Tony Cappell on De-Risking the Deal and Earning Higher Returns – EP 40

Tony Cappell on De-Risking the Deal and Earning Higher Returns

Today, I’m speaking with Tony Cappell. Tony is the Principal and Co-founder at Chicago Atlantic Group — a private market investment firm combining deep expertise with an entrepreneurial approach to multi-asset class investing.

As a debt investor with over 10 years of experience in the specialty finance space, Tony has completed over 150 deals comprising over $5B in total credit.

Prior to founding Chicago Atlantic, Tony was a Managing Director and Head of Underwriting at Stonegate Capital, a private credit investment firm that specializes in the cannabis industry. At Stonegate, he was responsible for credit, underwriting and the growth strategy of the loan portfolio.

Tony is an unbelievable source of information when it comes to understanding loan and fund structure. He knows exactly what to look for when it comes to protecting the downside and mitigating risk. He’s also a wealth of knowledge when it comes to enhancing a deal and creating opportunities to earn better returns — or what I like to call, income amplifiers!  

And today, you’ll hear us talk all about it! We dig into debt structure, strategies for de-risking a deal, how to negotiate better terms with things like equity kickers and liquidation preference, and why regulatory arbitrage is creating a massive opportunity in the cannabis industry. That, and a whole lot more!

Key Takeaways with Tony Cappell

  • How Tony became a lending expert and the expertise he gained when it comes to underwriting and analyzing deals.
  • The difference between debt and equity investment deals. 
  • What exactly is senior debt?
  • The importance of protecting the downside.
  • Why Tony and his partner started an asset management firm that specializes in the cannabis industry. 
  • Understanding regulatory arbitrage and cannabis investors are getting such high returns.
  • How to sweeten the deal with Income amplifiers!
  • Why warrants are the primary equity kicker that Tony’s firm uses. 
  • What does cashless exercise mean?
  • How to negotiate a liquidation preference into the deal so you can get paid back before anyone else gets a penny! 
  • The difference between Net Income, EBITDA, and Free Cash Flow
  • What is collateralized lending?
  • Steps you can take to de-risking the deal.

Tony Cappell on The Value of Securing The Deal with Collateral

Tony Cappell Tweetable

“Investing, whether it’s debt or equity, is not something you learn in a book. It's about experience. Every deal is different, every situation is different, and what really matters is getting a lot of at-bats.” - Tony Cappell Click To Tweet


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Read the Full Transcript with Tony Cappell

Justin Donald: Hey, Tony. I’m so excited to hang out today. I am so appreciative of you making the time because I know that life is crazy and busy, and in your world, you’re experiencing some of the most success and exciting things that you ever have. So, thanks for making the time to be on the show today. 


Tony Cappell: Thank you for having me. Happy to be on. 


Justin Donald: You know, it’s really fun getting a chance to really get to know each other over the last number of years. And it’s cool because we both have a mutual friend. Our friend, Brian Reiner actually connected us and he felt like I just had to meet you, like your level of expertise in the world of underwriting is second to none and that you are just a wealth of knowledge and that you have expertise in some pretty niche markets. And he’s right. I mean, I have just thoroughly, thoroughly enjoyed getting to know you and picking your brain. I mean, you love to share the knowledge you’ve accumulated. 


Tony Cappell: Absolutely. And honestly, thinking back to when Brian made the introduction, I mean, you never know what anything, what will lead to what, and I still remember waiting to connect with you. I think you were on a European, a mini road trip through Europe, and we had I think it must have been July or August when we connected and the feeling is mutual. I mean, the network that you have and had built and continue to build is second to none. And it’s been great knowing you and great doing business with you. 


Justin Donald: Well, thank you. I appreciate it. I’ve had a lot of fun. In fact, we’ve had some great results together. There’s no doubt about that. And we’ve met some cool people together and it’s really fun when you share a law firm as well that you trust and is top of their trade and their craft. That just gave me a lot of confidence as we move forward really in the introductory stages but it’s been fun. You know, when I think about you and I think about kind of how you got started in the business world, you really got your start in lending, right? And in underwriting deals that you have this level and the sophistication in the world of debt that not most people have because you can be a lender. That doesn’t mean that you understand what goes into these structures and how to actually underwrite and analyze these deals and protect yourself. I’d love to hear kind of your level of expertise and what you’ve done and how you got started. 


Tony Cappell: Yeah. No, absolutely. So, I started out at Wells Fargo, Foothill, and at the time, it was known as the lender of last resort at least from the banking world perspective and I was in the asset-based lending market. So, these are companies that either they want more leverage than a commercial bank is willing to give or the business is in a transitional period that needs a specialty structure. And so, I started it was collateral examiners. So, I would be the guy or the analyst that would go on-site to the business and do all the due diligence for the underwriter prior to doing a new loan. And so, I would go kick the tires. I’d spend a week or two at a company, write my report, move on. And out of college, I couldn’t think of a better first job because I would go to 20 to 30 companies a year. And you focus on cash flow collateral. Why is that business successful? What are the pitfalls? And you would just go and move on. You move on. You move on. So, it could be auto manufacturer Tier 1 or Tier 2. It could be cheese manufacturer, distributor. I mean, you name it, I did about 120-some deals while I was there. And so, that was an incredible experience. You know, we learned a lot and I guess you could say, fortunately or unfortunately, I went through the GFC or the global financial crisis of 2008 with them. So, I had the luxury of having to liquidate a few companies, I guess you could say luxury or burden, but that is an incredible learning experience and you see kind of what things are worth in the worst of times. And it was an incredible learning experience but that was very valid. 


