Cannabis Musings - November 15, 2023

Cannabis could use a dab of private equity.

Friends – first, another reminder to become a paid subscriber and participate in Ask the Law-Talking Guy!  Our first Q&A will take place in December.  Also, Cannabis Musings will be off next week for the holiday, returning sometime during MJBizCon.

We talked early this year about my contrarian theory that we wouldn’t see a lot of distressed M&A in the cannabis industry.  So far, my theory is proving to be right – M&A activity is lower than it was last year, and significantly lower from two years ago.  I suspect that’s because valuations remain poor across the country, and companies generally have their own problems to deal with, let alone taking on another’s liabilities.

Maybe, though, there’s a middle ground?  Earlier this week, Bloomberg’s very excellent Money Stuff column, written by my muse, Matt Levine, wrote about mainstream (i.e., non-cannabis) investment firms investing in unprofitable, yet worthwhile (non-cannabis) startups that are struggling in the current venture capital environment. Riffing on a story in the Financial Times, he writes:

I love how shameful it is. “Did you accidentally build a real business? Call us, we can help.” Some investors like real businesses! Just, not VCs. There is an arbitrage. Here’s Oren Peleg of Resurge Growth Partners:

“There’s a real opportunity here to play a very important role, which is to help companies transition from venture ownership to private equity ownership,” Peleg said. “No one is willing to send the hard message of saying this needs a reset, and that will be the role that we play.”

See, venture ownership is for companies with fast growth and no cash flows, and private equity ownership is for companies with steady or declining cash flows. The transition is painful — ask WeWork — but, sometimes, necessary.

See, this is why Matt Levine is my muse (though he could obviously benefit from a bisl more Yiddish). 

I think there’s an interesting corollary in the cannabis industry, which is similarly capital-constrained (although cannabis’ dry spell has been going on for a number of years now).  Licensed cannabis operators were showered with cheap money, blitzscaling and consolidating using overvalued stock as currency like it was going out of style.  Fundamentals like cash flow were all but ignored – the opportunity was all that mattered.  Dayenu.   

And then it all stopped.  Yet, the companies abide and, in my experience, are generally focused on sound(er) fiscal practices.  Positive cash flow may still be elusive (let alone positive net income), but I find that operators have generally come to realize that investors won’t tolerate the meshugas of the past, becoming better stewards of their owners’ capital (e.g., I suspect we won’t see very many lavish, B-List performer parties at MJBizCon in Vegas in two weeks like we saw during the salad days).

Within all of this lies an opportunity similar to what’s being described by Matt Levine outside of cannabis.  Distressed M&A hasn’t panned out, but I think this industry is indeed ripe for a shift from early-stage venture capital investment to mid-stage private equity (PE) investment, where focus is turned to companies with a solid foundation (or those that need their foundation rebuilt). A handful of cannabis-focused private equity funds have been playing in the industry for a while (many of which are friends of the newsletter), but the demand exponentially outstrips the supply.

PE ownership comes at a price, for sure.  Institutional capital has very different demands and expectations about little things like fiscal responsibility and attention to fiduciary duties, certainly relative to the investors who helped fund the creation of the state-legal industry and were willing to accept the messiness of the industry in its early development.  They tend to be more hands-on and get consent rights over major decisions to shape the course of the business, but also can bring a certain style of professionalism and discipline that, in my opinion, would be a net benefit to the industry in the long run.  In that regard, cannabis is no different from any other early-stage company – PE can help with that transition.

There is a real opportunity for an expansion of PE-style capital within the cannabis industry.  The easy part would be deploying the capital (i.e., investing it).  The hard part would be convincing high net worth investors to commit to cannabis-focused PE funds when there’s little hope of federal regulatory reform any time soon, 10-year Treasuries are around 4.5%, and industry valuations remain oy gevalt. 

The cannabis industry needs a hug and a helping hand.

Be seeing you!

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Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network and twenty-five years of dealmaking and capital markets experience.

© 2023 Marc Hauser and Hauser Advisory.  None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form.