SPEAKER_01: 0:00

If you're building a business in the cannabis, just focus on serving your consumer. Focus on building a strong, foundational company because the rising tide lifts all ships. So don't bet your business on some regulatory reform that you think is going to happen. Build a business for your consumers and when the regulatory change inevitably happens, the folks with the strongest fundamental businesses will benefit the most.

Ben Larson: 0:59

And we've got a great show for you today. We have Steven Ernest of Chicago Atlanticon. We're going to talk about how, why, and where capital moves in cannabis, reciprocity, and the limited license oligopoly, MA, ESOPs, and all things cannabis finance. But before we get there, NRA. Aloha.

AnnaRae Grabstein: 1:19

How was your trip? I missed you last week. I'm a trip. Hello. I was in Kauai. You were in Maui. I had really no internet at all. I was there. I have I've been on the board of an organic farming nonprofit called With USA for many years. And uh every three years we do this really intensive board retreat um and do a three-year strategic plan. And that is what was happening. Um and I actually also had to be in Hawaii. It had to be in Hawaii. So we have a bunch of farms that we work with in Hawaii. So um that was that was the excuse for going to Kawaii. And I actually just became the president of the board there um for the next year.

SPEAKER_02: 2:05

Congratulations.

AnnaRae Grabstein: 2:06

Yeah, which was great. I'm feeling really good about just putting some extra effort this year into making sure that we have farmers, new young farmers coming into the farming space uh broadly. So fun stuff.

Ben Larson: 2:19

I love that. I love that. I I need I need better boards to be a part of. I don't have any boards taking me to Hawaii.

AnnaRae Grabstein: 2:26

Oh, I know. It's it was pretty good. I told my son, he said, Oh, how was your day? Because my family came with me on the trip. And I said, Oh, good, I became the president today. And he said, Oh, Donald Trump isn't the president anymore. I well, no, he's still the president. Um, I'm just the president of this other thing. But yeah, I went to some incredible farms in Hawaii. I saw cacao growing, I saw avocados and mangoes and all these amazing tropical fruits, which was really inspirational. How was your trip? I love it.

Ben Larson: 3:00

It was great, it was great after we survived the the um the winter storm that rolled through, eventually hitting California and dumping like 10 feet of snow in Tahoe. Uh, but we got the preview uh island style and knocked our power out for for 24 hours. But we recovered, it was great. Um, had a great show with with uh Riley Kirk last week. Um, so that that was nice that we got to make that happen and then got the family home. But yeah, we did some surfing, we did some snorkeling, you know, all the typical island stuff. And I'm just excited because I spent a lot of time not in winter this year, and I've been enjoying that, you know, and and we have a little trip to to Miami this week.

AnnaRae Grabstein: 3:43

That's right, we'll be seeing each other in person for the Canab Bev Summit. Um, shout out to all the folks making the trip to talk about what's going on in THC Beverages and what comes next. It's gonna be a great event.

Ben Larson: 3:55

I live literally have a unpacked suitcase right here in front of me and another packed suitcase over here going. So um, yeah, it's uh it's living out of a suitcase right recently, but it'll be fun.

AnnaRae Grabstein: 4:13

Yeah, me too. Well, let's jump into a quick news update so we can start talking to Steve. Um, why don't you kick us off with what's going on in California?

Ben Larson: 4:22

Oh man, yeah. I I got I got to watch this hearing last week, which was a little disconcerting. We have assembly person uh Jackie Irwin uh with the cannabis industry and her crosshairs. And and essentially, uh, you know, Jackie Irwin, she's a concerned mom that doesn't think that the cannabis industry is constrained enough. Uh, and we all know that the you know California market is thriving and everywhere and you know all that kind of stuff, and it needs more constraints. Joking if you haven't been listening to the podcast for the last two years. Um, anyways, she she takes issue with the DCC and them not doing their job, but for some reason she feels like they need to do more rules instead of just enforcing the current rules. Uh, and some of those new rules are new uh packaging requirements, labeling requirements, uh limiting the dosing of beverages, which famously low-dose beverages don't sell very well in dispensaries, so uh essentially trying to eliminate the beverage category, I guess. I don't know. She just seems to take issue with everything. And the hearing itself sounded a lot like kind of like the Texas hemp hearings. It was very reefer madness. It was talking about all the calls to poison control and all this kind of stuff, and um, it's a little disconcerting, like with how challenging it's been to operate in California to know that this outgoing assembly person is trying to make this her last stand. And California has a history of of these like make a wish like grants, you know, where it's like, you know, it's your last term, so you get what you want. All this to say, I don't know how that uh jives with the governor's last term, and he's been trying to prop up the cannabis industry. So who knows where this all goes? But if you're a cannabis operator in California, get involved um and and try to do some reasonable uh lawmaking here this year.

AnnaRae Grabstein: 6:19

Yeah, it's hard as an operator to keep up with all the changes and and California has been hard, but I will say it also has been getting better for those that are left standing. Like I talk all the time to more and more groups that are kind of making it work in this market, and there has been a lot of folks that have left um the field, but those that are left, I've had I have a lot of confidence in. So yeah, Jackie or Irwin, go home. Um, no thank you.

Ben Larson: 6:44

Um we're gonna get we're gonna get a whole new batch of legislators next year, and hopefully it's gonna get better, right? You know, it's like hopefully they're younger, hopefully they're more aware of what's happening just with society. And so, like, we'll we'll have a new governor, we'll have a new uh majority leader, and we'll have a not Jackie Irwin.

