New pathways to capital for cannabis enterprises

For many in the industry, their initial investment thesis continues to hold true. For example, while the industry has certainly evolved, it is still more focused on the platform supply chain than on end-user brands. Investments in ancillary and tech-enabled companies in particular are getting more popular compared to plant-touching businesses. A noticeable change in the environment is that management of cannabis concerns is getting stronger; though capital is harder to raise, the fact that talented entrepreneurs continue to enter the market bodes well for the future.

While the financing funnel has been narrowing over the past few years, it is still very much there for stronger companies with solid fundamentals who can craft differentiated and compelling stories to meet investor requirements. Managing working capital and operating costs and focusing on margins is vital to creating pathways to liquidity, especially for companies that do not already have a strong investor base.

Compounding the financing issue is the fact that many companies today are overvaluing themselves. In the struggle for capital, they need to be more realistic about their performance. They also need to be more pragmatic about the timing of liquidity transactions, and, in light of increased market saturation, conscious about taking advantage of good opportunities when they arise.

At the same time, the reality is that cannabis is a “long play,” and if companies can’t manage the short term, they won’t survive. This means that operators must be practical about their capital needs today, mindful of the possibility of a recession, and fiscally prepared for riding it out.

Whether debt or equity, lenders across the spectrum are drilling down and becoming more careful in their underwriting, assigning greater value to not only strong fundamentals but also strong management. These are the companies that will be able to access capital and participate in buy/merge opportunities as the industry grows.

Overall, operators would be well advised to recalibrate their exit horizon if they’re looking to maximize value. Limited access to capital means more equity-based mergers than cash-based transactions in the short term. It also means that many operators can’t afford to be too aggressive as they consider these deals. Beyond M&A, restructuring in its various forms is also an option for overcoming capital weaknesses and weathering liquidity issues.

When one door closes, another door opens, and so it goes in the cannabis space. For example, while family offices were entering the space at a frenetic pace just a few years ago, interest has waned. Conversely, as institutional investors have grown more familiar with cannabis, there is significantly more interest than ever before, and with it, a lot of institutional capital will potentially be available pending regulatory changes.

In terms of private equity and venture capital, there are also a number of emerging investors focused on specific niches in the cannabis industry, such as tech-enabled services and the application of e-commerce platforms.

In the meantime, the idea that SPACs are “dead” may be overstated. While there has been a lot of carnage in that market, and in fact investors are now buying up distressed SPACs, they remain another alternative and an easier path to going public for many companies who need capital.

And while equity capital is of course an important part of the picture, over the past few years the debt market has been an accelerating trend as a means of growth and acquisition capital. This is especially true for MSOs and other companies that have significant real estate and other collateral, as well as strong cash flow.

New states continue to join the ranks of legal recreational and medical markets, and so despite what’s happening on the capital market side, the total available market of the industry will continue to grow. Numerous companies in alcohol and tobacco are getting more interested in cannabis investing as stigma declines and they become more knowledgeable about the industry.

In fact, investors are learning that cannabis is about more than dispensaries and buying products. There is a huge potential market in the use of hemp fibers for industries such as construction, automotive, and textiles, as well as nutritional uses for hemp seeds and pharmaceutical/consumer goods applications.

Overall, cannabis is an excellent growth industry, albeit an evolving one, with phenomenal prospects for the long term. While the market will likely look different in years ahead, companies with solid fundamentals, strong management, and strategic insight will be best positioned to thrive.