A private equity investment firm in Coastal Connecticut (PEI-CC) was approached with an opportunity to invest in a cannabis business. The Cannabis Business (CB), leasing a warehouse building and holding a license to grow, manufacture and sell recreational Adult-Use cannabis and cannabis-products in Massachusetts, was looking for funding to get the operation off the ground. The CB’s plan was to use the investment to renovate and launch the retail-portion of the building and reinvest earnings to build out the cultivation space.
The investment was $3.5M in the form of a senior secured loan with 15% interest. PEI-CC was to receive 9.5% equity in the company and the loan would be paid by a full cash sweep of CB until the debt was fully repaid. The debt would be secured by CB’s three licenses – the retailer, manufacturer and cultivator licenses.
PEI-CC, is a savvy and successful investment firm and know what they are doing when it comes to vetting potential opportunities. However, the cannabis industry was new to them. They weren’t sure how realistic the assumptions were in CB’s financial model; They weren’t sure if CB’s building was well suited for the tasks at hand; They weren’t sure if CB’s ownership team was capable of performing.
Opus was brought on board to review CB’s financial model, tour the building and review the architectural floorplans, and meet the leadership team.
On a high level, the financial model first calculated an assumed amount of cannabis produced. Retail sales were calculated next and the remaining product was slated to be sold on the wholesale market.
Upon investigation by Opus, the financial model turned out to be predicated on a variety of overly- and underly-aggressive assumptions. Retail sales were calculated based on the number of POS terminals and an assumed time per transaction, multiplied by an aggressive average basket; it was assumed that enough demand existed to occupy all thirteen (13) registers all day every day. To make matters worse, retail price assumptions were above the local market pricing with unrealistic price compression occurring over a 5-yr period. Compounding the issue even further, the amount of cannabis projected to be produced was at 70% above the industry average. After looking at each of these assumptions, Opus reasoned that total sales were likely closer to about 60% of what CB projected. Nevertheless, after changing some of CB’s assumptions the business was still projected to be profitable and potentially worthwhile from PEI-CCs perspective.
While touring the building and reviewing the floorplans with the architect, Opus believed the building to be in good condition for a cultivation facility; it was constructed of a suitable material, had favorable ceiling heights and there was enough space to have a retail store in the front portion of the building. The floorplans, although showed a basic understanding of plant lifecycles, didn’t show a deep understanding of the accompanying workflow; the sizing of rooms relative to each other weren’t sized appropriately and would have to be either underutilized or to cause bottlenecking as designed. Additionally, it was clear that there was a misunderstanding of the amount of staffing required to manage the operation; ancillary rooms such as locker/break/bathroom/administrative/etc were either inappropriately sized or missing altogether.
Throughout conversation during the site visit with the CB’s management team a few red-flags appeared. Industry specific terminology was being misused, in spite of the fact that this particular terminology was being marketed to PEI-CC as CB’s key differentiator. Additionally, at the start of the dead-end road on which CB’s building was located at the end of was a competitive business, so all customers of CB would have to drive by another store. When questioned about this, CB stated that this was actually an advantage in the cannabis industry i.e. customer discretion.
Ultimately with the insights Opus was able to provide, PEI-CC shied away from this investment.