AnnaRae Grabstein: 7:05

So yeah. And um similarly, just kind of calling out some struggles that are out there. Uh, we just saw an announcement that in Michigan cannabis sales plummeted 8.3% year over year for January sales, uh, amid kind of two big things. One is massive storms and also the 24% wholesale tax on cannabis. And Michigan had been a pretty bright light overall in the cannabis market as a mature market, especially, that did over$3 billion and really had like a high, a high per capita dollar amount of cannabis being purchased by consumers. And it's just been a bummer, truly, to see this new tax come and then, you know, things that we can't control like snowstorms just really hurt the operators there. So my thoughts are going out to Michigan today, and same with the whole Northeast, which is also hit with a massive storm. And we know that cannabis is a highly operational business and people need to get to work physically to, you know, manufacture things, take care of plants, serve customers and dispensaries, and it's really tough with these storms. So just sending out some love to all the operators in the Northeast that are dealing with power outages and customers not walking through their doors, staff stuck at home. Um, it's stuff that's really hard to plan for and it compounds. So we're we're sending you the big love and hopefully some rainbows and sunshine, or at least end to these storms soon.

Ben Larson: 8:32

Yeah. And there's uh there's a handful of hemp beverage ladies uh marching on the hill today and tomorrow. So godspeed, and hopefully you're wearing your galoshes.

AnnaRae Grabstein: 8:43

Yeah, seriously. Well, so let's jump into our interview today. Um, we're joined by Steven Ernest, a longtime cannabis investor and um and partner at Chicago Atlantic, one of the most active lenders in the U.S. cannabis industry. Um, Steve has been in the space since 2015 and he has worked at multiple different cannabis um banking and investment groups, uh, including Mazakali and Sharp Capital. And prior to cannabis, he managed um multi-million dollar or over a half billion dollar of assets at JP Morgan. Uh, so he brings a really great institutional finance experience lens to the emerging cannabis industry, but has over a decade of experience working in cannabis too. He's been at the forefront of cannabis credit markets uh with Chicago Atlantic, including the firm's recent ESOP deal with Illicit Cannabis, which was a first, to my knowledge, of a fully financed ESOP deal, along with lots of big debt deals to MSOs that everybody's heard of, like Verano and MerriMed and others. And they've made, they also made a super high-profile commitment to the New York Social Equity Umvestment Fund. Uh beyond capital, Steve is also involved in Students for Sensible Drug Policy. So we'll want to hear about that too. But excited to have Steve on the show today. Welcome.

SPEAKER_01: 10:05

Hello, hello. Thanks for having me. Excited to be here.

AnnaRae Grabstein: 10:09

Awesome. Um how's it going today? How's Chicago?

SPEAKER_01: 10:13

It's great. It's better than my uh compatriots in the Northeast who I know are dealing with uh a crazy, crazy blizzard. My uh wife was actually supposed to fly out there yesterday and that she's got an email alert. You know, sometimes they're like, oh, your flight's been rescheduled. It's like your flight's been canceled and we're not rebooking it. So uh it's great. Sunday in 35 here, so it's not, you know, could be worse.

Ben Larson: 10:37

Steve, for for for the audience's sake, Chicago Atlantic has been notable in the headlines. You guys have deployed a lot of capital, but let's get an understanding first of like what is the breadth of it? Like how much capital are we talking about? Like what kind of deals or or what size of deals are are you guys doing? And then we'll kind of dive into the nuts and bolts after that.

SPEAKER_01: 10:59

Yeah, so uh Chicago Atlantic, I think I mean we are one of the most, if not the most active investor in US cannabis. Uh we've deployed over three billion dollars in into US cannabis uh since inception. Uh, and I head up our originations team. So my my job here at the firm is to deploy uh new capital for the firm. Uh I'd say our average deal is like 30 to 40 million, uh somewhere, somewhere in that range. It's uh, you know, we're a bit of a victim of our own success. It's tough, it's tough for us to do like sub five million dollar uh investments at this point, just because we've deployed uh so much. So, you know, I'd say the the bigger the better when it comes to Chicago Atlantic, uh specifically in the in the cannabis industry.

Ben Larson: 11:41

Yeah, and and and these the types of deals you do are are debt facilities and and um yeah. Can can you explain that a little bit just because I'm more I'm more familiar with venture and yeah, you know, smaller venture companies to to your point about the size of checks you do, you know, we don't have a lot of debt options. And so it's like you have to get your company to a certain level to to kind of really access that that level of capital.

SPEAKER_01: 12:09

Yeah, so we are a credit-oriented investment platform. Uh you know, I we're not as a firm, we don't consider ourselves cannabis investors. We consider ourselves uh folks who invest where risk is fundamentally mispriced, right? Uh so a lot of the things that that we look for are uh you know industries or sectors that are shifting from vice to virtue, right? So I I think that uh you know cannabis is it's I mean it's it's how we built our firm. Like we actually started as a as a cannabis firm. We've we've since branched out into other investments uh as well. But uh, you know, the idea is like to protect your downside risk, right? And if you can go into these sectors where uh access to bank capital is restricted for uh a variety of reasons, obviously cannabis being uh federally illegal, uh, we found that you can generate significant alpha for investors, right? If you still hold your underwriting practices uh, you know, to understand where there is downside risk, right? Uh and and collateralizing real estate, we are we are a publicly traded uh real estate investment trust, but really what we are underwriting, what we are looking for is the sustainability of cash flows of a of a business, right? Uh because you know, if you put if you buy a building for$10 million and you put$30 million of you know, grow lights and racks and HVAC, right? Uh and the cash flows aren't sustainable, you're gonna have to liquidate that, right? Uh and and the value if it's not working, then it's unlikely someone's gonna come in and value uh those assets in the same way that um that you did, right? So uh a lot of my job is understanding how the capital markets in cannabis work, right? Uh and just because you've got, you know, the only border play in New Jersey, right? Uh does that mean that, you know, those revenues are gonna exist in perpetuity, right? Or you're the you know, first cultivator in a in a state, right? Uh, and understanding after seeing 40 medical markets and and 25 adult use markets mature over the last 10 years, not what it's gonna look like now, uh, but through the tenure of the of the loan of the uh of the credit facility, uh, which for us I'd say our average tenure is about three years. So that's uh that's uh how far into my crystal ball I have to look to uh red shack in this space.

