​How the Smart Money Invests in the Emerging Cannabis Industry

Rob Hunt, Partner at Tuatara Capital |

The cannabis industry, as it stands today, is exceptionally complicated, nuanced and fragmented. Currently, each state market operates in a vacuum because as long as cannabis remains on schedule 1 of the Controlled Substances Act (CSA) all state programs are operating in a cloudy area that has no definitive guidance provided by the Federal Government. This means that each program has been enacted and then evolved on its own with very little input from any other state that has come before it. As a result there is a great deal of inconsistency between each state cannabis program.

It is due to this level of inconsistency that Tuatara is able to best capitalize on cannabis based investments. To begin the process, Tuatara commits an inordinate amount of time researching the regulatory structures of each of the twenty-four state legal medical cannabis programs and the four state legal adult use recreational cannabis programs that exist within the United States. In doing so, we look for several key indicators that provide clues as to how a state program will perform from an investment perspective, including but not limited to the following:

  • Is the state program for profit, non-profit or not for profit?
  • In medical states, what is the criteria to be approved as a cannabis patient?
  • How many cannabis based business licenses are granted by the state?
  • Is it likely that this number will expand in the immediate future?
  • What are the zoning regulations?
  • Is the state government supportive of the industry?
  • How closely does the state monitor the program?

By assessing each of these criteria, our investment team is able to triangulate a corporate philosophy around how well we expect a state cannabis industry will perform by comparison to all other states. Once we have made the determination that a state is “investible” Tuatara will then further narrow the list down by attempting to determine where the best opportunities reside within a given state. In one state it may be the large-scale commercial cultivators, in another it may be the retailers and in others it could be the teams that are building brands that are scalable in to other states by way of licensing agreements. It is at this point that Tuatara will actively seek out the operators we believe represent the greatest opportunity within this premier sub-sector inside that state. It is worth noting that all of this initial analysis is predicated on thorough comprehension of the state regulatory scheme, prior to even beginning to assess a business model. This allows the investment committee to make swift determinations with regard to initial decision making.

By way of example, the vast majority of opportunities Tuatara sees are brought to it by third party introductions. If we are forwarded a transaction profile, our internal metrics allow us to say “not for us” instantly if the company operates outside of a state we are interested in. If the company resides within a state we have approved, then we will examine which sub-sector it represents. If it does not coincide with our sweet spot within that state, a “not for us” answer is quickly returned as well. These two scenarios represent more than 90% of what comes across Tuatara’s desk.

If a business model is a match for the approved state, then Tuatara will take a second look and compare it to other opportunities we have examined in the same space. Of those that make it to “second look” status, the vast majority are discarded at this stage as well. This could be because the approach is not novel, there is no defensible intellectual property, its top line revenue is low or its EBITDA margins are too small, it has little or no assets, the founders have do not have skin in the game or the management team is too green. More often than not, it is a combination of several of these factors.

However, when the stars align and lightning strikes, Tuatara will put all hands on deck to evaluate the opportunity. Once the team has made the determination to begin diligence in earnest, it will forward the management team a lengthy and invasive set of questions. If we like what we see, we will then begin to commit capital to properly asses the opportunity. That could come in the form of legal work, sector specialists, site visits or a third-party market evaluation. If a company can make it through this process, which ordinarily takes four to six months, then the Tuatara team will decide if it ultimately wants to fund the transaction and if it does, voila, a substantial equity investment into the company will be made.

Rob Hunt is Partner at Tuatara Capital, the largest private equity fund in the cannabis industry.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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