A due diligence process can range from a gut feeling to years of highly structured audits and stress tests. While it is inefficient for cannabis startups to prepare for institutional due diligence, there are focal points that can help extract an investor’s attention from their innate curiosity.
An entrepreneur’s focus is on what makes their company a worthwhile investment, while an investor’s focus starts with all their available investment opportunities. A fully diversified risk-adjusted portfolio may have a small percentage of assets dedicated to alternative investments. Cannabis is emerging as its own alternative investment class and will play an increasingly important role as a non-correlated asset class with high overall risk-adjusted returns in any adequately diversified investment portfolio.
Due diligence: The care a reasonable person should take before entering into an agreement or a transaction with another party
Once portfolio allocation towards the cannabis sector has been determined, an investor may move toward analyzing its various sub-sectors to make determinations on sector allocation with an eye towards adequate hedging, appropriate diversification and risk-mitigation. It is only after portfolio analysis and sector allocation is complete that single company due diligence can begin.
Founders are well served to include the following in any due diligence package they present to investors:
- Business Plan: Document setting out your business’s objectives and strategies for achieving them
- Executive Summary: This should highlight the strengths of your overall plan and therefore be the last section written and the first section of the business plan
- Corporate Formation Documents: How is your company structured? This has tax implications for investors
- Pro-Forma Financials: Relevant past financials and projected future economics for the business
- Organization Chart: Show the structure of your organization and the relationships and relative ranks of its people
- Term Sheet: The legal document that shows what an investor gets for the cash they are putting in. Do you have a defendable valuation?
- Pitch Deck: Marketing tool to tie together all of the above documents.
- Offering Memo: This is the most comprehensive item on the list and the most utilized legal document. State the objectives, risks and terms of the investment.
A comprehensive and complete due diligence package is essential to any capital raise conversation; investors may ask for additional documentation including letters of engagement, resumes, and board information. Investors navigate through portfolio allocation, sector determination and a diversification/hedging strategy prior to ever considering a single company investment. Founders are thus well advised to remember that investor choice is based on a number of factors, many of which have little to do with the company itself. Complete due diligence package preparation can bring confidence to any investment table conversation.