Lack of Professional Management Teams and Boards: Generally speaking, the industry is facing a shortage of seasoned executives and experienced board members that have demonstrable track records of operating success. This increases execution risk, weakens corporate governance, and damages credibility with investors, further impeding a company’s ability to raise capital. However, there are more professional investors and operators entering the business at an accelerating rate.
Systemic Risks Still Exist: The continual commoditization of cannabis has imposed downward pricing pressure on raw cannabis and cannabis products in several states. Furthermore, supply and demand factors vary by state, and illegally grown marijuana is still penetrating the system (albeit less frequently). These factors have and will continue to influence states that are enacting new cannabis legislation to adopt more conservative policies and regulations in order to mitigate these risks.
However, while these factors have limited institutional investor exposure to date, they are beginning to dissipate. Demand for professional private equity and venture capital financing is increasing as the cannabis industry shifts away from reverse mergers financed with toxic structures and towards markets where there are institutional and retail investors. Approximately 8% of financing rounds completed by cannabis companies in 2014 utilized venture capital or private equity firms as sources of capital, and an additional 8% utilized angel investors. In 2015, the percentage of cannabis deals in which private equity or venture capital firms were engaged rose to approximately 18%, while the percentage of cannabis deals in which angel investors were engaged rose to about 14%.
We expect this trend of increasing participation by professional and institutional investors to continue as they gradually increase their exposure to the cannabis market, attracted by strong industry growth rates, rationalized business models, and additional states legalizing and rolling out cannabis markets. Moreover, as valuations in public cannabis companies continue to normalize and become linked to fundamental performance, we anticipate increasing interest from institutional investors as equity investors, as opposed to the straight debt and convertible debt financing that has made up the bulk of financing in public cannabis companies to date.
Why do cannabis companies want to become publicly listed?
The OTC market is a platform for all emerging growth companies to access the public markets. It is one of the most mature speculative public trading markets in the world. For a private company, going public has several benefits, typically including: broader access to capital due to the liquidity advantages; higher enterprise valuations; the ability to monetize stock ownership; the ability to use company stock as a currency for M&A transactions; and stock options that can be used as incentive to attract and retain talent.
Since the beginning of 2014, the cannabis industry has been experiencing a shake-out – a separation of legitimate businesses from those that were less successful in capitalizing on their opportunities. This shake-out has been driven my numerous factors, including increasing clarity on legal and regulatory environments, especially at the federal level, increasing product and service focus among providers rather than trying to be a multi-purpose, one-stop shop, normalization of valuations, and a growing awareness of the industry’s long-term potential.
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