Justin Donald: I was going to say, and you got it early in your career like what better timing to see that early on. That’s powerful because you’re seeing what typically is going to happen under normal circumstances. That’s how most people analyze a deal. But what you want to do is you want to stress test that deal. And once you are able to see a deal and see the stress and how that impacts a company over a financial crisis, over a recession, over just anything that could be a huge burden or could trigger a collapse, you then become that much better to structure all future deals. 


Tony Cappell: Absolutely. And investing, whether it’s debt or equity, it’s not something you learn in a book. It’s experience. Every deal is different, every situation is different, every context is different, and what really matters is getting a lot of at-bats and being through from cradle to grave in these deals. And so, I just had the fortunate experience of being in great deals and tough deals. And that really adds to your overall let’s just say toolkit to know what to do if and when something happens but more so know what to do so it doesn’t happen again. 


Justin Donald: Yeah. And you had mentioned here, this is a good point, you specifically said there are debt deals and there are equity deals. And I would venture to guess as you and I would say, well, those are two opposite ends of the extreme, I would venture to guess most people probably don’t know the difference between the two or the fact that there is two different vehicles here. Can you elaborate on that for our audience? 


Tony Cappell: Yeah. So, I mean, really debt you think about it as the bank, right? Who’s the lender on your mortgage, the bank in your mortgage, or in this case, lender to the company? They are the first to get paid or in what’s called the waterfall or the liquidation preference. And therefore, they’re entitled to a lower return. That’s why it’s 3% for your mortgage or 4% to borrow for your company because if anything goes wrong, they’re the first to get paid, and thus it’s a much more protected position. Equity, on the other hand, is the last to get paid but you’re entitled to the upside. And that really there’s a lot of nuance in between but those are the primary differences. 


Justin Donald: And there are certain investments that are going to combine the two where there’s a debt component and there’s an equity component. And there are a lot of different ways to kind of construct one of those deals but that’s something that you often have employed in the past and currently employ in some of the investments that you do today, right? 


Tony Cappell: Yeah. So, really what we have done today and we built a firm and we seek out what we call inefficient markets where the demand for capital far exceeds the supply which creates a very, in this case, a lender-friendly environment. And so, because the demand is so high for the capital and in some cases, we’re able to not only charge above-market interest rates but we’re also able to get a piece of the company through warrants or through membership interest or other instruments like that, where it’s just an added kicker, an upside to your position. And again, there are not many industries and areas where you’re able to do this. It’s just about finding that inefficient market to do it. 


Justin Donald: Yeah. That’s awesome that, A, you found it and, B, that the gap is so wide. We’re going to talk about this a little bit more but before we dive into that, you move from Wells Fargo, if my memory serves me correctly, to a specialty firm, a very well-known like high-end brand. Talk about your experience there. 


Tony Cappell: And prior to that, I was at a middle-market bank in the Chicago area. We did a lot of asset-based deals but we also did a lot of workout deals, which are the deals that go from commercial to a different department because they run into trouble for one reason or another. So, there we learned a lot of how to deal with those situations. But most recently, I was the head of credit and underwriting in Stonegate Capital, which is a lower middle market specialty finance fund in Chicago. And we would do the businesses that are a high growth sponsor-backed, negative cash flow, those would be doing a senior debt deal within the assets. We would also do destress turnaround in special situations and then also some of what’s called rediscounting softer loans. So, these are we’ll call esoteric credit classes that a bank cannot do and we’re able to charge for the added risk that may be inherent in the deal. 


Justin Donald: Perfect. And you mentioned senior debt, and that just means you’re in the first position, the best position, the one that will be paid out first should the deal not work out. And even if the deal does work out, you’re in the first position. So, I think that’s a very important point there. And it’s great that you had the experience. I mean, you had the experience of super conservative. You worked for a bank. Banking, you know, these are Wells Fargo. This is like a conservative bank that’s going to be by the book and then you’ve got this specialty lending shop where you’re doing a lot riskier stuff and you’re investing or lending to companies that are high risk, high growth operating companies. I mean, a whole bunch of things under the sun but I feel like what a great cross-section of experience that you got doing that before you went on your own and started your own organization, right? 


Tony Cappell: Yeah. Again, I think like any investment since it’s at-bats and an experience of doing deal after deal after deal. And for every deal you do, you probably look at 15 to 20 deals that you don’t do but that entails an education process. Why does this deal make sense? Why does it not? So, there’s a significant amount of businesses you learn about through that process. And again, it’s all about debt is about structuring the downside. You know, you’re there. It’s about how much money you don’t lose versus really how much money you make, whereas equity is really the opposite. 


Justin Donald: Yeah. So, I love that emphasis on not losing money, protecting the downside. That is total debt play, a total lending operation where you want to make sure you’re not losing money. You’re okay with not as big of a return. You just don’t want to lose. And I think that’s a great point. Now, you had mentioned earlier that you underwrote 120 deals while you’re at Wells and I know you underwrote a ton of deals at various other places. I’m curious, though, of the number of deals you underwrote, how many deals did you actually look at? Like how many things came across your plate? 


