Cannabis Investors Would Do Well to Keep These Three Tenets in Mind
Mitch Baruchowitz, Managing Partner at Merida Capital Partners
What We Have Learned: Focus on adoption and make sure that investments have crossed the “fragmentation gap”, find management teams who have direct experience with the types of challenges they will face in their cannabis enterprise, and look for companies that serve large addressable markets that naturally increase as cannabis use increases.
(Sept. 24, 2017) The public market for cannabis companies is still developing, which leaves the vast majority of investment to the private market. My partners and I formed Merida Capital Partners to take advantage of our sector knowledge, and provide a vehicle for rational, institutional quality asset management in the emerging cannabis investment landscape. While there is a plethora of ways to invest in the space, Merida focuses on infrastructure and ancillary companies which do not directly touch the cannabis plant, allowing for formulation of an investment thesis with underpinnings in traditional investment metrics, if with a cannabis angle.
Due to the incredible entrepreneurial spirit flowing into the industry, hundreds of opportunities may catch an investor’s eyes each month. Virtually every interested investor I have spoken to in the past year has received a deck, business plan, forwarded opportunity, or other chance to invest in a cannabis company. The core issues most scrutinized are: How to evaluate any given company, and how to uncover any unobvious risks that investors should look for in their own investments?
Merida is a sprout-stage investor focused solely on ancillary investments. The intent is to seek out successful companies in the ancillary space, broadly defined, which are entering the hyper-growth stage of their lifecycle, and to work toward supercharging such growth while helping to build necessary corporate infrastructure, rational capital support, and governance around bold executives. By identifying three core tenets which may reliably help cut through the static, an investor might better get right to the signal to decide which companies fit initial review.
It is hoped that such indicators will help individual investors frame their own forays into potential cannabis investments, and bring a more efficient capital market into play to benefit the entire cannabis ecosystem. Such indicators are not bulletproof dispositive factors, but throughout the past four years Merida has found that by applying such initial filters, companies may be better identified as most likely to ultimately grow into successful enterprises with long-term value far in excess of their current valuation. Those seeking to invest in earlier stage companies, or cultivation, may not find them as helpful to investment research or diligence.
Rule #1: Focus on adoption and make sure that investments have crossed the “fragmentation gap”.
“Fragmentation gap” is a term Merida uses to describe a natural transition between operational launch and stable, sustainable revenue generation and growth. Essentially, the market will show whether a given business has a rational strategy for a widely desired product or service. To determine whether a company has crossed that gap, Merida identifies 30 individual factors to create an “adoption score” to quantify a given company’s relative attempts to span that gap.
Rule #2: Find management teams who have direct experience with the types of challenges they will face in their cannabis enterprise.
Merida suggests targeting companies whose executives have encountered and quantified the specific species, kingdom and phylum for the range of challenges they are likely to see in their current enterprise. Every growing company faces challenges that must be met intelligently. On top of those, however, the cannabis industry offers unique challenges that other business executives never need to navigate. Thus, success in the cannabis space requires a pioneering spirit and force of will to push through those unique issues.
Rule #3: Look for companies that serve large addressable markets that naturally increase as cannabis use increases.
Investors are encouraged to focus on large, demographically valid opportunities so that any risks taken are justifiable in relation to the inherent size of the opportunity. “Demographically valid” specifically implies those opportunities in large, addressable markets which grow simply by more demographic access, whether it is in either the medical, adult use, or research space, etc.
The next factors to study are the regulatory frameworks around such demographic growth, before zeroing-in toward the intersection of what regulations require and how increased use would likely drive further reliance on such tools. Focusing on such areas will better allow for probabilities of success even if when picking a second- or third-largest provider in any given vertical.
Admittedly, following the three core considerations described above cannot guarantee one’s success. Strategic influence and post-investment involvement in one’s portfolio can be just as critical toward assessing where to deploy capital. Nevertheless, it is hoped that following such guidance will enable individual investors to better identify prudent opportunities while weeding out potentially high-risk investments, and through the exercise enjoy higher probabilities for success.
Full disclosure: Manhattan-based Merida Capital Partners is the lead investor in New Frontier Data.
Mitchell Baruchowitz is the Managing Partner of Merida Capital Partners (formerly Greenfield Capital), a private equity fund focused on investments in infrastructure, data and technology in the cannabis space. Mitchell sits on the board of New Frontier, and is a co-founder of Connecticut based cultivator, Theraplant, and is a Board Member of Minnesota cultivator, Leafline Labs, which he also co-founded. He also is a partner in a Nevada cultivator and has a pending application in Maryland.