in late September. The company is currently in the process of pitching the fund to private equity investors, in the hope of attracting $100 million in investment capital. Chrystal is confident the fund will be closed, and actively moving on investment targets, by the end of the year.
$75 million of the total $100 million target, says Chrystal, has already been committed to, pending “final documentation”, by a “cornerstone investor”. The fund’s initial investment strategy has been detailed as taking stakes in between “ten and fifteen well-managed, fast-growing”, businesses in the legal and regulated cannabis and cannabinoid markets. Companies with interests in legal cannabis in the health and pharmaceuticals sectors are being targeted.
Kingsley Wilson, investment partner at Chrystal Capital, last week stated that the new fund will:
“address the equity funding gap in the hugely exciting and growing medicinal cannabis market . . . Overseen by a team with decades of cannabis and private equity experience, we believe that Verdite presents the vehicle through which investors can profit from the significant value creation now unfolding globally across the legal cannabis healthcare space.”
The company behind Verdite Capital has called the gradual end of the cannabis “prohibition”, a “once in a lifetime opportunity” for investors. A statement last week referred to a “global wave of decriminalisation and legalisation”, being catalysed by the fact the medical properties of cannabis are now better understood. Medical cannabis is currently legal in over 40 countries and 33 U.S. states. Demand in Europe is also rising, and laws and regulations relaxing.
Are Legal Cannabis Investments Permitted In The UK?
One of the primary reasons why Verdite Capital has become the UK’s first legal cannabis sector-specific fund of any kind is that laws and regulations around investment vehicles operating in the sector have been unclear. That’s continued to be the case despite the strictly controlled legalisation of medical cannabis in the UK in 2018.
The lack of clarity on legal cannabis investments has centred around the UK’s Proceeds of Crime Act 2002 (POCA). The Act makes clear that any returns realised through an investment based on activities that are illegal in the UK, even if not illegal in territories where the company operates, could be considered to be, and prosecutable as, proceeds of crime. Holding shares or other kinds of assets based on companies in the legal cannabis sector could be prosecuted in the UK as a money laundering offence.
There has never been any direct case of a UK investor in the legal cannabis sector, where activities of the company invested in are restricted to territories within which they adhere to the local law and regulations. However, the fact that the risk of prosecution exists, has understandably been enough to put most investors off.
While private investors have been demonstrably more likely to shrug the theoretical risk off, institutional and incorporated investors are more wary.
The FCA recently moved to clear up its position on legal cannabis investments, and even outlined the conditions that would allow companies in the sector to publicly list on the London Stock Exchange. On September 18th 2020 the FCA published their current approach to proposed listing on the LSE’s main market. Law firm DLA Piper summarises the FCA’s published conditions as follows:
- Recreational Cannabis Companies: The proceeds from recreational cannabis companies, even when they are located in those jurisdictions that have legalised it, are considered to be proceeds of crime by the FCA and therefore the securities of such a company would not be admitted to listing on the Official List in the UK.
- UK-Based Medicinal Cannabis Companies: UK-based medicinal cannabis companies can have their securities admitted to listing on the Official List (provided they have the requisite Home Office licences).
- Overseas Medicinal Cannabis Companies: overseas licensed companies may have their securities admitted to listing on the Official List provided POCA does not apply and they satisfy the other eligibility criteria for listing. However, such companies will need to satisfy the FCA as to the POCA risk and that their activities would be legal if carried out in the UK.
DLA Piper believe the FCA’s clarification is helpful but still does not fully address what constitutes adherence to the condition “that their activities would be legal if carried out in the UK”?
The law firm’s interpretation of the new guidelines is that legal cannabis companies who wished to pursue a public listing, or regulation as an investment vehicle in the UK, would have to demonstrate the following:
- provision of a legal opinion under the local law of the overseas company stating that the company holds the necessary regulatory permissions and licences to operate under the local jurisdiction;
- a further legal opinion by English law advisors (having regard to the local legal opinion), explaining to the FCA how the activities of the overseas company would be legal “if carried out in the UK”, with consideration of the equivalent measures in place under the UK licensing regime; and
- confirmation that the company is not involved with recreational cannabis in any capacity. The FCA could require director attestations swearing, prior to consideration of their eligibility application, that there is no recreational aspect of their business.
Does The Legal Cannabis Sector Represent An Attractive Investment Opportunity?
If the FCA’s recent, and future, clarifications and potential further relaxation of rules and laws around medical cannabis do mean the Verdite Capital Fund is the first of a wave of investment vehicles targeting the sector, should investors consider exposure?
Chrystal Capital sees the “once in a lifetime” opportunity represented by the legal cannabis sector as anchored in the fact that it estimates just $15 billion of the estimated $350 billion total value of the global cannabis market is currently legal and regulated. That is a huge, already established, potential market that companies in the sector have to target as international laws change, as they are expected to, over the next several years.
However, it is worth noting that legal marijuana funds in North America, where the sector is biggest, have yet to demonstrate they can produce reliable returns for investors. The nascent sector is still volatile, demonstrated by the fact the value of America’s ETFMG Alternative Harvest, the world’s largest legal cannabis fund, slid by more than 28 per cent in 2019.
Valuations of publicly listed companies, which the ETF invests in, are also arguably pumped up on the hype attached to the industry. That raises the question of how much value there is in unproven companies in the sector. Despite the legal cannabis sector’s significant growth potential, picking winners at this stage is difficult.
One of the industry’s issues is that there is little barrier to entry in the broad market. That situation is different in the cannabis-based pharmaceuticals industry, where protected IP can be secured. But with just a handful of cannabis-based treatments currently approved by the FDA, picking long term winners will still represent an investment challenge.
There is undoubtedly big investment potential in the medical and broader wellness and recreational legal cannabis sectors. The right investments will likely lead to serious returns. But any investors eyeing the sector would be wise to spread risk by broadly diversifying companies they are exposed to, investing through funds is one way to do so, and categorising such investments as having a high-risk profile.
The launch of the Verdite Capital Fund, the UK’s first, is certainly an interesting development that could herald more domestically-domiciled investment opportunities in the legal cannabis sector. Whether, of if, investors choose exposure to the sector will largely come down to risk profile, and tolerance, as well as a personal opinion of how the legal cannabis market is likely to develop over coming years.