What is the best type of cannabis business I should invest in? That’s a great question with an answer that is always the same. It depends. Finding a cannabis business to invest in isn’t just about the company with the best profit margin or sexiest product, it’s more about matching your passion and your skillset to what the cannabis business needs.
Are you looking for a turnkey operation that you hope to take to the next level with your supply chain experience or marketing skills? Are you looking for a great price on a struggling operation that could grow profitable with a cash influx and better cost management? Do you just have cash that you want to lend to a savvy cannabis operation so that they can expand while you share in the profits? Envision your ideal level and type of involvement before you start your search.
Got it? Great. Let’s start evaluating!
1- Evaluate the P&L Statement
We know. This is the obvious place to start in nearly every investment, but with cannabis we recommend really doing your due diligence in two main areas:
Look beyond the sales coming in and drill down into what the company’s streams of revenue are. Each area of sales should be evaluated based on its stability (or risk) in the supply chain and consistency of cash flow. You not only need to know how much the company brings in in sales, but also where those transactions are occurring. Unlike many other industries, the highly regulated nature of cannabis means that a change in state or local regulations could have a significant impact on your ability to earn or expand in the future. Understanding the “how” of a cannabis company’s revenue number is crucial to identifying any potential red flags.
- Cost of Goods Sold
While we strongly advise (and already know that you plan on) looking into both operating and overhead expenses, a cannabis operation’s COGS is worthy of a deeper dive. There is still little IRS guidance on what constitutes COGS for a cannabis business, since at a federal level cannabis businesses are considered illegal. This makes what is considered COGS a bit more open to interpretation depending on the type of cannabis business you’re looking to invest in, but it’s an important piece to understand because a higher COGS will reduce a cannabis business’s tax liability.
Both direct and indirect costs are allowed in the COGS number, however it’s imperative that the company you’re looking into has well-documented records of how they’ve arrived at those costs, particularly indirect costs such as rent, repairs and maintenance, freight, labor, and even depreciation and insurance.
Exploring the direct raw material costs will also give you insight into potential business risks. Are they sourcing all of their raw materials from only a few places? What happens if there is a disruption to the supply chain? Use the COGS section of the P&L to get a more clear picture on the actual operations of the business, so that you can better spot potential pitfalls.
2- Map Out the Balance Sheet
Aside from getting a snapshot of the company’s cash position, liquidity, receivables, and payables, the Balance Sheet is a great opportunity to look at the physical assets of a business. Depending on the type of cannabis business, the cost of equipment (and the availability of replacing it) may be important areas to be aware of. Be sure to look into the age of the equipment and develop a timetable for the short-term and long-term capital investments that may be needed to replace key pieces.
3- Keep An Eye On Operations
It’s time to move off of the financials and into the weeds of how the cannabis business operates in real life. There is a very strong correlation between a cannabis company’s level of compliance and their profitability. It’s important for an investor to evaluate how well a cannabis operation is organized and understand its processes.
- Look at the documentation around their Standard Operating Procedures (SOPs) to determine if they are adequate.
- Inquire about evaluation tools to manage the products and movement of products and what types of corrective action management takes when there is an issue.
- Ask what sort of training they have had around OSHA and how do they ensure they’re following all guidelines.
Any cannabis business worth buying should have a clear set of compliance programs in place and preventative maintenance procedures. All of these should be well documented and readily available for your review (or an auditors).
In addition, we highly recommend reviewing the business’s physical floor plans and facility plans to get an understanding of where everything is and how it functions. Companies may have too few assets to operate efficiently, or they may have too many, with expensive equipment going unused. Look at how they’ve used the funds they’ve already received to determine if your investment will also be used wisely.
4- Perform a Market and Sales Analysis
As we continue to peel back the onion that is cannabis investing, it’s important to spend time looking into the market within which your potential investment is operating: both geographically speaking and from a supply chain perspective. This analysis will show you the type of regulatory environment you’re working in, where your raw materials or products are coming from, and where your customers are located.
Although you may be investing in a cannabis business that is already operational, it’s important to perform a target market analysis to determine if the business is selling to the appropriate audience. It will also allow you to evaluate the performance of the business’s sales and marketing initiatives and gauge what actual demand might be.
Your analysis should take a critical eye to evaluate the competitive landscape. Who is already operating out there? Who could potentially expand to your territory? What products are competitors offering and how does your business want to differentiate itself from them?
Many investors are unfamiliar with the unusual market factors that are unique to the cannabis industry. This is why BeGreenLegal offers Market Analysis services to help you understand where your potential investment (or brand new business) fits within the competitive landscape.
5- Meet the People Behind the Business
While this is the final step, it contains one of the most important questions (and probably one that you will want to ask before anything else): Why are they selling this business? There is a lot that you can learn about the business when you understand why they’re in trouble, why they want to grow, or why they want to get out of it all together. Keep their response on your radar as you dig through each of the layers mentioned above to see if the answer appears consistent.
Meeting the people in the business is also important for a few different reasons:
- Understanding hiring policies and employee training will help you gauge the importance of compliance and knowledge to the organization.
- Knowing who is operating the business and what their passions for cannabis and goals for the business are will help you determine if your vision is aligned with theirs.
- If you’re buying part of a business or going to be a hands-off investor, you need to know that you can trust the operators that are in place and ensure you have a good rapport.
- Understanding if the current employees plan to stay on once the business is sold will help you determine if staffing will be a concern or not.
In an industry where procedure and organization is so important, having a qualified team at the helm is vital to future success. Do not gloss over this important piece of the evaluation process.
Next Steps in Your Cannabis Investment Plan
Investing in the cannabis industry requires a certain amount of sophistication to know what you’re looking for. If you’re passionate about getting into cannabis, but are still a little green behind the ears, our team is here to advise in all of the areas that you need an experienced guide. Our goal is not only to make sure you’re matched with a profitable cannabis business (or one with future profitability potential); we want to make sure that you’re matched with the right type of investment for your level of interest and your skill set.
We offer a variety of analysis services, such as our Business Acquisition Analysis, Compliance Analysis, Operations Analysis, and more. Contact us today at 916-866-8263 or complete this form to see how BeGreenLegal can help you make the most educated cannabis investment decision.