Tony Cappell: Well, I would say, I mean, it has to be in the thousands by now and it’s funny, you see deals and you may not spend a lot of time on. I mean, I do it and then you see it a few years later at a news release and you think I remember that name somewhere and sure enough, we looked at it for one reason or another. But the one thing that I’ve been just unfathomable about the United States is that there are so many businesses and companies in this country that there’s an endless amount of opportunities. And that’s one thing that it’s crazy because you would think at a certain point you’d run out but it’s not been anywhere the case. 


Justin Donald: Yeah. And it’s great that you’re taking all this experience but your foundation we didn’t talk about. You graduated from a very prestigious, very well-known business school, University of Chicago Booth, and you met some incredible people while you’re there. You met your business partners while you were there. You met friends and colleagues and advisors there. And I’m curious about that experience because I’ve just heard nothing short of tremendous things about the education there. 


Tony Cappell: Yeah. Honestly, I have a lot to owe it in the school. Well, it’s funny. I’m lucky because my wife effectively made me go to business school. I would have never gone if it wasn’t for her pushing me and, in fact, may have given me no choice. So, I had to take the GMAT, I had to do all these things that I didn’t want to do, and ultimately, I didn’t think I could get in either, that just all those things were working against her but she prevailed and for the better. And ultimately, I met my two current business partners there, John and Andreas, who, again, we built a pretty nice firm and without having such a strong, cohesive team where everybody kind of works and complements each other. You just can’t do something great without having that recipe. So, have a lot to owe the school. 


Justin Donald: Yeah. And it’s great because, I mean, it’s a lot of work to get into any business school but to get into one of the top in the nation, to get into Booth, you’ve got to do your homework. You’ve got to commit to the work and they are very selective. And I’ve had the luxury and pleasure of meeting both your partners and just think the world of them, and really what I think is cool is how each of you complements the other person so well. And we can definitely get into that but I guess we’re at the point now where you have all this experience, you’re about to embark on this journey of starting your own business, and I mean, that’s got to be nerve-racking. You are going into uncharted territory at this point and you start a specialty asset management firm that specializes in the cannabis industry. And I would think most people would say, “Gosh, Tony, that’s out of left field. Are you sure that you want to do that?” Because you started early on. You started before the buzz and the craze in this industry existed. So, I’d love to hear that story. 


Tony Cappell: Yeah. And it’s funny because, again, without the right people and the right recipe certain things just never happen. And so, really started at being at Stonegate and just seeing some of these businesses. This is in ’17 and ’18 and you see that here is an incredible opportunity. This industry while it’s still illegal from a federal perspective, it’s still there’s incredible growth that is coming ahead. And so, while you look at the non-cannabis industry, there’s just so much capital in the system right now. And so, what’s happening, a lot of deals are becoming, the structures are getting looser, leverage is going up, returns are going down, and that’s all a function of just too much capital in the system versus underlying credit risk. And so, we started to look at some of these other businesses. Now, we could never do them because of our LP base and we had background bank leverage, and so on. But here was an opportunity like, hey, you can specialize in a growing market that’s arguably uncorrelated to the greater market but then bring institutional know-how, policies, and procedures and build a real firm. And like I said earlier, it’s an inefficient market where the demand for capital far exceeds the supply. What you’re able to generate far above-market returns because of, in this case, it’s a regulatory arbitrage. So, it made all the sense in the world. I decided to leave Stonegate. And it’s funny because I told John, my current partner, “Hey, this is something we should look into,” and John built a pretty large hospitality business and he’s used to operating in one of the most competitive markets in the world. And again, he’s looking for that inefficient market. I told him about it thinking there’s no way I would ever do it but he said, “Yeah, let’s do it.” And he didn’t even think about it. And I’m like, “Whoa, whoa, whoa, you know, like, I don’t know about that.” And so, ultimately, that is what kind of made it so that John is the entrepreneur to the core and ultimately had the vision where I’m more of the banker lender, let’s say the sky is falling guy. He had the foresight to kind of see forward much further than me. He convinced me to then ultimately leave and get this started. 


Justin Donald: Well, it’s great because you say no. That’s your job. Your job is to be as critical of every investment that there is. You go into it as, “This can’t work. And if I can prove the fact that it can, then this is a good investment.” But you go into it saying, “No way. This is a bad deal. Everything’s wrong with it. It can’t survive for so many reasons,” and then you kind of work against that mindset and that theory. And I think that’s great. 


Tony Cappell: Definitely. And one thing, I’ll take it a step further because right now with our investment committee, myself, John and Andreas, and there’ll be other people coming on soon but we have such different backgrounds and perspectives and things that I like that John hates, that he likes that Andreas hates and so on. And so, we have a very diverse investment committee. If you go to most investment firms or even the best finance firms, it’s very myopic. Everybody looks at things the same way because they all came from the same background. It’s what is the cash flow? What’s the collateral? It’s the only one we look at it. In the case of cannabis, it’s such an operationally intensive business that having the operational view versus a financial or collateral view is just as important, if not more important when determining winners and losers. So, John brings a view and experience to our team that I think separates us from other people because he can go and he can see how does everything flow. What is the production? What’s the cost of production? All the things that may not show up in a financial statement but really is what matters at the end of the day. And so, we have done some deals that I had trouble with in the beginning but John convinced me because of X, Y, or Z, and these deals are turning out to be incredible deals because we have warrants in some of them and we’re going to get paid an amazing return on a risk-adjusted basis, given that we’re senior secure debt. 


