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What do investors look for when analysing cannabis investment opportunities?

A panel of experts discussed key factors for cannabis investment opportunities at the Global Cannabis Intelligence (GCI) Virtual Summit for global leaders in cannabis and psychedelics.

As the nascent cannabis industry matures and more cannabis businesses are launched, what investors look for now may differ from the early stages of the industry. Initially, licence applications may have clinched a deal, but now – management teams, exit pathways or infrastructure may top the checklist. 

The panel at the GCI Summit featured: Patrick Rea, managing director at Poseidon Asset Management; Alfredo Pascual, vice president, investment analysis at SEED Innovations; Pete Karabas, founding partner at KEY Investment Partners; and, Daniel Yazbeck, founder at Yazbeck Investment Group. The experts discussed the key aspects that they look for in investment opportunities. 

Patrick Rea highlighted the increase in entrepreneurs launching businesses into the cannabis industry, with the last six to eight months seeing more companies looking at the biosynthetic production of cannabinoids. Specifically, with interest in developing rare or minor cannabinoid products.

Read more: Exploring cannabis regulations and investment in the UK

As the world looks towards alternatives to plastics and other environmentally damaging materials, Yazbeck also highlighted the increase in hemp companies falling across investment desks. 

“There are so many creative applications that are coming across my desk and I’m very excited about this space because it’s just the beginning of the hemp industry. For its industrial applications, I don’t think we have really tapped that market so I’m looking at that space heavily.”

Karabas agreed with this sentiment highlighting how this sector is ripe for innovation, and also pointed out the attractiveness of specialty finance companies and those exploring fast onset technologies. 

“I think it’s difficult to find which ones actually work – the science is still in its infancy. So, for example, how do you take an edible and change it from an edible that has an onset of an hour to an hour and a half, to having an onset of 20 minutes in some cases. That has been an interesting area of focus.”

Pascual emphasised where these development and innovations are coming from, comparing the industry stage in the US market with European countries.

“With my focus on Europe, what I see the most are companies that want to be part of the supply chain when it comes to medical cannabis, either growing or extracting or distributing. I would say that is with maybe 90 per cent of the investment opportunities that I see in the medical cannabis industry in Europe. 

“When it comes to non-medical CBD then I would say it is mostly brands that have differentiating factors – mostly in the UK – which is one of the most advanced markets in Europe when it comes to CBD. We do not have recreational markets in Europe but there are a couple of experiments just starting, in the case of Switzerland, for example. But these are limited experiments and no sales are happening yet. There’s a lot of expectation when it comes to recreational, particularly now with the new expected German government.”

Pascual noted key areas of analysis and indicators that investors are looking for today when it comes to cannabis.

“I think that it is an expectation in North America that when you invest in a medical cannabis company, that company will be able to operate in the not-so-distant future recreational market as well. The way that I see this here in Europe – whenever I recommend an investment in medical cannabis company – I need the medical cannabis company business plan to make sense with the current regulations. I wouldn’t recommend investing in a medical cannabis company in Germany just because it may legalise recreational cannabis, for example, and that company may have an upside then. If that happens, then wonderful, but there’s absolutely no certainty. 

“The business plan needs to make sense as a medical cannabis company. For that, we look at valuations, financial projections, and historical performance.”

Rea added: “There is a difference between running a venture fund with other people’s assets, making the investments and being a high-net-worth individual in the cannabis industry and the cannabinoid industry in the United States. There’s not really any institutional capital in the traditional sense of investing in the space. So, you’re left with family offices, cannabis-focused venture funds, and high-net-worth individuals. So, as an individual, you may have the ability to just sort of place your investments where ever you like, without regard for managing to a protected return target, and we definitely see a fair bit of that.

“For us as a venture firm, we have got to be very textbook in our analysis.

“There is a lot of failure in cannabis businesses and startups in general. We are always going to talk to an entrepreneur about the exit pathway and timeline because it’s important for entrepreneurs to understand that, if you’re talking to a fund, we have a projected fund timeline – we have an eight-year fund term. So, if you’re looking to continue to run this business for 12 years, we’re not a fit. 

“Very importantly at the end, is the value of the company and exit – so, what that is based upon is either multiple revenues or multiple EBITDA, and are they coming to the table with an expectation that is reasonable, nuanced and with an understanding of what that market currently is at the exit.”

Karabas added: “We look at very similar things through slightly different lenses. The cannabis industry is really at an inflection point here, especially in the US. For the first time, I think you have a critical mass of States and it’s increasing at an exponential rate, and you’re starting to see more comparables. 

“One thing we’ve run into in the current period of time is entrepreneurs setting valuation too high. And, more often than not, you can set yourself back if you have an overvalued company at a Series A or Series B. Down the road, when you need additional capital, if you haven’t left yourself a lot of wiggle room, you can find yourself in a not-so-great situation.

“So, aside from some of the more traditional financial metrics, what we look at is also in the past. If you raised capital in the past, how have you used that capital? What kind of runway is the capital that you’re raising going to get you? 

“I think a big thing across all of the cannabis industry is certainly this idea of duration risk in properly estimating how long it it going to take this company to grow, and how much more capital are they going to need. If it takes longer – if the regulatory environment doesn’t shape up how they see, before you know it – I always say – you can have a great, successful company and end up with a bad investment because you had to raise too much capital. Now all of a sudden, you’re diluted and you might not be able to hit the growth projections.”

Yazbeck highlighted that he takes a more simple approach to analysing investment opportunities.

“I look at a company or a group of folks who are producing a specific product. I’m a cash flow investor. So, can you create a product and sell it at market value? The second is, do you have the team in place to do that? And a third point that is very important for me is, does this team have the relationships to create a market for that product, do they have the capacity to do that? 

“If you look at the state of the markets – take the medical market in Europe – it takes millions of dollars to become GMP compliant. Companies like Tilray have invested millions and millions of dollars to create facilities, and what are they after – a $200m market in Germany? The goal is when recreational kicks in.

“So, are you going to be a first mover in recreational because you have a medical? In the end, if you can produce a product at a cost of goods sold, or you have a margin, and hopefully, the margins are going down, like in California with flower, for example. Do you have the relationships to do that, then you can then continue to produce a business – it’s about cash flow for me.”

The GCI Virtual Summit is taking place 7 – 9 December. Please visit summit.gcintelligence.com/ to find out more.

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