Investment & Distressed Assets In Cannabis: Navigating And Managing Risk In Today's Market

New investment into the cannabis industry has recently slowed down due to a combination of stifling regulations, economic uncertainty, lack of access to capital and restrictive banking options. That said, increased quantifiable visibility into cannabis businesses’ operations and financial performance will allow a skilled investor to continue to take advantage of the new opportunities now arising from a unique convergence of market conditions.

Back to the Basics

While eager players who entered the space early currently struggle to save their distressed cannabis businesses, investors in what is now considered a maturing sector want to focus on business fundamentals and financial performance. We have entered a “back to the basics” environment whereby a company’s day-to-day operations, management and profitability are under heavy scrutiny. If a company does not have the revenues and structure in place to invest in operations, scale and growth, savvy investors are keeping their distance.

Added challenges arise from the fact that the cannabis industry has traditionally operated in a closed loop. Its investment ecosystem is one in which deals are made in private circles; among friends, insider investors and professional acquaintances; or with a few already privy to a particular opportunity. It can therefore be very difficult for new and outside investors to navigate and identify viable opportunities, let alone gain the necessary visibility into them to properly value a business or asset.

Enter Receiverships

Investment opportunities do exist, and proper visibility into and assessment of both value and risk can be accomplished. Case in point, currently unprecedented liquidation events, such as the sale of a business via a receivership network or public legal notices, whereby proceedings occur through court supervision, offer greater transparency and objectivity. In these cases, the risk of over-valuation due to business distress and self-interest is mitigated.

Operating within the private cannabis sector is still akin to the Wild West. Absent a supervised court receivership, accessing knowledge about assets is difficult. And while the cost burden on distressed businesses, on insider investors and on their assets rises during a receivership, a receivership with a limited scope allows investors to access information about assets, with the time to analyze and understand their value, and acquire them free and clear as determined by the Courts.

Before taking the plunge and putting money into a distressed cannabis business, investors should do their homework. Evaluating, ranking, and monitoring both operational and financial performance of the business becomes critical to effectively identify the right opportunity and manage its relative risk.

Good Navigation and Management

While some investment groups may claim to have a proprietary process or special formula, a cannabis company is a business like any other. It makes a product for wholesale or retail just like traditional manufacturers. The fact that it works in the cannabis sector does add a layer of complexity and uniqueness that requires an experienced eye to understand it, but a careful analysis of its history and how it became distressed will provide information about what is next for the company. Overhead costs, pricing, operational efficiency, reputation, product quality and brand value are some of the key indicators of the worth of a struggling enterprise.

The legal, regulatory and financial framework surrounding the distressed business should also be a focus. What goods or services is the business selling? For how much, compared to market competitors? What are the margins? Is the commodity value trending up or down? If it is a business with a cannabis license, is the market capped, as it is in Illinois, or unlimited, as it is in Oklahoma? Will that number affect supply and demand? Knowing the regulations of the state where the business operates is an important tool to understanding any perceived or stated value of the business and how an investment might be used to differentiate the company from others in the sector.

Looking Ahead

The cannabis industry might appear to be operating in survival mode right now, but the market is dynamic. The economy will bounce back, and legislation and politics will eventually catch up to the realities of social acceptance and consumer demand.

The market will create substantial investment opportunities in the coming years, and cannabis investors will then be forced to compete for the top assets. Lessons learned through receiverships will help. The big difference between gauging investment opportunities in cannabis and other industries will be the lack of data to base cannabis investment decisions on. That said, at the end of the day, cannabis is a commodity market; core investment principles that apply to other commodities will also apply to cannabis.