MJBizDaily Investor Intelligence

1 MJBiz Daily | Investor Intelligence mjbizdaily.com/investing • Key insights on vetting fund managers and due diligence in cannabis • Red flags when assessing a fund opportunity • Insight from top fund managers on their portfolio strategies Cannabis Capital 3 Things to Know Before Investing in a Private Equity or Venture Fund By Lisa Bernard-Kuhn T he race to woo investors among cannabis-focused private equity and venture funds is reaching a frenetic pace with newly launched funds setting out to raise more than $1.2 billion already this year. Since January, more than half a dozen firms have begun new funds with capital targets ranging from $30 million to $500 million—sizably larger than the initial rounds launched just a year or two ago. The bolstered targets reflect evolving investor interest in cannabis. “Institutional investors are waiting for funds and fund managers who have a demonstrated, proven track record in the space,” said Jeffrey Howard, a managing partner at Illinois-based Salveo Capital. “There is a lot of noise about new funds and existing funds raising money. Most don’t have track records, and if they do, they should be judged on that record.” As the fundraising frenzy ramps up, here are the top considerations investors should keep in mind about cannabis-focused funds and a snapshot of developing opportunities. KEY MANAGEMENT EXPERIENCE While the prospects that are unfolding present enormous upside, regulations are rapidly evolving on a global scale—delivering a host of new challenges and opportunities. “The biggest mistake I see new entrants to the space making is assuming that they can run a PE firm in cannabis from the 50th floor of a New York City high-rise with a team of former investment bankers,” said Codie Sanchez, an investor and partner at Cresco Capital Partners, a cannabis-focused private equity fund. “This industry is incredibly complex from a regulatory, banking, exit and operations standpoint, and you need industry experts paired with quantitative and structuring expertise.” Jacob Ellman, an accredited investor and managing director of DMO Holdings, agreed. “People who only know about money are at a big disadvantage in this space,” he said. “You really want to see subject-matter experts on the team.” Funds with subject-matter experts or experience running cannabis companies are best positioned to tackle the due diligence needed to build out a focused portfolio and strong investment thesis. Considering a fund that’s exploring the next line of U.S. Food and Drug Administration- approved cannabinoid-based medicines? Ask who is on the fund’s pharmaceutical advisory committee, Ellman said. “There are always going to be more deals than there are people to perform due diligence,” he said. “If there are no subject-matter experts or no clear focus for a fund, that’s a red flag.” DUE DILIGENCE IN CANNABIS IS COSTLY For any private equity or venture portfolio, thorough due diligence is essential to reducing risk to investors. The cost of that work is most often covered as part of the standard “2 and 20” compensation structure applied by most private equity firms: • A 2% annual management fee is charged to investors on the amount of funding deployed, which is used to cover firm’s overhead costs. • A 20% performance fee is then charged on any profits the fund pumps out above its set return. If a fund sets a return of 10% but delivers 15%, the private equity firm will get 20% of the additional 5% achieved. However, the 2% management fee that experienced investors are used to is “not substantial enough to cover the due diligence in cannabis,” Ellman said. The cost of traveling to multiple locations to tour grow facilities, for example, can ring in at a minimum of $10,000 per deal, Ellman noted. continued on page 2 April 15, 2019 IN THIS ISSUE Cannabis Capital Watch Metrics That Matter Market Matters M&A Spotlight