Justin Donald: Yeah. And I definitely want to dive into some of these terms you’re using, some of the perks, some of what I like to call like when you look at a deal, there are certain ways that you can amplify the deal, amplify the terms, amplify the income. So, I call them income amplifiers. So, I really want to dive into those. But before we do, you mentioned something earlier that I think is really important and I want to kind of capture this. You said something that you really love about the cannabis industry is regulatory arbitrage. And I think in order to do this topic justice, because I think this is one of the greatest keys, one of the biggest perks, I mean, this is the reason that this is so lucrative, I’d like to dissect this a little bit with you. 


Tony Cappell: Yeah. Absolutely. So, what that means is, and for everybody’s purpose, cannabis is still considered illegal on a federal level. But we all know that there are various states, I think about 40 states now have some form of legalization. Now, the federal government has not done anything from an enforcement perspective and that’s for a long period of time. So, while it’s still considered illegal, they haven’t done anything enforcing it, and so on. And so, because of that, all of the traditional capital providers are not in the space, whether it’s banks, whether it’s institutional investors, just all the capital that is just shut out. So, because of that, there’s a very capital-starved environment. And so, ultimately, because we have capital, we’re able to generate far above-market returns because a lot of people are not allowed to invest or are afraid to invest because of the perception of that differential between federal and state legality. But that is a perfect scenario where I think we are very comfortable that this market’s only going one direction. It’s not a matter of if but when it’s fully legal. And because of that, we’re very comfortable doing deals specializing, learning, and building a real firm while people are still worried about it. And then that’s why we’re able to generate such high returns 


Justin Donald: And you’re able to generate high returns because they’re willing to pay abnormally high interest rates. And the reason for it and I think sometimes people look at this and they say, “Oh, man, you’re gouging the cannabis industry,” but that’s actually not it. The reality is they would rather pay a high-interest rate than give up the equity in their company because they’re growing so fast. These are like quarter-over-quarter like massive. You’re talking 30% growth, 25%, 30% growth quarter-after-quarter. I mean, the industry is just booming and I think it’s important for people to realize that this is a win-win situation. It’s a win for the cannabis companies that don’t have to give up equity or don’t have to give up as much equity. It’s a win for the company for your specialty firm. And then it’s a win for the investors because they make abnormally high returns then as well. And so, what a cool just way to kind of connect those three different areas, those three different groups that generally are not aligned. 


Tony Cappell: Absolutely. And one thing, and this is one thing and it’s a simple concept but that really they forced the concept into your brains at business school, and everything is about opportunity cost. You know, in the case of the borrower, like you said, they can borrow at 12%, 13%, 14% or they can sell a piece of their company, which then is ultimately way more expensive. So, they do this by choice. They want to do this but they are borrowing at these higher rates. The return on the capital that they’re getting and using is significantly more than what they’re paying us. They may be buying another company or a dispensary or a cultivation facility. They’re going to be generating 50% to 100% returns for their equity. So, paying us a higher amount, it doesn’t matter because the equity is the beneficiary of that spread of return and that’s why it all makes sense. But everything needs to be priced off of opportunity cost, and that’s really the way to look at something. 


Justin Donald: Yeah. And you talked about the spread or the delta, that margin of difference between what you’re paying for money and what you’re earning with that money. And that’s the name of the game and everything. That’s the name of the game in real estate. It’s the name of the game in cannabis. It’s the name of the game in running a company. It’s about repurposing the dollars that you borrow or the dollars that you have invested and generate a greater return than the cost of that capital. And you guys not only do a great job of really purposing capital well but you do a great job of finding companies that are poised to expand at a rapid clip. And I think that that’s tremendous. 


Tony Cappell: And to that point, if you look at one of the things in lending you ask yourself, what is the use of proceeds? That’s an important fact. In this case, virtually every single dollar that we’re lending out is for growth CapEx or mergers and acquisitions. Those are both highly accretive uses of capital. And so, that is a great thing to be financing because you’re ultimately adding value to the business that you’re giving money to, which further mitigates your risk and maybe makes you more money because you have an equity kicker or something else along the way. As the flip side of that, let’s say you’re financing a dividend. Well, if someone’s taking money out, it’s not a great signal and it’s a worse reason to be financing a business. So, that’s an example where because there’s so much growth that’s going to be ahead of us for the next five to 10 years, it’s great to invest in a rising tide environment. It doesn’t matter what industry you’re in. It’s a lot easier to be right but it’s also a lot easier to make an outsized return. 


Justin Donald: Yeah. Great points all the way around. And I want to give some props to Andreas, one of your other partners, because he is quite possibly one of the most brilliant people I’ve ever met. I mean, that guy has a mind that works at a level that my mind cannot fathom. And this guy, I mean, to give some perspective, this is a guy that is not a lawyer but has studied law and has studied contracts at such an in-depth level on his own time, on his own accord that he knows more than a lot of attorneys out there. And he is often proving attorneys wrong that are kind of questioning his decisions or the way that he’s interpreting terms. It’s really just fascinating. 


Tony Cappell: Definitely, he loves to read. And if he hasn’t, if he doesn’t know something, you can bet that he’s going to read until he knows it and we’ll know in the morning. And one thing I tell people and you go back to the Stonegate days, most of the legal and the credit decisions would always go through me and I was kind of a one-man show to a certain extent. Here, being on some of these credit agreements he calls it, I’ve never felt more ineffectual in my life. And it’s ultimately a great thing because I don’t like to do it anymore. And so, he’s way better at it and again, it’s just been very vital because these loans and these structures are so complicated in this industry much more so than the non-cannabis world. So, it’s worked out great. And again, he’s been a great addition to our partnership because he does so many things great that myself or John doesn’t and vice versa. 