AnnaRae Grabstein: 14:32

It's it's really interesting that you're talking about predicting the future, because obviously for debt, of course, you're trying to predict whether somebody can service service the facility and uh hopefully that you don't have to to step in and take ownership over um over the debt because they couldn't. And so we've talked before about the show. I've joked that that proformas are like financial pornography, like they really are fantasies a lot of times from operators, and and I think that you have to deal with that a little bit. Like I'm sure that you are receiving these proformas from folks that are predicting their own future. And I'm curious if you could talk about kind of how much you take what an operator tells you their future is going to look like compared to how much you then decide what their future might look like based on your own experience watching the other markets. Like you you made an example about Jersey and that border store and what it might do today versus the future. But kind of say more about how you decide whether an operator has the right line of sight on their future or how much you you predict their own future for.

SPEAKER_01: 15:41

It's a great question, uh, because it it really is uh I think what has made uh credit sort of the de facto investment vehicle in cannabis is uh asset managers in general, we're judged on our track record, right? Uh and from a credit perspective, I'm much I'm looking at what you what you have already accomplished, right? You have to come in with a track record, right? We are we are not funding groups that have like, oh, I've never operated a cannabis business and I won this license, but look at my pro forma. Like to me, that's that's equity or venture, right? Which is very much uh about the future. And credit is much more about the past, right? Uh and about the traction that you have, right? So I'm not underwriting a deal based on the future performance. I'm I'm underwriting it on past performance, but I have to understand where the past performance is going to end up through the tenure of the of the facility, right? So, you know, you could be like, oh great, I've got uh, you know, a$25 million revenue business and I've got five million dollars in EBITDA. But again, if you're early in the maturity cycle of a given state and I know that competition has not hit your market yet, uh that I have to be more conservative with that, right? And and I certainly want to be uh using the capital that I invest for EBITDA accretive investments, right? So you better have a plan to say, okay, I'm gonna take five or you know, 10 million from Chicago Atlantic, but I'm gonna take my five million in EBITDA and I'm gonna go to 10 or 15 million in EBITDA. And somebody like myself who has spent 10 years studying this has to agree that that is going to actually make sense and on the timeline that you're suggesting, um, which is almost always more flowery than uh than than reality. Uh and so, you know, you guys were talking about California a little bit when we started on this call. Uh I moved out to California, I bet I kind of bet the farm. I was like, I'm gonna go out and I'm gonna live in California, and California cannabis is gonna be king, uh, and they're gonna set the set the culture on this thing, which I I I still believe. Um but it was too nascent, right? And and now I think what you're seeing in in California, you know, to that to that uh pro forma conversation, I can I'm I'm starting to look at pro formas and believe them in California, right? Because you because you've had so much attrition. Uh and so it's like, okay, well, if you're profitable now and you've been profitable for the last two or three years in California, I think there's excellent buying opportunities, you know, certainly as a retailer, to go out out and and consolidate, uh, consolidate the space. So, you know, part of what we look at is also the the operator, right? Like understanding, like I can walk into a a store, like you can, you know, I could you can kind of tell like who's you know, who's operated at retail before and who just you know was at the right city hall meeting and just won a license uh and had limited limited competition, right? Uh so yeah, it's um it's it's a blend, but I'd say it's it's especially 10 years in, it's more about historical performance um while underwriting the uh commoditization of the revenue and and therefore profitability of a given business.

Ben Larson: 18:46

Yeah. I I I love that you mentioned the operator because that's a big similarity with venture, right? It's like it's always about like who's operating and that's who you're investing in. Um, it's all about the operator, right? I mean, yeah, that's all you have to go on. So you mentioned the operator, you mentioned the historicals. What's like the the third secret filter that most people don't know about like when they're when they're approaching you? Like what what what's the big either positive or negative flag that that you look for?

SPEAKER_01: 19:19

Uh I'd say you know, it's funny in in capitalism, I think the irony of capitalism is that the less you need or want my money, the more I want to give it to you. Uh so like, you know, if you're like pitching me really, really hard uh and you're not understanding if you're if you're pitching really hard, I'm probably more reluctant uh to to invest in and lean in. The people that I want to invest in are the people who frankly don't need my money, but have found a really great, uh, really high ROI opportunity, right? It's like, okay, I can go consolidating, you know, I could grow my business by 50% or double my business. Okay. Now I don't need the capital, but I have a really attractive opportunity where this capital makes sense. Uh so yeah, I guess what's a reluctance to want the money.

Ben Larson: 20:12

Yeah, that's funny. I I was just reading uh uh a post by Ben Kovler because they just took on a uh facility and he's like, uh if it's not if it's not raining, grab an umbrella or something like that.

SPEAKER_01: 20:24

Yeah, you're right, yeah. Uh yeah, and for Ben, you know, he's got a great, great balance sheet. Uh and he can, and and and then you know, he's a group that we would love to to lend to, right? Uh, but he's just been able to achieve uh cost of capital lower than uh our structure can can tolerate. So uh but yeah, that's a that's a good example. And he's big on your beverages too. I know uh he's uh I'm sure you just saw the launch at the United Center, which is not as cool as it sounds in the headline because they're not they're not serving at Bulls or Hawks games. Not yet. So that's like you know, it's probably two-thirds of what goes on at that. That's the big win.

AnnaRae Grabstein: 21:05

Well, so Steve, tell me, you know, you guys structure your deals as senior secured, uh, which most people know means that, you know, if you if you don't pay, you're gonna get the keys. And so I want to hear more about that, of of what that really looks like. And um, if you could share some experiences of when a deal has gone wrong and and kind of what the outcome has been uh for Chicago Atlantic and and for the business.

