An Unconventional Approach Befitting a Unique Asset Class

When an industry’s hot and generating abundant buzz, it tends to draw investors—professional and otherwise—eager to capitalize on the promise of potential hockey stick growth and seemingly willing to brush off the possibility of early stage potholes.

Cannabis was no different.

A bit more than a decade ago, as the legalization era dawned and a multi-billion dollar industry took root, investors ranging from friends and family to venture capital firms flocked to the space.

In a period we call cannabis euphoria, investment expectations were something akin to the early days of the internet, with operators trading at 20x to 30x forward revenues.

Trouble is, as a highly regulated industry, cannabis unfolds at a much slower rate than the internet, so it took a lot longer than hoped for legalization to occur and state-level supply chains to get built out. In turn, the euphoria dissipated and many of the early movers headed elsewhere, leaving a considerable shortfall in accessible capital.

Who remained?

Small, niche investment firms that:

• understood the industry’s true fundamentals
• structured deals that better fit the long game
• created thoughtful, disciplined capital streams that aided operators

All while rewarding investors for their patience.

Yes, that describes how we work at Altmore, but more broadly, it reflects the advantages a boutique firm possesses through the considerable ups and downs of a massive market transitioning from the shadows of illegality to legal status.

Unquestionably, an Expanding Opportunity

The size of the cannabis industry keeps growing, with North American sales reaching nearly $36 billion in 2023, according to Research and Markets, and the additional economic impact in the U.S. totaling another $64 billion, according to MJBizDaily.

The Research and Markets report projected that North American sales would hit $298.5 billion sales in 2032, a compounded annual growth rate of nearly 27% over the next decade.

And yet, investor interest has fallen sharply from a post-pandemic jump.

According to Viridian Capital Advisors data cited in Green Market Report, the cannabis industry raised $1.7 billion in capital between March 2023 and March 2024—a sharp decline from the $8.8 billion raised in 2021, according to data analyzed by MJBizDaily. Furthermore, the first five months of 2024 saw just $811 million in fresh capital, according to Viridian data reported by Green Market Report.

The dropoff may be attributed to investor wariness over previous setbacks (driven in part by unrealistic return expectations), rising industry competitive pressures, legalization limbo, and hot new investment themes elsewhere.

But the need to finance the cannabis industry’s expected growth remains. And provides an ideal landscape for boutique investment firms to work through the unique challenges and opportunities of a niche industry experiencing considerable growing pains.

Nimble Approach Firmed Early On

Six or seven years ago, a popular approach for funding a cultivation facility was to buy a property, immediately sell it to investors at a much higher value, use the excess to build out the desired facility, and sign a long-term lease to make the investors whole.

For example, an aspiring operator could arrange an option to buy a property for $5 million, sell it to investors for $20 million, use the additional $15 million to build out the cultivation facility, and agree to a 20-year lease on the property with the investor owners.

Who knew there had to be a better way? Operators.

And that’s what one of our potential clients told us as we discussed the specifics of the then-standard approach, he asked us:

“Is there any way you can just loan me the money for 4 or 5 years?”

That prompted an internal discussion about what was truly tenable for these early stage businesses. Sure, a 20-year lease would be a great deal for our investors and us, but that’s a long time in cannabis. Nobody knew—or still knows—where the industry is going to be in 5 years, let alone 20.

That’s when we realized if an operator needs capital, a better use of those funds would be to grow the business and pay us back in 4 or 5 years. Not saddling the business with a 20-year lease.

Thanks to our borrower, we pivoted.

Our business model couldn’t be about over-leveraged deals, owning real estate assets, and oppressive leases.

It was about targeted, collateral-backed senior loans with terms that rewarded us for the risk we took on and fit the borrower’s timeframe. Plus, to firmly align with our clients’ upside goals, we developed an approach to secure warrants alongside the loans.

Working Hand-in-Hand with Portfolio Companies

In a constrained capital environment, it can be tempting to secure lucrative deals that skew heavily toward the investor.

What other options do most operators have?

But in the spirit of that early discussion with one of our, now, long-time borrowers, our firm works on a different plane—one rooted in the concept that when our clients achieve success, so do our investments.

That shared ambition leads to a sense among many of our borrowers that we’re more like a financial partner than a singularly focused lender.

We don’t follow loan-to-own or predatory practices. Instead, we’re here to help our portfolio companies succeed at their current stage so they can advance to whatever’s next, whether that means an IPO, bond offering, or another advanced form of financing.

For example, not long ago, we helped a client raise considerably more than they anticipated in an equity raise. Separately, when another client decided it was time to sell, we helped find a buyer.

In short, if you’re a middle-market cannabis company seeking to level up, we can work with you to get there. And if you’re considering working with us, we’ve got almost two dozen CEOs who can vouch what it’s like to work with Altmore.

Fostering Goodwill with Investors

Just as our unconventional approach stands out with potential borrowers, our thoughtful and collaborative process offers a contrast for investors wary of committing to the high growth yet highly volatile cannabis industry.

To help mitigate the potential downside, our investments result from a highly professional vetting approach that blends:

• Private equity style due diligence
• Extensive legal expertise

We know our process doesn’t resemble a typical private credit practice, but our team has thought long and hard about how to invest in this industry in a downside-protected way.

More specifically, our due diligence efforts dive deep into every single credit we look at. It’s a funnel that may start with 100 opportunities but leads to underwriting on seven or eight and ultimately results in two getting funded.

Meanwhile, we value our relationships with investors as much as those with operators: It’s not the size of the investment that we prioritize, it’s the cultural fit. If that’s not there, we’ll pass.

Because issues will arise, and at those times, it’s essential that we can sit around a table, roll up our sleeves, and work things out together.

Warranting a Different Look and Feel

A boutique firm’s independent nature can manifest in uniquely structured deals.

Here at Altmore, our spin usually involves warrants: A right to a portion of the equity in those businesses that we have thoroughly examined for creditworthiness and growth potential, and that the operator is willing to give up to a trusted financial partner.

Initially, we negotiated for warrants as a percentage of the loan. So, 15% warrant coverage on a $10 million loan translated into $1.5 million worth of warrants, typically issued at a strike price discounted from the company’s most recent valuation.

Currently, as we’ve evolved our strategy to investing in operators to whom we can add outsized value, we typically negotiate for penny warrants, or nearly straight equity grants to the lender. These securities usually have a 5- to 10-year term, so liquidity events occur deep into the relationship and extend the potential returns for investors, all while aligning us with the borrower, given our share of the operations.

We believe this is a mutually beneficial strategy for both operators and investors alike as legalization advances nationwide and borrowers have the potential to grow more significantly.

Patience Proved to be Virtuous

It’s still early—very early—in the cannabis industry timeline. And there appears to be some considerable potential growth left in the hockey stick.

Admittedly, there have been times when it’s challenging to stay in our private credit lane. Most notably when cannabis equity was flying so high it was essentially getting scorched by the sun and people were turning single licenses into multi-million-dollar gains in six months. Similarly, there was a time when debt was out of favor, relative to every other asset class.

But we persevered, stayed in our lane, and watched:

• The equity market essentially flame out
• Venture deals become too difficult to evaluate and gain interest of new investors
• Real estate investment opportunities dry up as the industry matured

Presently, debt has emerged as one of the only, and more frequently an ideal approach to cannabis capital—a favorable development for our firm.

We don’t know how long this environment will last, but it’s currently as good as it ever has been to deploy capital—and our experience in this unique asset class is paying off.

Especially as our distinct approach means we’re viewed as a valuable resource to borrowers and investors alike.