Justin Donald: And the way he can crunch data is just out of this world. So, just hats off to him, all the praise in the world. And just to your team, the way that you guys operate, and your strength, it’s really cool. I want to get to a couple of things. So, number one, when you look at a deal, when you look at investing, so for me as an investor and for our audience as they are investing in things, there are two things that I talk a lot about. One of them is protecting the downside, protecting the risk, derisking a deal. The other one is enhancing the upside, creating more opportunities to earn some better returns. And so, in my book,  The Lifestyle Investor, the second commandment is all about derisking the deal. And then the sixth commandment is all about income amplifiers. And so, I want to tackle both of these with you because I think you do them brilliantly. And let’s start first with the upside because you’ve mentioned a bunch of terms that just are music to my ears. All right. You’ve mentioned equity kickers. I love equity kickers. This is like one of my favorite things to negotiate in a deal and you’ve talked about warrants as well. And I think it would be great to kind of hear the difference in those and why you might want one over the other and when one is applicable and one’s not applicable, because basically, in either case, you’re getting free equity or you could execute the option to get free equity. So, let’s talk about these. 


Tony Cappell: Yeah. So, I would say the majority of what equity kickers were able to get out in the form of a warrant or a warrant is an option to purchase. And if you think about it, let’s just say, for example, you have a company that is trading at $10 a share. Let’s say we do a loan to that company and today we’re entitled to 10 warrants at $10 a share because that happens to be the share price at the time of the deal. Now, that is not always the case. It’s just some prime example. Let’s say the loan is a three-year loan and at the end of three years, the company is now worth $20 a share. Well, we have the option to purchase that company at $10 a share and it’s trading at $20. So, we would then make the spread between our strike price and what the company is worth at the time of exercise. And so, that is what would be a warrant or a stock option, which again, is the majority of what we’re able to get. The reason that that’s what we’re getting is because it’s easier to sell to the company that, “Hey, I’m putting money in now, I’m investing in the debt, but I want to participate in some of the upside, a small piece of the upside that I’m helping create.” And so, you’re not coming in at zero. You’re not coming at a dollar. You’re coming in at 10, which is that price is then. And that’s really why options or warrants are really the predominant form of equity kicker. Now, sometimes you’ll get what you actually get equity in the company. The reason we’re not getting that is that it creates more tax consequences for us as the fund or as the firm and we would rather not create any tax issues by doing that. 


Justin Donald: And that makes sense on a lot of levels. Another point that I want to bring up about, the difference with equity kickers and warrants, is if you’re starting a new business or if you’re buying something out of bankruptcy, it’s a lot easier to issue equity at that point in time when there’s no sales versus a company that’s already operating, there are sales, right? So, there Is kind of like a value to the company. It’s hard to assign that equity. So, it’s a lot easier to kind of go with the warrants and say, “Well, here’s your strike price,” and you would only execute then if it makes sense in the fact that the shares would sell for more. So, it’d be in many cases people would wait. You would exercise that option at the time that there was that delta and you’re going to make a margin and it would be kind of like a cashless transaction. It’s not like you have to put in a thousand shares times $10 a share. You would just make the difference in the strike price and that current price. 


Tony Cappell: Yeah. And that’s called cashless exercise. But all deals, it all depends on how you structure them from the front end. We prefer cashless exercise because we would love not having to put money in. So, that’s the preferred form. 


Justin Donald: One of the things I love a ton about what you do, Tony, and what I do when I structure deals is negotiating a liquidation preference. And with a liquidation preference, you are basically moving up or down. Ideally, you’re moving up in the pecking order of who gets paid when and where. And so, I’d love to talk about how you use these liquidation preferences to your advantage. 


Tony Cappell: Yeah. I mean, in terms of like the equity kicker, it’s harder to get the liquidation preference. Sometimes it could be in the form of what’s called preferred equity, where you may be entitled to get one time or two times your money before the common equity gets any of the return. Sometimes that’s how it’s done. But in general, being in the debt is really how you protect that. So, from a liquidation perspective or for preference perspective, you get paid 100% in full before anybody else gets a penny. And that’s why in the majority of what we do is in the debt, of course, so that if anything does go wrong, we’re absolutely getting paid. 


Justin Donald: And there’s a difference also between creating a liquidation preference on the gross proceeds versus the net proceeds, right? So, the net proceeds mean someone else got paid somewhere before you did but the gross proceeds mean you are truly first in line. You are the first person to make a profit or make money on a transaction. And I know that that would be the goal of every liquidation preference. 


Tony Cappell: And another example of that is like people and we haven’t done this and we don’t but people that structure royalties as a percentage of revenue as opposed to a percentage of net income or EBITDA or free cash flow, you’re effectively taking your cut at the top line. So, before anybody grabs anything, you’re getting paid and that’s why they’re very punitive to the company that’s paying them. It’s what we think of as like the government in taxes is like they have a royalty on everybody, so they get about 50% of your work, which is it’s a function of the country we live in but it’s a great position for them to be in. 


