Assessing the Value of Distressed Assets

New investment in the cannabis industry has slowed due to a combination of stifling regulations, economic uncertainty, lack of access to capital, and restrictive banking options. Nevertheless, skilled investors still can capitalize on opportunities arising from this uncommon convergence of market conditions.

While eager players who entered the space early struggle to save their distressed businesses, investors in the rapidly maturing sector want to focus on business fundamentals and financial performance. By taking a “back to basics” approach that puts a company’s day-to-day operations, management, and profitability under heavy scrutiny, savvy investors will keep their distance from companies that don’t have the revenue and structure in place to support operations, scaling, and growth.

Added challenges arise from the industry’s closed-loop investment ecosystem, where deals get made in private circles among friends and professional acquaintances, thereby restricting knowledge of opportunities. It can be difficult for new and outside investors to identify viable opportunities, let alone gain enough visibility to value a business or asset properly.

Nevertheless, there are still investment opportunities with visibility into and assessment of both value and risk. Currently, unprecedented liquidation events under court supervision—such as the sale of a business via a receivership network or public legal notices—offer greater transparency and objectivity, mitigating the risk of overvaluation.

Cannabis receivership typically takes one of two paths. In some cases, it enables distressed businesses to rebound and become solvent. But when that’s not possible, it’s an avenue to organize and liquidate assets for creditors and investors to recoup some value. Since cannabis businesses cannot declare bankruptcy due to the plant’s federal illegality, receivership often is the last resort for business owners to try to get something out of their enterprise before it shuts down for good. Keep in mind, “last resort” does not mean “last minute.” By waiting too long, there may be little value left to protect and monetize.

Without a supervised court receivership, accessing knowledge about assets is difficult. While the cost burden on distressed businesses and their assets rises during a receivership, a receivership with a limited scope provides investors access to information about assets with the time to analyze and understand their value as determined by the courts.

Before investing in a distressed business, investors should evaluate, rank, and monitor the business’s operational and financial performance to identify the right opportunity and manage its relative risk.

A cannabis company is a business like any other—making a product for wholesale or engaging in retail commerce just like traditional companies do. The fact that the industry is heavily regulated adds a layer of complexity and uniqueness, but a careful analysis of how the operation became distressed will provide information about what lies ahead. Overhead costs, pricing, operational efficiency, reputation, product quality, and brand value provide key indicators of the worth of a struggling enterprise.

The legal, regulatory, and financial frameworks surrounding the distressed business also should be a focus. What goods or services is the business selling? How do its prices compare to those of market competitors? What are the margins? Is the commodity value trending up or down? If the business owns a license, is the market capped (e.g., Illinois) or unlimited (e.g., Oklahoma)? Will that number affect supply and demand? Knowing the regulations of the state(s) where the business operates is an important tool for understanding any perceived or stated value and how an investment might differentiate the company from others in the sector.

The industry might appear to be operating in survival mode right now, but the market is dynamic. The economy will bounce back, and legislation eventually will catch up to the realities of social acceptance and consumer demand.

The market will create substantial investment opportunities in the coming years, and investors will compete for the top assets. The big difference between gauging investment opportunities in cannabis versus in other industries? The lack of data on which to base decisions if investment in the cannabis industry continues to operate in a closed loop with backroom deals that keep sales from public scrutiny.

Investors who forego the backroom deals and focus on sales through receivership under the eye of the courts can treat cannabis as the commodity market it is, complete with the same core investment principles that apply to other commodities.