A web of lawyers, consultants, investors and entrepreneurs are working around the clock to design and facilitate complex deals between many of the 25 largely unknown winners of the Ontario retail cannabis lottery and entities that consider themselves veterans of the cannabis industry who are intent on participating in the province’s cannabis retail system.
But structuring these deals is proving to be more complicated than first believed, given stringent ownership requirements laid out by the Alcohol and Gaming Commission of Ontario (AGCO) that prevent lottery holders from ceding any kind of control over the future ownership of a cannabis retail store at least until the lottery period is over in December 2019.
“There are lawyers that are contacting us saying they have clients looking to do a deal, and if we might know a lottery winner. And then you have lottery winners who want to sell their licence, but now realize they can’t just do that, they have to have a role in running the business,” said Rami Chalabi, a partner at McCarthy Tétrault’s cannabis group.
“So we are trying to figure out ways to help where we are onside with regulations,” Chalabi explained.
On Jan. 12, Ontario announced the 25 winners of its cannabis retail lottery, who had until Jan. 18 to submit an application for a retail licence, which upon receipt would allow them to begin setting up a bricks-and-mortar store in a designated region of the province.
A vast majority of the lottery winners were sole proprietors, but the AGCO’s rule of ownership effectively means that these individuals will not be allowed to either sell their licences (once received), enter into a franchise agreement that would see someone else run the cannabis shop, or enter into any kind of partnership that would see them share or hand over control to another entity.
“The AGCO has specified three things that I think many people were not prepared for: you cannot change the name of your business, the structure of your business and who controls your business,” explained Brenna Boonstra, who oversees the retail licensing group at Cannabis Compliance Inc., a cannabis consultancy. “If you’re a sole proprietor, no one can buy equity in your business, so you cannot take on partners.”
Brenna Boonstra, Cannabis Compliance consultancy
The question that lawyers and consultants are trying to figure out, according to Boonstra, is how can an entity who did not win in the lottery profit from a cannabis retail licence?
Abi Roach, the founder and owner of Hot Box Café in Toronto, Canada’s longest surviving cannabis lounge, calls the lottery process “ridiculous” because “most people who put their hat in the ring just wanted a golden ticket to get rich quick.” Roach says that she and her team at Hot Box had their floor plans, security plans and personnel in place months ago in anticipation of participating in the legal recreational market. That was before the lottery system was announced.
“I’ve spent 20 years in this business and now I have people calling me saying do you want to buy in? They don’t understand the fact that as a sole proprietor you cannot change the structure and ownership of the company. So what can I really do at this point?” Roach said.
An option for people like Roach, according to Boonstra, is to strike up some kind of revenue-sharing arrangement with a lottery winner, in exchange for the expertise on running a cannabis store.
“I’m actually seeing quite a few revenue-sharing agreements being set up, deals that are not related to ownership and equity. For example, someone who has a lease on a location suitable to open a cannabis store, could enter into a revenue-sharing arrangement with a lottery winner,” Boonstra explained. “But again, ‘control’ is a complex legal definition so you have to make sure the deals that you make are somehow not related to ownership and equity.”
Real estate investor Daniel Sax submitted a lottery application, did not emerge successful, but subsequently got contacted by a number of parties working with lottery winners who were interested in striking some kind of deal. Sax runs Sensi Properties, a real estate investment business that works with licenced producers to scout out buildings and locations suitable for cultivation. At one point, Sax claims he was close to “tying up 20 properties” in anticipation of Ontario’s cannabis retail market opening up.
But after three days of what he calls “complete mess and chaos” he decided to give up on making a deal with any lottery winner altogether.
“This whole process has been overtaken by greed. People are asking for millions, and so to me, the deals that I see being done are not economically viable. Absolutely not a sound investment decision,” Sax said. He declined to divulge details of what exactly transpired between him and a number of lottery winners.
… the deals that I see being done are not economically viable. Absolutely not a sound investment decision
Lottery applicant, real estate investor Daniel Sax
Chalabi, too, confirmed that he knew of bids directed to lottery winners that ranged between “$5 million and $7 million.
“You can’t sell that licence now, but there are people who are willing to pay and who are lining up to get into a position that will enable them to be part of this market in the future,” Chalabi said.
David Phillips, the former president of the Ontario Cannabis Store, believes that the AGCO has been quite clear in the language they have used all along in terms of the ownership and control lottery winners must have over a future cannabis store.
“But it seems that there is now a lot of creative thinking going about to determine ways that novel partnerships can be entered into. My advice to lottery winners is, be extremely careful as to how your lawyers and consultants structure any deal because the AGCO will apply very rigorous scrutiny and they are well-equipped to do so,” Phillips told the Financial Post.
Ontario’s cannabis lottery period ends on Dec. 13, 2019 — after that point, the provincial government has said that it would “open up” the retail licence application process. There are no clear rules how exactly that process will work, but the ownership guidelines spelled out by the AGCO technically only apply as long as the lottery period is in place.
“I think the way some people are rationalizing it is that if you enter into a deal with a lottery winner right now, you can have terms that say ownership and control remain with the winner until the end of the lottery period, then we renegotiate,” said Boonstra.
Sax, however, says he cannot understand why someone would invest so much in an arrangement that could fall apart if the “government changes their mind on a whim.”
“You have to navigate a partnership with X number of parties, in a very tight frame of time, to maybe make money in the future subject to what the Ford government wants? I’m happy to sit back, have my popcorn and watch this mess unfold.”