Following up on my prior posting about loan-to-own investing in the non-hemp cannabis industry (link), I thought it might be helpful to unpack some of the interplay among lenders in the capital stack (an insider term of art used to describe the different financing sources in a company – equity, debt, SAFEs), in particular, secured and unsecured lenders.

When a lender is secured, it means that they take a lien on the borrower’s assets to “secure” (further ensure) payment of the loan (which typically results in a lower interest rate, because there is presumably less risk if there is a default). On the other hand, the unsecured lender is relying solely on the financial wherewithal of the company to pay back the loan (which typically results in a higher interest rate, because there is presumably more risk if there is a default).

The interplay between the secured lender and the unsecured lender is critical to figuring out what happens next. The secured lender wants to control its destiny by selling the collateral – the assets or the business as a whole. On the other hand, the unsecured lender knows that it has much less control over its destiny – its rights are the same as those of any trade creditor (landlord, supplier) - so it has to work quickly and aggressively to enforce any rights it has, such as filing suit to get a judgment (and a judgment lien) and throw a wrench into the foreclosure sale (for example, who would want to buy a company that is being sued?).

With the secured lender wanting to maintain control of the process and the junior creditor wanting to do whatever it can with its limited toolbox, how does that play itself out? Frequently, the secured lender will require the junior lender to sign an “intercreditor agreement”, where the junior lender agrees to (among other things) standstill (meaning, wait) from suing for a period of time (from 90-180 days or indefinitely), to give the senior lender time to get control of the process and negotiate an outcome with the borrower (which could include a bankruptcy).

Why would a junior lender agree to this? Generally, because the senior lender knows that, if it wants the loan, the borrower has no choice but to convince the junior lender to sign. The borrower also benefits because, without an agreement between the senior lender and the junior lender, the senior lender has more pressure to foreclose quickly, to forestall the race against the clock motivating the junior lender to file suit and do whatever it can to get a seat at the table. And all of this is fairly typical in capital markets – junior lenders sign intercreditor agreements all the time and price the risk of having to standstill into the deal.

What is different about all of this for a non-hemp cannabis company? For the most part, all of these dynamics are in play; however, they are also thrown off by the lack of bankruptcy (either for the borrower to choose voluntarily, or for the unsecured creditors to try to force involuntarily) and the regulatory problem of foreclosing on permits. All of this needs to be appreciated when playing the multi-dimensional game of intercreditor chess.