SPEAKER_01: 21:37

Yeah, for sure. Uh, you know, cannabis uh obviously is a very nascent and and choppy industry. So, you know, we uh we are partners with our uh with our borrowers, right? I mean, it is you know, it's always like this is not a 30 year home mortgage, right? Or I'm gonna lend you capital and then I don't think about it again, and maybe until you get refinanced, right? So uh we are always working. working with our uh with our operators and you know frankly for for me as a you know sort of the lead uh originator here at Chicago Atlantic a lot of the ways that I deploy capital is by finding really accretive ways for my clients to clients to grow right so uh the same mentality is true if some if if it becomes distressed right if things don't go the way you know as planned I'm working with a group in uh in in Ohio right now you know kind of on a couple licenses that we lent into and you know it just didn't go as as well as they as they thought there was a couple of covenant trips and uh I spent the last week talking to investment bankers and and buyers and saying like okay like well let's like let's explore the the different routes you know out of out of this option that's a that's a win-win uh for for everybody involved right uh you know when you deploy three billion dollars into this industry on one hand it's not even remotely feasible to be like oh I'll just take the keys out of everything it's like no like you can't you just you you wouldn't even have the breath to like to to operate that much but the flip side of that is you have to be prepared to operate right um because not everyone is going to be rational not everyone is going to you know uh uh agree with you uh and you know Ben as you know in the in the venture world like a lot of these companies are you know it's like uh it's their baby you know uh and so there's this emotional uh attachment right that um not everyone can get out of the way of so you know I'd say when there is a default situation we're talking to our borrowers very very early on and we've gotten so much better. I mean our underwriting practices just internally at Chicago Atlantic have become so much more holistic we had a call yesterday uh just to go over like the sort of you know distress in in the portfolio right like and when I say distress I mean did you trip on a covenant right did you miss your your cash covenant last uh last month did you miss uh you know we call the uh FCCR covenant which is a fixed charge coverage ratio which is basically an indicator of how well that they they can service uh the debt and when one of those things is tripped my underwriters tell me uh and I'm on the phone immediately with a borrower and saying like hey like what what's going on right and like it there's usually a uh a pretty amicable uh solution out and you know my job is to go out there and to these to these borrowers like say my I've spent my life researching this industry investing in this industry here are the options as I see it right and it's very rare that a borrower is like you're way off base that makes no sense right they're usually like yep yep yep yep uh at worst they'll be like yes to all that and here's one other option that I have that you know uh you you couldn't have known about or weren't thinking about well you said you you have to be prepared to operate yeah that's not Steven Ernst operating right like have you guys stepped in to operate some of these assets and and what what has that been like yeah so uh our founder uh John Masarakis he uh started his career by building out a 50 chain pizza store on the East Coast uh and so I kind of joke he's like our internal Ray Groc. He actually is an operator uh which is I think what's really what helped us be successful early on, right? It wasn't just a bunch of financial minds in here saying like, oh this pro forma checks and like you know the the math works on an Excel spreadsheet. You know, you had an actual operator coming in saying like are you serving your consumer right like uh you know are these uh manufacturing best practices are you using data or are you just going with your gut as to what you you know you think uh the the consumer wants so uh so we are operators ourselves uh and so we we have operated we operate a a plat call a platform called Bureo uh and it is a pathway out for some of the distress assets that we we may uh find in in and outside of the portfolio so yeah we are not only investors but we are we are operators uh as well that's super interesting yeah when in talking about kind of the challenges that operators face when when things don't go the way they expect I mean that's fairly common in the industry sometimes it's due to the operator but let's give them all the benefit of the doubt and you know like going back to what you were saying about maturity cycles um they're pretty intense in the cannabis industry and and they and they vary greatly from from state to state and so I I guess or do they I I don't I don't know like how how do you bake that into your predictions and like how does that kind of like translate to the operators and I don't know are are there any states that are actually doing it better than most or or do you just assume the worst and hope for the best for sure you know and uh I I think that the cannabis markets uh they they lie on a spectrum on one end of the spectrum uh you have markets that are great for the consumer think your Californias your Oregon's um you know your probably even Oklahoma I'm a little apprehensive to say but uh and that's great for consumers all around the country yeah exactly uh and then there's uh and it's sort of inversely correlated right if the market in Michigan right um but if the market is great for a consumer which means they have access to uh you know uh a ton of competition a lot a lot of brands at very low prices uh it's it's very uh difficult on the entrepreneur right um for for for all of those same reasons right so you know historically I think the investment capital moved into limited license states and right and rightfully so right because when you have an unlimited license market uh you know I was living in California in from 2015 to 2020 uh you know I keep saying New York in today reminds me of California in 2017 where there's sort of more brands than retailers right uh and when there's more brands than than retailers right uh it's very hard to kind of pick a winner and say like who's gonna who's gonna win this war right it takes a while uh for for those groups to kind of separate from the pack um and we have made a couple of strong investments on the brand side wild and Jeter are two clients that we've built up over the last three or three or four years and they're number one in you know both of their respective their respective categories. And to your question are there markets that are better uh from a regulatory perspective absolutely I mean the uh I found that the red states in general uh are more business friendly they kind of avoid these uh social equity conversations which uh you know I was very bullish on and very um we've been a big part of I mean New York we we funded the New York social equity program uh here in Chicago my home state uh you know obviously a strong social equity program uh and all the way back to California when they did social equity in the in the in the Bay Area right uh geez that was 2017 20 2018 and like huge failure I mean listen I uh it to me it's like communism right I applaud the idea and I think the idea was great but we've tried it a bunch now and like it just doesn't really work right from uh yeah it's so let's let's dig into that yeah because like that New York deal surprised me when I saw it because all I could think was like we've seen this so many times what in the hell is Chicago Atlantic thinking backstopping this this equity program in New York and credit to New York it's actually been better than most markets as far as promoting the the equity operators but yeah like what was the mentality kind of going into that deal uh you know I I I gotta give credit to uh our CEO uh Peter Sack that was sort of his his brainchild and I mean he's one of my favorite humans in the in the world and uh and just a brilliant brilliant guy but um I think we went in and we said like hey these state governments and listen this was three years whatever three or four years ago at this point when these conversations started and we said hey these social equity programs seem to be a part of the uh the state legislature uh or let legislative process right there most of these states are coming on and saying you've seen again in Illinois you saw it in uh Maryland uh New York I think most of the blue states do some sort of social equity program and we thought okay this would be great like if anyone is capable of solving this problem uh I think it's you know we we've got as good a shot as as anybody so let's lean in here and and try to do you know the first private public social equity partnership uh that that we knew of so it was kind of like an ambitious shot on goal uh and you know ultimately the the the credit quality isn't for us on that deal was not the operator but the state of New York right and so you know that's that's what makes that deal tolerable right the state said hey we want to do this and we said okay if you want to do this like we will fund it and you guys will you know bat b backstop it up to a a certain amount uh and that's and that's how we're gonna go forth into it. So listen it's been choppy it's I think probably like you said the best social equity program that's that's happened is as far as like you actually have seen some of these folks you know get get equity in it. But I still do question how scalable something like that is. Originally we committed 150 million I don't know we I don't know if we ever get to that to that point. I'm not sure that they can scale you know enough high quality operators uh to survive through and like New York is maturing right I mean New York two years ago you had a license you probably did okay in two years less so it's competitive like you've seen in California right like you know you just like uh you just can't gift a business right like that's just not how capitalism works uh like these businesses are extremely difficult to run even with all of the right people in place right uh you know the the analogy that I give is like I mean like oh hey Ben didn't have a swimming pool uh growing up so we're gonna sponsor him to go to the Olympics uh because he didn't have to right and it's like okay you can sponsor him but I don't think he's gonna do that well right um Ben is very talented actually swimming I'm very weak in swimming yeah I'm sure I'm sure he I'm sure he is right but like when you're going up against like the people who are per you know the most qualified and capitalism has a way of you know of selecting who is most qualified to drive that value to the to the consumer uh I I just think it makes it very difficult to select on any basis outside of who's the most competitive.

