5 Things to Consider Before Investing in the Cannabis Market
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It's no surprise that brands like Constellation and Estee Lauder have dipped their toes into the rapidly expanding cannabis industry over the past few years. As someone who has made more than 100 investments in the cannabis market, I've learned what to look for when deciding if an investment into a market as complex— and in many cases—as new as cannabis is worth the risk. Below I've summarized five things you should consider that may not be required in different, more traditional industries.
1. Know the limits of operating in different markets
Unlike most other industries, the U.S. cannabis market is frustratingly fragmented. Each state counts as its own market, with some counting as more than one. For example, Colorado is both a medical and recreational market, whereas Arkansas is only a medical market. As an investor, it's critical to understand the maturity of the market you're looking to work in and whether or not the company you're considering investing in can operate in more than one market. For example, Trulieve, which is based in Florida, has additional operations in California, Connecticut, and Massachusetts, creating more growth opportunities than a company that can only operate in one state.
2. Understand the total addressable market while taking regulatory barriers into consideration
Population is an essential factor in determining total addressable market; however, an investor can run afoul in thinking a state with a large population will translate to more potential customers. It's more pertinent to think about a particular state's regulatory scheme and how old the market is and then make an investment based on how much red tape you'll have to cut through to grow. For example, California has a population of almost 40 million versus Oklahoma, which doesn't break one million residents. Despite the vast difference in their populations, Oklahoma has a laissez-faire approach to regulations, allowing anyone to open a dispensary with products readily available. In contrast, California has tighter regulatory policies, leading to limited product availability because of local ordinances or state regulations. Despite having a large population, you may see suppressed sales due to the regulatory structure.
3. Be wary of over diversified SKUs
While some people may think more is better, manufacturers with too many SKUs can adversely affect your investment in more ways than one. First, every SKU has an overhead cost for a company and takes up budget due to its unique packaging, labels, regulatory compliance testing, and more. If a company has too many SKUs, it can quickly blow up a budget. Additionally, too many SKUs can create a paradox of choice for consumers. They become overwhelmed by having too many options and instead decide to go with a competitor that offers fewer, more specific products. It's better to steer toward a more focused company with only a few SKUs that they can build up to appeal to different segments or types of shoppers without cannibalizing their sales.
4. Realize that cannabis requires third-party testing before going to market
Suppose you haven't worked in the cannabis industry before. You may be unaware that all cannabis products must pass a safety test by a third-party lab before being sold in a dispensary or a regulated cannabis channel. Easy access to testing may not seem like a big deal, but it can quickly go haywire, which is what happened in California as it fluctuated from 26 labs to 52 and then back to down to 33 in less than a year. As an investor in a cannabis company, if you want to bring a product to market and cannot get testing done promptly, your inventory will be stuck on a shelf in a backroom as it waits for authorization to be shipped and debilitates your cash flow.
5. Don't only use your gut; use data to ease uncertainty
There are many questions to ask before investing in any industry, let alone one as complex and new as cannabis. Diving into a rapidly shifting market can seem overwhelming, but it doesn't have to be. Using data to understand the total addressable market, consumer motivations, market forecasts, and historic data can help guide the decision-making process and minimize or eliminate uncertainty. Mature markets like Colorado and Arizona can be blueprints for what to expect in new markets like Texas and Oklahoma. It's essential to surround yourself with experts and assets that can help you identify the best way to move into the exciting and opportunity-filled world of cannabis.