Justin Donald: Yeah, there’s no doubt. Now, you just mentioned three important financial terms that I think we should actually break down as well. You mentioned net income, EBITDA, and free cash flow. And these are all different, I guess, financial mechanisms or profit mechanisms that you can use to calculate the success of a company. And different industries are going to kind of focus on different ones. You’re probably, I mean, there are investors that really feel strongly on some over the other but I’d love to hear kind of your opinion on those three and what you prefer and if there is a reason to prefer one over the other. 


Tony Cappell: Yeah. I think from a lending perspective, you always want to look at free cash flow. So, free cash flow means at the end of the day, how much cash have you increased? So, from day 0 to day 10 or day 20, and that means effectively your net income after tax minus any capital expenditures. And so, what I’m as a lender, cash is king. I want to know how much cash you’re making after you pay everybody because I want to make sure that you can pay my loan back and I want to make sure you can pay it back in the time that we are giving you. Now, from an equity perspective, generally, EBITDA is the more important metric. It’s important in debt but equity likes to look at EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization, because what that means is what is the operating income of the business and without taking effect of the capital structure. So, take out how much interest it pays, how much taxes it pays, and a few other things that have nothing to do with the operations of the business. Because at that point you can see what is the earnings power for the business under any capital structure. And so, that’s really why EBITDA is the more important metric for equity. 


Justin Donald: And so, in what cases do you use net income or in real estate, it would be often referred to as net operating income. 


Tony Cappell: Yeah. Net income is really, in some cases, net income equals free cash flow. It depends on the type of business because, again, not all businesses have a lot of capital expenditures or having to buy capital equipment to continue to or operating assets to build a business. So, it all depends on the head business but net income is also important because net income could mean free cash flow as well. 


Justin Donald: Awesome. Now, what other mechanics do you use that help kind of sweeten the pot? Like, how can we create more income amplifiers than what we’ve just discussed? And by the way, what we’ve just discussed are great. I mean, if you got just one of those, it can be incredible but often you guys are getting many of these. And in the deals that I do, I’ll often get these layered on top of one another. So, is there anything else that we should pay attention to? 


Tony Cappell: You know, it all depends whenever you’re pricing a deal, a big part of it, and this is and again, I think we spoke about this, Justin, on a lot of our calls is psychology is a big, big factor in investing, lending, in pricing. And so, knowing how your customer and it could be your borrower, it could be the company that you’re buying, how they think and how they operate. And so, one example that we love to think on is that sometimes the only thing that matters to the borrower is the interest rate. They don’t care about the closing fee or the OID, which is called original issue discount. They don’t really care so much about the other fees because they’re fixated on interest rate. And so, in that case, you’re able to have a lower interest rate but have higher fees that ultimately get to you to a better spot from a return perspective. 


Justin Donald: That’s awesome. And those are kind of like the focus is on upside, on income amplifiers, how to enhance the overall return. Let’s take the other side of the coin here and talk about how do you derisk a deal? I mean, one of the ways most certainly is collateral. You had collateralized your loan or an investment. You could collateralize for a lot greater than the value of the loan or investment. I think that is a real interesting way of doing it. There are other mechanics that you can put into place but I’d love to hear some of your thoughts on how you do it because this is really where you are the master, right, an underwriter, an analyst, like this is your sweet spot. 


Tony Cappell: Yeah. And we spoke about being senior, right? Senior meaning you are the first get paid in the capital structure. The next piece that goes along with that is secured. So, senior secured lending, that’s what we do. That means that not only are you first but you have a security interest or a position on specific collateral. That could be real estate. That could be equipment. That could be accounts receivable. It could be intellectual property or it could be the stock of the business. All of these are forms of collateral that further improve your position. Like your bank that is your mortgage provider, they are lending you money based on the value of your house and therefore they lend you 60% or 70%. And they feel that at no point or at very, very low percentage chance that they’ll ever lose money because it’s backed by the collateral. And so, number one is just being secured and being secured at a very low, what we call a loan-to-value. So, lending 20%, 30%, 50% against that collateral value really gets you in a good spot. Beyond that, there are other ways to improve your position. You could be having a personal guarantee from the owner. That I would say it’s more so in place for a cooperation guarantee than an actual access to secondary capital. But it’s good to have their attention and cooperation if anything ever was to go wrong. Beyond that, it’s really what I like to call structuring the covenants in place so that if anything happens from a financial perspective or anything changes, that you have an ability to effectuate change before there is real deterioration in value in your borrower.


Justin Donald: Yeah. That’s really good. So much wisdom there. When I think about collateralizing effectively, you can have as many forms of collateral as you want. It’s all up to kind of the negotiation here. And so, you can have something that’s two times a value, three times, four times, five times. You could have various different things. You could have accounts receivable. You could have real assets. You can have equipment. You can have owner’s pledge, stock of their company. There are so many different ways to do it. I’m curious what’s most common and maybe for you, what’s most desirable? 


Tony Cappell: Yeah. The most common is what’s called a UCC filing on their business and their receivables inventory. And that’s putting on file that you’re a secured party and so that anybody else looking, they will see that you are first position on that business or whatever position. And so, it’s called the universal commercial code and it’s a way to perfect your security interest. On real estate, it’s either in the form of a mortgage or a deed of trust. So, again, that’s a filing that anybody can find out and look and see that you are perfected on that spot. So, that means they can’t sell anything without you getting the proceeds of that or the sale is null and void and therefore the buyer doesn’t own anything. And so, those are the most prevalent. Now, in terms of our structures, we are big believers in stock pledges of the membership interests. And because effectively that’s where it’s important when you have a business that has in some cases more intangible value where we’re lending to these businesses that have the licenses. The licenses to these businesses are extremely valuable. And again, I’ll give you an example. Pennsylvania is a medical-only state and this is in the cannabis industry. There’s 26 grow-processing licenses in a state of, I think, 13 million people. That piece of paper that gives you the ability to cultivate and sell is worth a lot of money. Having the pledge of the stock of the company that owns that is the best way to be secured from a structural perspective. 