AnnaRae Grabstein: 32:36

So yeah well from a structural perspective what you guys did in New York isn't the only like kind of really interesting and unique outside the box deal that I have heard about you doing. And you recently announced the deal that you did with S1 Enterprises, also known in the market as Illicit Cannabis and they um recently became an ESOP which is an employee owned company and we've talked about this on the show. I've done a bunch of personal research into this for clients who are interested and um it's it is really unique and I think while absolutely different than social equity it it also is kind of putting the future in the hands of people that maybe wouldn't be owners of businesses um otherwise in a in a pretty cool structural way. And it's it's been a it's been a popular structure for groups like grocery stores um that have become employee owned in years past. And usually these deals um basically what happens is a founding team um basic the owners sell the company to their employees and the employees who generally individually don't have the money to buy the the whole company will finance it in some way. And in cannabis this isn't the first ESOP deal but it's the first that's been uh publicly shared that it's had outside financing come in and generally ESOP deals have been financed by the sellers meaning the employees enter into a debt agreement with the owners the founders often of the company um which means that the founders don't actually get liquidity quickly. It's like a slow, it's a slow drip, which isn't really what they want. And so you guys got involved in this illicit deal and you came in and you financed the whole thing, which means that now the employees um own the company and they're in a kind of debt deal with you instead of with the original owners who theoretically get to exit stage left with some cash in their pocket. Is that a good understanding of of what happened? Can you tell us a little bit about that deal and how you guys approached it and got involved in it?

SPEAKER_01: 34:44

Yeah for sure. So another another fun fact about uh esops uh is that the most esops in the country are uh out of Kansas City uh and that's where Elicit is headquartered as as well. So there's just a concentration a concentration of of eesops outside of cannabis there. But yeah I think you you're you're you're mostly accurate in in what you said. You know the only thing I would say that probably the the main difference would be the owners are very much so staying on and staying involved right um you know I think you'd have like a same issue of like the social equity issue if you truly just sold your business to like the employees and you were like we're just gonna strip all the leadership out of here and uh you know good luck uh you know bud tenders and cultivators you know managing all the all the you know the the the corporate side of the of the business so you know for I think cannabis operators and listen eesop I think the benefits of ESOP uh can be most concisely explained in two words which is no tax so you know if you're and and not just 280 right no fit no federal no no state tax right um because you know the the spirit of an Aesop is the government going out and saying uh hey I want to incentivize uh business owners to shift ownership to their employee base right um you know it's like uh it's a it's like a social uh a social program so I think that when you look at these cannabis operators you know someone's been doing this now for for a decade it's a lot of fatigue right I mean a lot of these folks you know they were 30 40 when they when they started now they're 40 50 um and like they just want to go buy a home and like put their kids in like private school you know like in a in like a nice a nice school right this isn't like I'm gonna take this giant check and like go hang out on the beach right um and you know the Aesop owners uh the the the trade off is obviously no tax um obviously like you could get liquidity as as as we saw with the the um uh illicit eesop uh but there are usually like warrant structures where they can get another bite at the apple so you're kind of muting your upside a little bit you know where an Aesop would where uh you know an ESOP owner would lose is if there was some watershed moment in cannabis right and next year multiples jumped from you know whatever four to five times zebra to 20 times zebra right as we kind of saw in like the 17 18 19 days right um but I don't think anyone thinks that's really you know on the on the table right now uh and so it's like you know you take that tax free growth and you you pay down these these these sellers notes uh uh and then you have a really a really strong business so I think you'll see more of these eSop transactions happen due to a lack of uh liquidity options for operators that have been you know at this game for a long time and as we you know you guys know and talk on this podcast all the time it's not for the faint of art right I mean there's a lot of regulate constant regulatory changes in this business right you're living in constant ambiguity so to even take some chips off the table uh and say like okay I've at least got a nest egg after working in this industry for 10 years as an owner and risking everything and living in complete complete ambiguity at least I have some kind of liquidity off the table um you know to know my family's gonna be taken care of.

