We have a very exciting show for you this week! In this episode of M&A Masters, we’re joined by Codie Sanchez, the managing director of Entourage Effect Capital Partners and one of the most sought out speakers in the cannabis business.
Entourage Effect is a unique private equity firm as it was the first to focus exclusively on the cannabis industry. Since 2014, Entourage Effect has invested over 100 million dollars in over 40 companies!
We’ll chat with Codie about how she got into the cannabis industry, what sets Entourage Effect apart from other private equity firms, as well as…
- The entourage effect
- What potential investors should ask about cannabis
- The way cannabis is viewed as an investment
- What makes cannabis different than other agricultural products in terms of due diligence and the M&A process
- Entourage Effect’s ideal target market
- And more
Mentioned in this episode:
Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here, that’s a clean exit for owners, founders and their investors. Today I’m joined by Codie Sanchez, managing Director of Entourage Effect Capital Partners, a very unique private equity firm which was the first to focus exclusively on the cannabis industry.
Since 2014, EEC formerly known as Cresco Capital Partners, has invested over 100 million dollars in over 40 companies. Codie is one of the most sought out speakers on the business of cannabis so I’m thrilled to have her with us today. Codie, welcome and thanks for joining us today.
Codie Sanchez: Wow, thank you for having me, Patrick. Lovely, since I’m working from home this week, like everybody else, this is a perfect opportunity.
Patrick: Gotta love technology here. Now before we get into EEC and Canada’s overall type of industry, how did you get to this point in your career? Because it’s got to be a great story.
How Codie Got to This Point In Her Career
Codie: Yeah, well, I don’t think very many people wake up as a young teen and decide that they want to go be in drug financing, so I’ll tell you that it wasn’t my high school counselor that I talked to about this. I really started out my career as something completely different from finance. I was actually a journalist. I worked on border issues along the US-Mexico border, particularly narco-trafficking and human violence and atrocities along the US Mexican border.
And so I did that for a few years. And then as one does, realized that it’s really not enough to shed light on people’s stories and to raise awareness. I wanted to make some real change. And it seemed to me like the way to make actual change was to go to where power flows from. Which, at the time, I started to realize was largely monetary. He who had the biggest checkbook made the biggest changes in society.
And so with that, I sort of pivoted my journalistic focus and moved to finance and kind of worked my way up some of the larger companies in the financial realm. Everybody from Vanguard to Goldman Sachs to State Street until my last firm where I ran our emerging markets division, specifically in Latin America. And that’s when I really started getting interested in these nations and emerging markets. We did really well in Latin America. And so when I was exiting that business, I was looking for what was the next nascent and emerging asset class.
First I was looking at it from a profitability standpoint and where did I actually think we could make more money on, from an investment standpoint, and then I was looking at it from a standpoint of where you can make an impact. And I sort of lucked into cannabis by feeding this first fund back when we were Cresco Capital Partners in 2014. And tracking in the cannabis industry from there. That’s when I saw how profitable this industry could be and the sort of what we call generational wealth opportunity.
And then secondly, I’m actually married to a military man in the Special Forces. And so I saw the impact that it had on veterans with PTSD, which we’re very involved with. And so that got me really interested in it from a societal standpoint.
And from a total return standpoint, it made me comfortable enough to take the leap and actually make moves in this industry that was capital-starved, had a huge latent demand within it, was over-regulated and also had a large amount of innovation coming from the proliferation of products from both cannabis and hemp.Patrick: When we think about context of time with this 2014, California probably had medical marijuana legal. Had they gotten direct recreational by then?
Codie: No, they had not gotten to recreational yet. So, you know, at that time, this really looks like a big risk. Not to mention the fund was actually headquartered out of Texas, which certainly loved its veterans but was not interested and still hasn’t made major moves on the cannabis front.
Patrick: That’s really prescient being able to, you know, be ahead of the curve there and see where it is because it’s easy falling back today and being able to predict expansion of this industry. But, you know, six years ago, that’s something, is really, really prescient there. But with the focus exclusively on cannabis, that’s not too much different from other private equity firms that may be focusing on a vertical as well. Other than the exotic vertical that you have, what is it that sets EEC apart from other private equity firms?
What Makes Entourage Effect Different From Other Firms?
