Deconstructed: Cannabis Due Diligence

Evaluating cannabis companies can be a complex endeavor. Most companies point to graphs illustrating a massive acceleration in growth as legalization spreads across the country. Considering that half of all cannabis companies are less than 24 months old, it is difficult to correlate the broader growth of the industry with individual company growth. There are several ways to look beyond fancy charts to understand a company’s prospects:Visit the company: It is easy to have a great idea for an industry with a ~30% CAGR but not as easy to actually capture that growth. The most important aspect of valuing a cannabis company is assessment of key personnel. A strong management team will bring experience from other industries and a history of execution to pivot when necessary in this constantly evolving industry. A strong team will also have a network of relationships to help them weave the social fabric around them just a little bit tighter. It is who you know, and who they know.Understand the business model: Is this a B2B or B2C model, is the company in a space with entrenched competition or is it moving into a new space in the market? Develop a thorough understanding of the product, pricing, placement, and promotion. What is the plan for growth, and is it contingent on events outside the control of the company? How scalable is this business, and what are the barriers to entry? Identify supply chain issues and regulatory hurdles. Invest only in what you know and understand.What are customers saying? When a startup identifies a real market gap, targets the exact demographic who is likely to buy, and finds that they are willing to pay for the product – they are validated on several levels. This is called a market fit, and is an essential test prior to every prudent business investment decision. The customer, in this instance, is always right.Investor Partners: It is very easy for great ideas to meet the wrong capital. Do existing and potential investors understand and agree with the direction and roll-out of the growth strategy? Are their adequate financial resources in place for companies to achieve their planned growth, and does management have a plan to connect with the right type of capital while also having the discipline to say no to capital? Investors and entrepreneurs need each other equally, and the best relationships remain symbiotic.Heed red & even yellow flags: 85% of all early-stage companies never make it past their Series A rounds. Determine hurdles a company will face, whether competitive or regulatory. Will the company continue to enjoy high margins with falling commodity prices? There is a common misperception that growth is always good, but growth can mask faulty underlying genetics. Utilize experts to help evaluate business strategy, products/services, valuation and management teams.Establish your investment thesis: There are ~30,000 cannabis related businesses in existence, with hundreds more being formed every week. Comparing expected growth rates will likely make any cannabis company expected return look attractive, but it is important to manage that with the associated risk. Where does cannabis have a place in your investment portfolio, and where does this company have a place within that allocation?It is essential to build a broad and deep network of industry players to optimize your deal flow, assist in due diligence and then help with valuation, asset allocation, and support. Identify companies that are long on entrepreneurial spirit and short on capital, align your vision and goals with those of the founder, make only high-conviction decisions, and enjoy the journey.