AnnaRae Grabstein: 38:14

I was really excited to see this deal just on a personal note because I think that there is the employees in cannabis have some of the biggest hearts out there. And I think even the structure allowing um employee ownership is really powerful and it gets people involved in a way that stock options never really have come to be fruitful for for cannabis employees who have been able to get small small little pieces of companies but then there's just really no exit there. And so this is just another structure and I think it's really great to see some institutional capital coming in and supporting it. And I think it will lead to more transactions in the future.

SPEAKER_01: 38:54

Yeah and like listen I think two you know 280e which I I know is talked a lot about a lot in in our world I mean it's punitive right I mean what is the equity value of a business that's paying tax on gross profit right not probably not that much right so you know I think the ESOP actually does two things it actually does shift ownership into the into the employees uh an ownership that has value right not just uh you know stock options like you know I like joke with my friends in the investing community community like if you don't own worthless cannabis stock you have not been in the space that long like it's just it's right I mean it's like literally just part part of it. I mean what percentage of cannabis companies you know that you could have invested in eight years ago still have you would be in the money other end I don't I don't know pretty dead portfolio to speak to that one. It's like uh yeah and listen and I think that's also why you know the credit side of things um has won out from a track record perspective right uh you know even if something goes poorly on the on the credit side well at least we invested some in something that you know had demonstrable value outside of you know a hope and a dream of being the the the best in class which is part of my apprehension with the beverage play right I'm like I don't know I don't know who's gonna be the like for me to select the winner in a crazy competitive race uh and this is coming from someone who's invested in you know dozens of early stage companies in in cannabis early on from from 15 to 20 very very few of which still of which still exist right but if you're writing on past performance or at least you've got hey you know uh you want a really limited license and I'm gonna put you know 20 million dollars into launching three or four dispensaries and a and a cultivation there's at least some value there and as a debt investor you're at least at worst case you're an equity investor at a lower cost basis right versus if you invested in in any equity valuations from again 17 to 20 I mean it you're just the it was yeah I wrote a report I was working with uh Viridian capital advisors and in 2019 I think it was like February March of 2019 the Canadian LPs were trading at 100 times trailing revenue it's like I mean what you know what I mean like what you're never getting out right it just there was no path to get out of that ever.

Ben Larson: 41:31

But if you're a debt investor you're like okay well whatever at least you own whatever you know whatever whatever exists and at the time of underwriting uh there was some asset right uh some hard asset or some revenue and profitability of the business so you can end up owning something right yeah yeah so look I I I know you spend a lot of time looking at the past but we have now mentioned 280e we've now mentioned regulatory uncertainty the beverage category which is largely hemp I I believe you're talking about yeah and so 2026 seems like a pretty consequential year uh you know there's a lot of talks around schedule three there is the pending hemp ban uh with a lot of activity in DC how are you thinking about this year from a from a risk assessment basis um like what are the impacts if if we see some positive movement on say schedule three yeah so actually I just wrote this uh about this in our I I read our quarterly uh newsletter to our investors which I posted on my LinkedIn if anyone uh cares to read it but um I kind of view it as a shift from a directional headwind to a directional tailwind uh I think a lot of folks want to think about this as again some some switch that you merely flip and everything's okay again um but let's let's dive into since there I think there's both such big and important topics.

SPEAKER_01: 43:00

Let's do rescheduling first. So you know uh you know we were talking about how long uh the New York market takes right to get from nothing to to where it's at today like we're six years into the whatever five five years plus into the adult use program and it's a two billion you know two two billion dollar market uh in a in a market that I think arguably it's probably roughly the size of California, right? Maybe it's a four or five, you know, it's halfway there. Schedule three is going to take time it already has taken time right when did the HHS come out and recommend that it reschedules I think it was like October or November of 24 I think if my memory serves me uh correctly. And so we are two plus years down the road from you know a major governmental department saying we're gonna do this and then Biden came out and said do this and nothing and nothing happened. And then Trump came out in November and said do this and nothing and nothing's happened. Uh so what the you know the question is like what does it actually take uh What is the timeline and what is the impact, right? Of schedule three on a go forward basis. And I and my crystal ball is super fuzzy on this stuff. I mean, I could not have been more wrong on the regulatory side. Like, I think if you would have asked me 10 years ago when I started in this industry when federal legalization was going to happen, I would have thought it was, you know, sooner than I think 10 years into it into it.

Ben Larson: 44:25

I think I I think I was saying five years when I first got in.

SPEAKER_01: 44:28

Yeah, it was always five. It was like five years perpetually. And then like seven years into that, people were like, just stop asking me. Yeah, exactly. But okay, so for rescheduling, uh, what I think you're gonna see is I do think that when Trump says jump, his, you know, his cabinet and Congress says how high, right? Uh, and so I think there's there's a demonstrable difference between the Biden administration and the Trump administration as far as like executive orders and like uh you know the willpower to actually get things done. The better question I think is like, what does it actually mean? And like what is the the timeline for that uh headwind to become become a tailwind? Uh and it's not enough for Pam Bondi to come out there and say, hey, we are officially rescheduled, right? Uh if we go from schedule one to schedule three today, right? Then the question is, when will the IRS opine on what I consider to be, you know, the majority of the impact of rescheduling is the removal of 280, right? Outside of that, I mean, yes, research, obviously, um acknowledging that it's a medicine, great. Uh, I think if it you know helps more folks get get out of prison or less folks get in trouble for it, I think that's all great. But from a business perspective, 280 going away is really like what 75% of the benefit of rescheduling. And so what I think you're gonna see is the IRS is gonna come out, they're gonna opine and say, they're gonna they're gonna draw a line in the sand, right? They're gonna say anything before this date, 280 yet applied, anything after this date, 280 uh does not apply, right? And then they're gonna have to go and they're gonna have to uh request the money back from all of the companies that have not been paying this, which is almost all the companies, right? So there's this giant uh, you know, what we call an uncertain tax position in the space right now. Uh and I think what you're gonna see is half the industry has no ability to ever pay that back. The IRS is a for-profit enterprise, right?