Codie: Yeah, so first and foremost, it was certainly originally that we were in cannabis. And I was not dissimilar from many institutional investors at the time. I had only really worked with pensions, sovereign wealth funds, endowments. And at the time in 2014, I wasn’t public with my engagements in cannabis. I invested as a passive investor.
And, you know, continued to do that through the GP up until 2018, when I actually went public and became more comfortable with the legal ramifications of that. But it certainly took me a while. Matt Hawkins, our founder, was the one who took a lot of the early risk, was putting his name out there. That, I think, has pretty much gone by the wayside. When we talk to investors there aren’t very many any longer that are worried about legal ramifications. So that has changed wholeheartedly, even in a couple of years since I’ve been full-time focused on this business.
And so, you know, that’s one of the big differentiators is one, we know where all the bodies are buried because we’ve been in this game a long time and it is still a cottage industry where you can pretty much reach out and touch about any of the major C suite executives across the industry if you’ve been in it for a few years. But the biggest differentiator, in my opinion, is that we really have been preparing for this moment. Did we expect a pandemic?
Absolutely not. I wish that we were that forward-looking. But what we didn’t expect was a major valuation reset in the cannabis market. We thought the market was simply too expensive back in 2018 and 2019. And so we started structuring our terms more like a distressed investor with a lot of financial oversight with the ability to take over companies if milestones aren’t achieved with larger check sizes coming out and that has just accelerated for us as we continue to launch new funds that are focused exclusively on distressed opportunities.
I haven’t seen in this industry, very many true distressed and turnaround experts. And thankfully, we have a few on our team. Tiffany Lifs and Joe Blizeddie are the two that came on to really head up this segment of it that are from some of the bigger distressed shops in private equity. And so this ability for us to get into a, you know, generational wealth creation event industry like cannabis, it’s growing at a 25% tagger.
Right now with Coronavirus hitting, the industry from a sales perspective is up anywhere from 100 to 160%. It’s a vise industry which is, has some, you know, historical insinuations of being recession-resistant. And then on top of that, it experienced about a 90% downtick in the valuation of public stuff which trickled to private companies. And so if we can take advantage of those distressed companies to do turnarounds, like we have in a few of our portfolio companies, I think that we’re positioned probably similar to how some of the big PE firms were positioned post-2008 that had capital to deploy.
Patrick: Well, I think you’re bringing in both the resources and the commitment to this sector. I mean, 40 companies investment in the last few years, probably more than that now, but you’re definitely walking the walk. Talk about the element that you and I discussed earlier about the entourage effect. It’s more than just some series from Showtime. What is the entourage effect? And how does that encapsulate what you guys do?
What Is the Entourage Effect?
Codie: Well, yeah, thanks. I mean, I think it’s probably apparent that we’re all finance nerds and not exactly marketing geniuses because you would have laughed if you listened to any of our phone calls about changing our names once we had merged our two companies together. There’s another large cannabis company in the space that we’re friends with called Cresco Labs that we kept getting confused with.
And so we changed her name to Entourage Effect and it turned out to be kind of perfect because what it means, this is a medicinal term in the cannabis realm, which means that the whole is greater than the sum of its parts. And so there’s this odd effect in cannabis within the plant where, if you know much about it, inside of the cannabis plant are things called cannabinoids, and these varying cannabinoids up which we haven’t even charted all of them, but there are upwards of 60. When they come together, you have an effect that people talk about in the cannabis plant that helps with let’s say, nausea, or it might help with inflammation or it might help with sleep or anxiety or all the things that people use cannabis for.
And what we found Is cannabis, very interestingly, if you were to pull out one of the cannabinoids, like THC, that’s the psychoactive portion of it is a cannabinoid, CBD nonpsychoactive, now more mainstream, is another cannabinoid and you were to use both of those independently, the effect is not as strong or comprehensive as when you use the whole plant. And that is what’s called the entourage effect because it has all those 60 cannabinoids in there working together to do more for you than if you took any one of those cannabinoids individually.
Patrick: And tell me how the entourage effect works for one of your portfolio companies.
Codie: Right. So the way we thought about this from a venture capital and private equity perspective is the Japanese have a thing called karatsu. And this has been sort of brought over to the VC landscape which is kind of like a gang of people that all get together and they help one another as a grouping of companies create unfair advantages. And we think about our entourage as stuff like that as well. We’ve actually invested now in over 64 companies.
