Investing in a cannabis startup doesn’t have to feel like setting out on an adventure into the unknown. With thorough due diligence, you can understand this new industry while evaluating a good business opportunity.
Due Diligence: Smart Tips for Investing In A Cannabis Startup
In many other sectors, investors often know the right questions to ask and the types of financial risk they are getting into before investing. However, the legal cannabis industry is different on so many levels.
When investing in the marijuana sector, even seasoned investors are often left with more questions than answers when analyzing the numerous local. state and federal rules and regulations as well as the legal implications affecting cannabis businesses. Add to the fact that the industry is evolving at lightning speed, and investing in marijuana can seem like a goldmine.
There are certainly so many ways to make money in this industry. But it’s important to know how to ask the right questions so as to obtain the most detailed information and avoid jumping into a bad investment, or more importantly. Losing all of your money in the process.
The starting point for investors looking to take a dip in the legal cannabis industry is to gather as much information as possible about the industry and get to know all the benefits and risks of entering the cannabis market. Investors must, therefore, conduct due diligence on target companies.
Due diligence should include both general due diligence as well as due diligence specific to the cannabis industry. Including analyzing the investment from a legal standpoint. Cannabis specific due diligence does not. However, means looking at a target company’s legal compliance. It means evaluating the company’s business processes and understanding how it manages some of the legal challenges of operating a marijuana business.
Obtain As Much Information as Possible
Like any other business, cannabis investors must strive to learn as much as possible about the industry they are planning to enter. This is especially a challenge in the marijuana industry because it is a sector that is still growing and evolving.
The biggest problem continues to be the fact that cannabis remains a schedule I drug. However, investors can still join the industry because the national government allows businesses to operate in states where marijuana is legal. Once an investor has crossed this hurdle. There are various other challenges and risks that the investor must be aware of, including:
Inability to use financial institutions like banks:
This is a significant problem that raises other major issues like cash management and security.
Federal tax concerns:
Section 280E of the federal tax code forbids cannabis companies from making any major business assumptions that might affect their profit margins.
State licensing requirements:
Inability to comply with all the state laws and regulations can be costly and can result in the shutdown of an otherwise legal business.
-Residency observance for investors and companies
Local rules and regulations:
Local governments can place additional rules and regulations on business operating within their locality. Some localities have banned marijuana despite its legalization on the state level.
-Real estate concerns: It can be difficultés to secure a property that permits the operation of a cannabis business. And even when companies do find a place, rents may be ridiculously high.
Investigate the Target Company
Conducting due diligence on a target company starts with licensing. An investor must ensure that the target company is fully licensed and compliant with all local and state regulations. This includes being prepared for regular inspections and meeting annual requirements to maintain their business license.
Strict compliance with licensing laws is the keystone of any cannabis company because non-compliance can result in excessive costs and decreased profits, or worse. The loss of an operating license, which could mean the shutdown of a business.
Licensing, however, is just the tip of the iceberg when conducting due diligence. Other legal and regulatory issues that need to be addressed include:
-Real estate concerns
-Advertising and branding
-Compliance with local laws
Additionally, it is important for an investor to understand how a company navigates the complex legal cannabis industry in order to obtain good profits so that investors get good healthy returns. Some of these complexities include:
Background checks on employees:
Aside from criminal checks conducted by state regulators, an investor should check on media reports and past activities about a business
Cash management and security:
Because of banking restrictions, marijuana companies operate on a cash basis, which can create security concerns about the safety of liquid money in the company
Third party relations:
Investors should make sure that any third party vendors that work with the target company are also properly licensed. Non-compliance with rules and regulations by third parties could have significant implications on the target company’s operations.
Just like any other business, investing in a cannabis business involves a lot of risks. The most important thing is to conduct due diligence so you can make a smart investment, and more importantly, avoid losing all of your money.