Ben Larson: 46:32

They're they're last time I checked, that was like a like a billion dollar bill. Like, do you know what it's has it balloons? I think it's more than that.

SPEAKER_01: 46:39

I think it's more than that.

Ben Larson: 46:41

Because that was like two years ago, I think that it's multiple billions.

SPEAKER_01: 46:44

Yeah, it's multiple billions, yeah. Which again is a drop in the bucket from a government spending issue, like three billion dollars. Like, pretty sure the national deficit is run up more than that on this call. Um, so you know, I don't think it's like a uh a make or break, but I think you'll see the IRS opine, they're gonna go to the half of the businesses that have zero capability of paying this back, and they're gonna say, Well, I'd rather have something than nothing. And they're gonna get on a payment plan with them. And then the groups that can't afford to pay it are gonna say, uh-uh, you let them pay 50 cents on the dollar. There's precedent for that. I only want to pay 50 cents on the dollar. And then GTI is gonna come and say, uh-uh, I already paid my 280 tax. I want a refund because you're not charging these guys the whole, you know, the whole thing. So there's gonna be a, you know, a litigation period on this, right? That I think is going to take years, right? Uh, I mean, I think you're from the time Pam Bondi comes out and says we are officially Schedule three, I think you're talking about a three-year period where we figure out what this uncertain tax position actually means across the space. And so it's not like there's gonna be some flood of institutional capital that's coming in. Let's not forget, schedule three is identically federally illegal as schedule one. Identically.

Ben Larson: 48:01

There will, however, be a flood of venture and retail capital. Sure, fine. Yeah.

SPEAKER_01: 48:06

I mean, maybe, I don't know, look at look at like up to Trump's announcement. It was like markets were up, up, up, Trump's announced announcement, crash. I mean, like, I even if you had a crystal ball, Ben, if you were like, I'm gonna give you the next two years of headlines, I couldn't, I still couldn't trade on it. I like I have the the the Canadian, you know, the CSE and retail investors, like, I mean, I'm done trying to guess that game as far as like how they're gonna react to these uh that's true to these things. So, you know, I think it's the next few years is figuring out what that uncertain tax position actually means for these for these companies, which is which is big, right? Um, but slow, right? It's again, it's not like one day you're gonna wake up and be like, oh, you don't owe anything anymore. And like, you know, even if they go and they say, hey, uh, as of 2026, you don't owe anything, they're still gonna have to have a payment plan. And actually, there's a um there's an interesting detriment that could happen too, where the government says, none of you have been paying 280 at all. You all owed 280E, and now you're on an actual payment plan and you actually have to start paying 280e, even though it doesn't exist in the future. So the balance sheets in the short term could actually be pressured uh because we're actually talking about 280e and what it actually means for these companies. Oh my god.

AnnaRae Grabstein: 49:21

And you've made investments into companies that have these uncertain tax liabilities, uh, and they're very public about it. They're public companies. So, I mean, so you must feel at some point kind of comfortable enough with the risk that this isn't gonna put you in a bad position, that there is a workable solution ahead for you know, Verano as an example.

SPEAKER_01: 49:44

100%. So, I mean, we include the uncertain tax position as leverage. We, you know, for us, like we are primed by the US government. And so, you know, there's some companies that have crazy 280 liabilities, like five, five times, you know, EBITDA 280 liabilities. And like, we were not willing to go into those companies, right? But if you're like, hey, I've got one turn of EBITDA of uncertain tax position, okay. Well, if I'm gonna go invest in it one and a half to two times EBITDA, and you've got this uncertain tax position, well, that's that's much more tolerable, right? Uh, and so we absolutely underwrite for that that uncertain tax position in in every company. And we include it in their in their leverage covenant, right? And so, you know, you can't just continuously uh accrue it, in which case, you know, you have to have a pretty hard high margin profile uh to make that work. So listen, I'm bullish on it. I think it is gonna change. I just think it's gonna be much slower than people expect and understand, right? You're not like JP Morgan's not coming in because you know the it gets rescheduled. Like it's just that the economics aren't you know are quite there.

Ben Larson: 50:57

Yeah. Okay, so I'm already getting anxious on time. This I I want to I want to part two of this conversation at some point in the future, but we do have the Canabev summit coming later this week. And so Steven, we had a uh a couple exchanges at the Ignited conference earlier this year or last year. Um yeah, let's let's just kind of dive in a little bit. Like, what's your perspective on what's happening? I know you see it as uninvestable from a you know from a credit perspective, uh, but there's a lot of hype around it. What do you think is happening this year?

SPEAKER_01: 51:32

Yeah, there is a lot of hype. Uh, and that is you know, just not our investment philosophy here. Uh you know, invest in the in the in the hype cycle. Hype doesn't pay the bills. No, that's like very, very venture, um, which is fine. And like I have like so much respect, I mean, for you know, American capitalism and the venture venture community. I mean, it's it's it's super fun and exciting, and you know, is the is the foundation uh that builds a lot of a lot a lot of great industries. Uh now on the hemp side, for me, I just I don't see a visible future where hemp, which to me is just cannabis, like I I frankly, like I'm a little annoyed uh that I've had to talk about this for like three years now, like constantly. Like hemp and cannabis are two different things. Uh, you know, the the the joke analogy that I make is if uh, you know, I popped up uh uh a table and uh was selling alcohol across the street from a bar. And I told the cop, I'm like, no, it's not alcohol, it's alcohol, it's fine, right? I would be tased on the street of Chicago if I said that. They would no one would care. Uh and so I think there's a little bit of intellectual dishonesty out of the hemp side uh in regards to this being legal and this being talked about uh and having any sort of framework to grow into. And so, and listen, that being said, like I'm a free the plant person, like I want to see cannabis, you know, everywhere. I think it should be uh descheduled, right? Um, but it has to be regulated. Uh, you cannot mix the honor system and capitalism. And that's what I see hemp as today. So until there is some level of framework where you know the adults sit around a table and we talk about this, and it's gonna be annoying and it's gonna, there's gonna be a lot of stupidity involved, right? But uh there has to be a pathway, right? There has to be a regulatory pathway that says, hey, like if if they come out and they say, which I do think my gut again, my crystal is super fuzzy on this, but my gut says if anything on hemp happens, it is a beverage carve, right? Um and if there is a beverage carve out at some level of milligrams, it I think that legitimizes cannabis as as a whole. We say there is a federally legal, right? Now now it's like now you have to re-question schedule three, right? Completely. Because you're like, nope, we have a federally legal thing. Like, how is this different? Um, but until that happens, I just don't see a uh credit product that is appropriate uh for that space.

