Key Person Risk and the Value of a Cannabis Business
I recently heard Ron Seigneur speak about valuing cannabis companies at the Colorado Bar Association. His presentation highlighted many issues that make figuring out a fair value for a company in the industry extra challenging, including:
How do you predict a growth rate for a relatively new, and federally-illegal, industry?
How do you incorporate risks relating to the rapidly changing federal regulatory landscape?
Not mentioned above, but of equal importance, is Key Person Risk, which is when a business becomes highly reliant on a specific individual. This isn't unique to the cannabis industry (another example is Tesla's Elon Musk), but it is especially prevalent in this industry because experienced managers are rare, and licenses to operate are issued to specific groups of individuals.
As an investor, you need to understand which individuals are key to a company's success, and ensure that they are (1) able to continue to operate the business as it exists today, and (2) able to grow with the business.
For example, are you expecting a group that has been successful in Colorado to apply for a license in, say, Pennsylvania? You’ll want to make sure that any key person can pass Pennsylvania's background checks before you invest -- and the checks will vary from state to state.
Though many states focus on criminal convictions in conducting their checks, most also leave room for vaguer assessments of character. For example, here are some of the guidelines for Colorado and Pennsylvania license applicants:
The applicant may not have any Controlled Substance felony conviction in the ten years immediately preceding his or her application date
The applicant may not have a criminal history that indicates that he or she is not of good moral character
Applicants will be scored on whether they are of good moral character
Applicants must consent to any investigation, to the extent deemed appropriate by the Department
The takeaway? Certain individuals are going to be key to the current and future value of a cannabis business. Make sure that you know who they are, and that you know enough about them to make sure that they can grow the business in the way you expect.