Investors Remain Cautious While Technology Holds Promise

Investor Caution DALL-E mg magazine
Illustration: DALL-E / mg Magazine

With federal legalization nowhere in sight and legislative reforms unlikely this year, companies looking for investment in 2024 are in a more precarious position than ever as multistate operators and other competitors size them up for mergers and acquisitions (M&A).

Interest rates shot through the roof and inflation worries spooked investors in 2023, so investment capital dried up and an already competitive industry became even more challenging. Unfortunately, 2024 is shaping up to be more of the same.


“I think there’s going to be more acceleration of bankruptcies and restructurings in 2024,” Rami El-Cheikh, corporate strategy partner at EY-Parthenon, recently told Investing News Network. “I think the balance sheets are very stretched. That’s going to be very problematic, and [even though] a lot of the cannabis companies have been very active with their cost-reduction programs, I don’t know to what extent they can further reduce costs and further streamline their operations. They’ve been at it for about a year or two years now. So, without improved capital markets [or] competitors exiting the market, it’s going to continue to be a challenging, challenging industry.”

Viridian Capital Advisers’ data also paints a bleak picture for 2023 capital transactions. Between February 2022 and February 2023, ninety-three M&A transactions valued at more than $2 billion took place. During the same February-to-February period in 2023–2024, transactions dropped to fifty-nine worth a total of about $1.2 billion. Cannabis capital raises also ended 2023 on a multi-year low. Only $1.85 billion closed through the fifty-one weeks ended December 22, compared to $4.33 billion during the same period in 2022. Sixty-one percent of the capital raised during 2023 was debt financing—a significantly higher portion than in any other comparable period since before 2018.

Cultivation and retail were the favorite sectors for investment in 2021 and 2022, but now capital barons are more cautious and circumspect about where and how much they invest. One area that has been picking up steam over the past few years is technology, including software and services that help companies perform daily operations (point-of-sale systems, for example), as well as analytical tools that help inform business decisions and strategies.

These companies are the ones that most interest Ian Dominguez, founder and chief investment officer at private equity investment firm Delta Emerald. As he evaluates software and media companies, he looks for unique technologies that can’t be replicated or replaced easily by competitors or products that exist in other industries.

“Our view is that there is technology today that can help operators solve problems that are really big for them,” he said. “So I think, big picture, technology remains one of the most attractive areas to invest in. By our research and estimates, $900 million was spent on cannabis technology across the industry [last year]. About half of that was spent on cannabis-specific software, and the other half was spent on non-cannabis software like say Salesforce CRM or [Amazon Web Services]. That $900 million, we think, is going to multiply by thirty over the next ten years, so the objective here is to capture as much of that tech spend that we already see growing by orders of magnitude in the next decade.”

Over the past five years, Delta Emerald has invested in twenty-two companies in the cannabis industry. In return for each investment, Dominguez said, the firm typically takes an equity position of about 10 percent. Companies in Delta’s portfolio include ecommerce platform Jane Technologies, point-of-sale solutions provider Blaze, analytics firm Happy Cabbage, and wholesale platform Nabis.

Data collection and analysis form a critical part of the investment process for Dominguez and his team. Not only do these tools help direct them to appealing market segments and companies, but they also help the team steer clear of risky investments and challenging operating environments.

“Avoiding landmines in this industry is half the battle,” he said. “We could spend the rest of the day talking about why we avoided cannabis delivery back in 2019, when that was all the rage because of COVID. We actively made a decision to avoid any of these cannabis delivery companies, because we knew that, for instance, 70 percent of all transactions still to this day originate in the store. And if you look at the people that spend the most money on cannabis, those people prefer to transact in-store and not online through delivery.”

Dominguez offered two stats that reveal quite a bit about California, where the illicit market continues to thrive five years after adult-use legalization and intense competition makes survival difficult for companies of all sizes. First, California dispensaries gave away $770 million dollars in discounts on $5.4 billion in sales. “That’s three quarters of a billion dollars that is basically being lit on fire,” he said. Compounding the problem, the average Bay Area retailer’s shelves hold about 450 individual product SKUs—twice as many as they need, in his opinion.

“Not only are they carrying too many SKUs, but they’re also carrying too much depth of inventory at each SKU,” Dominguez said. “For a retailer, inventory is your lifeblood. That is how you generate cash flow in your business. So there is an enormous opportunity across the country to improve decision-making, from the buyers’ perspective, and not buy so many SKUs and so much of each SKU.”

In California and other markets that are experiencing price compression—a growing trend impacting states across the United States—companies would be wise to get lean and mean and take a hard look at every aspect of their business operations. For the foreseeable future, investors will be more cautious than ever about where they spread their money.