Ben Larson: 54:06

Well, stay tuned on that. But I'm gonna expect your backing when it does drop.

SPEAKER_01: 54:11

Yeah, no, my job is to deploy, right? Like, I be I I would love nothing more than for beverage to be totally legal. If like if they came out tomorrow and said beverage is completely legal at any milligrams at any store, I'd be like, hallelujah, great. Like that that's awesome. I don't think it, I don't think it takes away from the regulated operators on the on the retail side. Um, I don't think there's a lot of opposition, right? I mean, the retailers in in any state, that's not what they're fighting against. They're fighting against uh, you know, someone who's not following any regulatory body whatsoever, saying, I'm gonna go buy, let's just call Spade a spade. I'm gonna go buy cannabis, right? I'm gonna go buy the psychoactive uh cannabinoid THC, right? Uh across the street from you, and it's the exact same products at a lower price that's untested, right? Like I don't think that's that's A, it's not fair from a business perspective, and B, I don't see it as uh uh beneficial to the consumer. Uh right. I don't think consumers should be buying untested products. And again, you can't just be like, I'm doing it right, and so it's okay. Like you have to do.

AnnaRae Grabstein: 55:21

Also, as it relates to this debate about hemp and schedule three and just federal policy in general, we've seen a lot of infighting in the industry, both kind of within the regulated cannabis space, within the hemp space. Uh, and then we've seen even crossover of regulated cannabis operators launching in hemp, less so of hemp operators launching in cannabis, but it's starting to happen. There's folks that play on both sides. Kind of what's your perspective about uh about this kind of mixed message coming from the industry and how that is potentially kind of harming the path forward for anything to get done? And like, do you have any thoughts on how we can make it more clear of what the industry actually wants or get on the same page together?

SPEAKER_01: 56:10

Yeah, it's it's it's tricky. I mean, I think that people just want to be treated fairly. Um and like there, I think there was been a mentality of like if you can't beat them, join them, right? Uh and I think that for cannabis operators, I mean, especially like in California, uh, a lot of times California, like there is just there is no pathway to profitability. Like you said, Ben, you know, uh, if you're like, oh, I want a 10 milligram, you know, maximum dosage in a beverage and it has to be in a dispensary, like we already have the data on this. We know that that doesn't, that that doesn't work, right? And so if you're an entrepreneur, like you're like, I'm gonna take the risk to do what actually works and serve and serve my consumer, right? Um and so hemp, whatever, the hemp loophole was a very natural outlet for that. And I think there's a lot of benefits from that, right? I think that uh you wouldn't have you know Ted Cruz or Mitch McConnell or these Republican senators even talking about cannabis whatsoever, uh, you know, if hemp didn't prolip proliferate across the uh uh across the country. So like I do think we need to get aligned again as someone who's been in this for 10 years though, I just unfortunately the easiest thing for a politician to do is nothing. And so if I'm betting on regulatory change, I am I am betting on nothing just almost every time at this point, knowing that I'd rather just be wrong the one out of a hundred times uh than you know, right out of the the the one out of out of a hundred times. So uh I just don't see how hemp in 300 days does something that cannabis has been incapable of doing for 10 years.

AnnaRae Grabstein: 57:46

Oh, we'll see. Well, Steve, um, it's come to the end of our hour and uh it's time for our last call. So I'm gonna turn it uh over to you one last time for advice, call to action, or closing thought to leave the audience with. What do you got?

SPEAKER_01: 58:01

Yeah, I'd say uh if you're building a business in the cannabis industry, just focus on serving your consumer. Focus on building a strong foundational company uh because the rising tide lifts all ships. So don't bet your business on some regulatory reform that that you think is going to happen. Build a business for your consumers. And when the regulatory change inevitably happens, uh the folks with the strongest fundamental businesses will benefit the most. So it's a bit of nihilism, but the good news is there is a lot in your control today. Uh, and what happens uh you know tomorrow can only can only benefit you. Amen. Amen.

AnnaRae Grabstein: 58:44

Thank you so much. Yeah, great to have you.

Ben Larson: 58:46

Yeah, NRA, Ben, appreciate it so much. Yeah, Steven Ernst, Chicago Atlantic. Thank you for the last hour. Yeah, man. It's knowledge bombs. Really do want to keep catching up because there's so much more we could talk about.

SPEAKER_01: 58:58

But yeah, I want to do a whole one on hemp. I feel like we need we need to dive in.

Ben Larson: 59:03

Uh we should probably schedule for for April or May. There should be some action by then.

SPEAKER_01: 59:10

Yeah, I'd love I'd love that.

Ben Larson: 59:12

All right, cool. We'll talk soon. Thank you both.

SPEAKER_01: 59:14

Bye.

Ben Larson: 59:15

All right, everyone. What'd you think? Another great show. Thank you for engaging, for dropping your comments, for liking, subscribing, sharing, doing all the things. Thank you to our friends and family, coworkers, Evertos and Wolf Meyer, and of course, our producer, Eric Rossetti. If you've enjoyed this podcast, please share it with your friends. Like I said, drop us a review, really helps us get discovered. As always, folks, stay curious, stay informed, and keep your spirits high. Until next time, be in the needles, Ami Ami.