Investing insider: Tips for due diligence in cannabis investing

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(This is an abridged version of a story that appears in the March 1 edition of Investor Intelligence.)

Codie Sanchez is a “traditional, conservative, risk-centric investor at heart.”

But after taking the time to analyze and understand the cannabis industry, Sanchez, a partner at early stage investment funds CS Ventures and Magma Partners, recognized the opportunities underway and emerging in this new market.

In the latest issue of MJBizDaily‘s Investor Intelligence, Sanchez shares tips – in her own words – on how to assess opportunities without relying on stigma and assumption:

Go where the game is played.

Unlike other industries I’ve invested in, cannabis is rife with scale-inhibiting regulations, founders with potential black marks on their record and a change rate that can leave portfolio companies in the dust.

Since they say you can either go do something for 10,000 hours to become an expert or go learn from someone who has already done the 10,000 hours, I chose the latter.

This meant investing in private equity funds that were open to me co-analyzing their deals with them, investing alongside them and running deals I get by them.

However, a caveat: As the Kauffman Foundation’s research highlights, in venture, only about 3% of all the firms in the universe generate 95% of the entire industry’s returns.

Thus, make sure you do due diligence on your fund of choice.

The question begs, how do you analyze the funds in this space? Due diligence is complex and not to be explained in one paragraph, but here are two critical screens:

How long have they been investing in cannabis?

I want someone who has at least a five-year track record. It shows me how they have matured with this market, as past behavior is always the best predictor for future behavior.

Although never ever a guarantee.

Second, I want a firm that has partners who have been operators (aka led companies) and those who have been portfolio managers (leading private equity or venture funds).

Often in this space, you only have one or the other.

I avoid those firms that only have operators, as that means they have no experience in venture, private equity and institutional investing.

This space requires a large amount of due diligence, risk analysis and focusing on capital markets to help structure the exits.

These traits come from those who have run venture and private equity funds before.

Just as important is that you don’t invest with those who sit in ivory towers.

This is a business in the soil, after all.

We former Goldman Sachs alums can smell an opportunity a mile away, but if we haven’t had experience in cannabis, if we haven’t been with our ear to the ground for years in this space, we can mistakenly believe that this industry acts like any other.

Get more tips from Codie Sanchez on doing your due diligence in cannabis investing in the March 1 issue of Investor Intelligence, the new premium subscription service from MJBizDaily.