Justin Donald: Yeah. And these licenses in the states where they restrict them, I mean, these can go anywhere from like $10 million to $70 million for a single license. It’s just incredible. And so, I get that one of your advantages is targeting operations, targeting businesses in states where they restrict these licenses. I know it doesn’t have to be limited to that but I believe there’s just so much more upside and so much more protection when that’s the route you go. And you guys are great at that. 


Tony Cappell: Again, that goes to lending you’re lending at such a low level to the enterprise value of the business. And that means that they’ll never let you take the business. And we’re lenders. We just want to get paid our interest and then get paid back and we move on and do the next. But because of that dynamic, the risk of default is so low because the equity owners will lose so much more if they end up not paying you and that’s like, for example, we could have a $5 million or $10 million loan against a company that’s worth $100 million. If they actually default and not pay you, you may be in a better position. Now, that’s not what we want but because of that, it lowers our risk of default, which is ultimately what we’re looking for. 


Justin Donald: Yeah. In other words, if you own a company that’s worth $100 million, you’re going to do whatever you humanly can do to figure out what you need to, to not default. So, you have the greatest motivation ever from the borrower. And then on top of that, if it just doesn’t work out, you’re in an infinitely and exponentially greater position as the lender. And so, I love the leverage that exists there. And I really love, you know, you’re basically creating a contract that is strongly encouraging a certain behavior to take place to honor the deal as it stands. And if for some reason someone didn’t, your opportunity is better. And so, I always talk about when you’re going to lend, I like structuring deals where the second-best option is just the original agreement and the interest and warrants that you structured but the best option is if they default. Again, you don’t want it to happen but that’s the best structure. 


Tony Cappell: Yeah. And again, we pick people and great operators that it’s very unlikely to happen because it’s a very timely thing. But think about like in real estate lending specifically, the real estate lenders say, “Would I be happy owning that property for the amount of money?” Absolutely. Then that’s a great deal. And sometimes that is really a great real estate lender’s internal underwriting and that’s how they view value. And that is really kind of a simplistic way of thinking about real estate money in that case. 


Justin Donald: Yeah. Are you getting it at a good price? If you’re getting it that far undervalue, why not? This is a great investment. I love that. So, Tony, tell me where the name Chicago Atlantic Group came from because I love the name. It just has such a cool vibe to it. It sounds very prestigious and very large. And so, share that story because it is a fun story. 


Tony Cappell: Yeah. We were looking for an institutional name or we wanted something that sounded almost like a railroad like we’re playing Monopoly or something like that. And it came together also with the help of there is another firm who is here in Chicago, that is Chicago Pacific Founders, that I happen to know some of the partners there and our family. And so, someone ripped off their name to a certain extent but just went the other direction in the country. So, we were targeting that railroad and that institutional name. And that’s really why it came together. And of course, our roots to the University of Chicago and so on had something to do with it as well. 


Justin Donald: Well, I love it. You’ve got people and companies that inspire you and it’s cool when you can kind of use that for kind of what you’re building your foundation on. And I think that that’s awesome. I always say steal from the best with pride. And so, especially when it’s just things like names or ideas or wisdom, just take it as your own and you can always give credit where credit’s due but utilize that content. So, I think that that’s awesome. So, you’ve got this great company. You started with very few people. In fact, you and I spoke originally and when we talked, there weren’t any investors yet. In fact, the first time we spoke, the subscription docs were still getting finalized. And so, I feel so proud and excited that I could be one of the first, if not the first, to know you and get to know Chicago Atlantic Group and to really vet this deal at a high level and your company. And so, it’s like when you’re first to hear about a band, this local band that ends up blowing up and becoming huge. And so, that’s how I feel about you guys and your organization. And it’s so neat to see like today having a record day in your organization on a couple of different levels. And just the clientele that you now attract is vastly different. I mean, you’re in the institutional realms now versus just the retail realm and I think that that’s a cool evolution. I just want to pay you props and offer a sincere congratulations. 


Tony Cappell: I fully appreciate that and I can kind of tell you never in a million years would I have thought looking back 12, 24, 36 months, you never know where you’re going to end up. And I mean, we’re far in excess of anything that we expected and I think, again, it’s a function of great people, a great team that cares about creating and building value for people. And then, of course, I mean, Justin, having people like you in early investors is invaluable because, one, right now I think we’re over 200 investors and we’ve raised it now over $200 million. We have grown through. It’s been all organic growth. It’s been through word of mouth, through mainly happy investors like people like yourself. And that’s the best way to grow because, again, you’re not having what’s called a placement agent or a banker raising money for you. It’s literally people just being very happy and say, “Hey, talk to my friend,” and that kind of builds off and it snowballs or it builds off itself. Now, we have families in Ireland, Switzerland, Monaco, Sweden. These are all people that invest with us that have all been introductions. And it’s just it’s crazy to think of the people that I’ve been able to meet along the way. It’s really about for us, you know, we are trying to build something long term and make money for people. And we’re looking at 10 years or 15 or 20 years. And so, that’s really what matters when you’re building a value. 


