By Emily Paxhia
Many startups in the cannabis industry are seeking capital as the “green rush” intensifies, promising to make investors wealthy in exchange for some much-needed cash.
But a fair share of these businesses struggle to find money, even though the financing pool is as deep as its ever been.
Seasoned investors in the cannabis space often look for companies with certain characteristics, and businesses that fit the bill stand a much better chance of cementing a deal than those that do not.
With that said, here are five types of companies that are attractive to investors in the cannabis industry:
#1. Ancillary Companies
Companies that touch the plant – retail stores, dispensaries, cultivation operations and infused products manufacturers – can offer great margins and the potential for rapid growth.
But some investors are still concerned about placing capital with companies that are technically illegal at the federal level. The political risk is simply too high.
For this reason, ancillary companies are currently very appealing to investors.
These types of businesses – which provide products and services to the industry but don’t handle marijuana – provide some shelter from legal issues and the risk of policy fluctuations.
An ancillary company also typically isn’t subject to the same rules and regulations as cannabis-touching businesses. So they are less complex, and their expenses can be lower.
Additionally, margins for companies that grow and sell marijuana are expected to diminish over time as the industry expands and more cultivation operations enter the market – providing investors with yet another reason to target ancillary businesses.
#2. Scalable Companies
Investors are interested in companies that can expand beyond cannabis and into other sectors over time.
A company involved in controlling the climate of a grow room, for example, can apply its technology to agriculture in general or in-home climate control.
We know that the current methods for maintaining an even temperature and humidity are fairly inefficient and costly. Improving this will be a focus of many aspects of society going forward – creating immense opportunities for companies involved in the space.
Another example: Testing being done to understand various compounds or undesirable elements (mold, pesticides, etc.) in the plant or extract can have applications in other industries. Consumers are increasingly looking to understand what they are putting into their bodies, so there’s a good chance some of the methods tied to cannabis testing can apply to other types of products people consume or ingest.
These types of scalable cannabis companies provide a hedge against the risks of the marijuana sector and also can make for a richer investment in the end.
It might sound like Business 101, but companies that serve a unique need in the industry – those that create markets instead of join them – are ahead of the game when it comes to landing money.
Companies that are anticipating issues or exploring opportunities before the competition pique investors’ interest. This can involve anything from developing cultivation efficiencies to preparing for diversification of the marketplace.
There are a lot of companies all trying to do the same thing right now. Investors are going to dive into areas that are untapped and look hard at “first-movers” in these spaces.
We recently attended a growing expo where a good 60% of the exhibitors were selling variations on the same product: plant nutrients. I am sure there are a lot of key differences, but if your company can serve a unique need – something that few, if any others, are addressing – you’ll stand out to investors.
However, it’s important for entrepreneurs to consider how long that unmet need will exist. Investors will want to know how a company plans to thrive in an evolving space, and they’ll want to understand the potential exit strategy.
For example, banking is a significant issue for many companies in the industry. A business that can help address this issue must provide a solution that would still be relevant when the banks decide it is safe to participate. Otherwise, it’s not an ideal investment.
Same thing with data collection. There will be large corporations entering the space when they feel the federal government is on board, so investors will want to place capital with a company that has anticipated change accordingly.
Keep in mind that innovation doesn’t have to be incredibly technical. Sometimes the simplest ideas are the most impressive.
Similar to innovators, disruptors are very appealing because they offer the potential for huge returns.
This industry has been underground for so long that inefficiencies and ineffective processes have become commonplace. The companies that come into the space and are willing to make wholesale changes to the deeply entrenched methods are going to stand out.
But be forewarned: This requires some serious research and development.
And it’s important to point out that disruptors should look to work with growers, not against them. Most growers are wary of any potential disruption to their crop, as this could seriously impact their business in a given cycle.
The same is true for dispensary owners who are working hard to stay compliant with state regulations. They cannot really afford the risks, so working to solve problems within those guidelines is critical.
#5. Environmentally Conscious Companies
This is a “green” industry in more ways than one. New companies that develop efficiencies for energy and water use or costs (and ideally all three) are very attractive to investors.
Not every investor cares as much about this, but it is critical in our examination of companies.
There are several reasons that we value environmentally conscious companies.
For one, it simply doesn’t seem practical for a fledgling industry to continue with poor practices in this regard.
And as I mentioned earlier, the margin compression of the future will drive the need for improved growing efficiencies.
We are in a severe drought in California, and some states are instituting water bans for cannabis companies. As the industry tries to gain broader appeal, it will be more difficult to “sell” the idea if environmentalists or policy-makers who are trying to preserve resources are against cannabis.
Furthermore, investors want to see that companies are looking at products made from recyclable material – rather than cramming landfills with paraphernalia or byproducts of the industry.
This is the chance for the marijuana industry to show that is a hub for progress and innovation. More investors will enter an industry that has staying power through respectable practices and foresight.
Emily Paxhia is a founding partner at Poseidon Asset Management, a San Francisco-based fund that invests in cannabis companies