Justin Donald: You know, it’s so cool seeing where you started with smaller investors and most companies, most investment organizations, they never make it past that. Well, you not only got past retail and you still bring retail in but you have family offices that invest with you in your company. You have billionaires that invest with you and your company, and most organizations never have the privilege of being able to attract investors and investment organizations like that. So, very cool. 


Tony Cappell: Well, again, I think we’ve all learned an immense amount during these last few years. If you would have said three, four years ago that I would be spending a lot of my time raising money, I would have said, “You’re crazy.” But really it’s very simple. People have to like you, they have to trust you, and they have to believe in what you’re doing. And those are the three things that matter. And without one of them, there are a thousand reasons to say no but then there are only a few reasons to say yes. And so, getting that right is it’s so simple but a lot of people fail to do that. And again, it’s easier and easier to build off itself as you continue to build track record and show people returns and comfort, and it kind of takes care of itself. And now, it’s a lot easier because, again, it’s not a concept anymore. The proof is in the pudding. 


Justin Donald: Yeah. That’s so cool. One last thing before we kind of wrap things up here today, I’d love your opinion of where the industry is going. We all know that it’s taking off like a rocket ship. But from the standpoint of federal regulation,  in my opinion, and probably in yours as well, there’s a limited horizon of time where the way that your company is structuring deals right now is going to end. And by the way, the mechanics you have in place can apply to any industry. You just have a hot industry and there are going to be plenty of other opportunities even once cannabis is federally legalized. But I’m curious on your opinion of like how long are we in this phase where it’s super high interest and super high returns with lots of equity kickers and warrants versus when does it kind of compress to more normal interest rates and maybe less of the kickers? 


Tony Cappell: So, overall, I think there’s at least 5 to 10 years of what I would call alpha remaining, which means the outsized return on a relative basis to your alternative or senior debt in the non-cannabis world versus senior debt in the cannabis world. Here we are, this industry now, it’s estimated that it’s about an $80 billion retail market in the United States, 20 billion to 21 billion of that is in the state, the legal states, whether it’s medical or recreational. And there was 59 or even more than that, that’s still in the illicit or what’s called the gray market. The transformation of going from a $20 billion to an $80 billion industry is there is so much value created when that happens. Also, the amount of capital that’s going to be needed to make that transformation is endless. And so, ultimately, there is an incredible opportunity that rarely exists in your lifetime where I think the last time something like this happened was the prohibition days of going from alcohol being illegal to legal. Everybody did it but then that time is where you have a dislocation in the market, where there’s an ability to make an outsized return and be very protected. So, I feel that there’s at least 5 to 10 years of secular demand growth and overall industry growth that will be far in excess of any other industry. And so, again, investing within that is, I think, a very good place to be and allocate from a capital perspective. Whether it’s in debt or equity, I think both are prime opportunities. So, I think that there is a very long runway. And again, cannabis is something that you want to be with a specialist as opposed to an agnostic investor because there are so many nuances for people to learn and it’s something that you want experience in. 


Justin Donald: Yeah. Caution to just investing in any cannabis company that’s out there because you guys don’t do that. The leaders in the industry don’t do that. I think that that’s really important. But keep in mind that whenever things do legalize federally, I think that there’s always this delay, this lag before it catches up, before the laws around the legalization catch up. So, even if something is federally legal like cannabis or hemp is a great example, hemp is federally legal, though banks still can’t lend on it and it’s been legal for some period of time now, right, a couple of years or something. 


Tony Cappell: Yeah, like well over two years. But the banks can but they just choose not to. 


Justin Donald: There you go. And so, there is going to be this timeframe that even once it is legalized, that you still don’t have traditional lenders or traditional banks that are in the game. It’s going to be a lot more still specialty lending organizations like Chicago Atlantic Group, which is a premier leader in this space, and you now have the attention of all the big cannabis companies, which I think is really exciting. I mean, you’re a first-stop shop. I mean, I know some very high-level, executive level, I mean, I know a lot of entrepreneurs that are running these companies that are being bought by the powerhouses, the darlings in the industry, the big names. And I know people that have run those companies that are saying you’re the first stop, Chicago Atlantic Group. And so, I just think that that’s cool and I wanted to share that with our audience 


Tony Cappell: I appreciate that. And again, it’s been just doing what we say and saying what we do. And ultimately, reputation is a very valuable thing and it also could be you’re only as good as your last deal so you always got to do right by people and do the right thing. 


Justin Donald: That’s awesome. Tony, thank you so much for joining us here today. I appreciate it. This is such a fun, in-depth conversation not only about your story but your wealth of knowledge on the actual tactical side of things, the actual mechanics of how to get a good return, or how to protect yourself from a bad return. And so, I thank you. Where can we find out more about you and about Chicago Atlantic Group? 


Tony Cappell: Yeah. I think the best place to start would be, our website. We have a lot of information on there. If people have questions, I do like to share knowledge about debt and so on. They can shoot me an email at, which T-C-A-P-P-E-L-L @ Chicago Atlantic dot com. 


Justin Donald: Awesome. Hey, thanks again. And to our audience, to everyone listening and those of you watching, I just want to again end today’s episode the way I end each episode and that is to challenge you to take some form of action today, move in the direction of financial freedom and a life by design, a life on your terms and a life that is inspiring and compelling to live at the highest levels. So, we will catch you next week. 


Tony Cappell: Thank you. 


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