And one of the benefits that companies have when we invest in them as let’s say we give a company $10 million. They certainly are happy, yes, perhaps about that. But one of the other advantages is those 64 companies that we’ve invested in, they are many of them now the largest names in cannabis. And since the ecosystem is one-modded, so you can’t have out you know, external forces coming in and playing in cannabis yet due to a federal illegality, those 64 companies play a huge part and are very interconnected in the ecosystem.
And so for instance, we have a company called Sublime. They have a product called Fuzzies. It’s one of the top pre-rolls, or is the number one pre-roll which is a pre-rolled join in California. And this company when we invested in them, we put in the capital, we helped them from an operating standpoint, we did a bit of a turnaround with some efficiencies inside of the company.
And then we went on to introduce them to our largest MSOs and vertically integrated company, which means companies that are dispensaries, so they’re the ones that are the retailers giving out the product to consumers. And we were able to take those Fuzzies into some of the biggest retailers in space, and we can immediately add millions of dollars to top-line revenue by engaging them within our portfolio company ecosystem. And those companies are willing to put those products on their shelves because we continue to fund them. And so it’s a beautiful unfair advantage that happens when you become an EEC company. And the same thing is true of ancillary services as well.
Patrick: Yeah, you just get all that automatic infrastructure and channels open that otherwise weren’t accessible and it’s all established. I think it’s also impressive that, particularly on the turnaround side, you’re not dealing with exclusive cannabis people that have worked in cannabis that know turnaround or finance or some for cannabis. You’re funding financial experts, turnaround experts, legal experts outside that we’re doing things for larger institutions. And they’re taking that skill set and that knowledge base and bringing it to bear on this underserved market.
Codie: I think that’s crucial. Yeah. I mean, if you were to look at some of our chief restructuring officers that we bring on board, or, you know, the CEO of a company like Sublime has, his background is in semiconductors and also a time at Amazon and rolling out the Kindle. So we’ve sort of moved to professionalize some of the management in the industry, paying homage to the institutional knowledge that comes from those that have been in it for a long time. But onboarding those who have worked at the largest, most efficient companies out there.
Patrick: Explain how cannabis is viewed as an investment. What do you think of it you know, what should potential investors think about cannabis?
Codie: Sure. Well, I mean, I think one of the best ways to think about it is if you’re looking to invest in a private equity fund or a venture capital fund, you first look at the math, right? So if you were to replace cannabis with the word widget and you were to say that you have an industry that is doing 25% tagger, or average growth each year, it’s been doing that for the past six years, that you have a 200% increase in consumer adoption year over year that in this pandemic, let’s say, it’s listed as now an essential service right up there with doctors and grocery stores and gas stations.
And in tandem with that, you have an industry where capital is nowhere near a commodity. The industry is completely capital-starved and so investors get to drive the terms in a way they never should be able to with an industry that’s doing double-digit growth and it’s the number one employer, actually in the US, for the past two years from a new employees growth perspective. And so
Patrick: Yeah, that’s not getting reported.
Codie: Yeah. No, it’s not. It’s actually, if you Google it, you’ll see Codie’s not making it up. But you can see there’s a couple Forbes articles that show you about eight to 10,000 cannabis jobs are being created a month. And those actually are not reported at the federal level because of the illegality. So if I was just to tell you those numbers, and I didn’t tell you cannabis, you’d probably be thinking and that’s really interesting. What industry is this?
And we should probably have some exposure. And if I was then to tell you, oh, by the way, the industry just had a massive reset, in which it is down 90% from its highs across the board, and is now trading at a very standard, let’s call it consumer staples, consumer discretionary level, but people would be stampeding into this industry. But the beautiful part for us and for other investors is that the big boys can’t invest yet due to vice clauses and the legal status.
And so we can invest now but to be frank, you know, Patrick, I think I’ve got two or three more years left of this because if, you know, if governments are willing to list cannabis as an essential service right now during a pandemic, how much longer can they say that it should be federally illegal?
Patrick: There’s something that makes cannabis different as you’re looking just from an m&a perspective. So we’ll talk about that. How, what makes cannabis different from other, you know, other ag products or other businesses in terms of either diligence or whatever you have to go through for an m&a process?
Cannabis Is a Diverse Commodity
Codie: Yeah, well, one, I think it’s important to say you’re not wrong by saying that some parts of cannabis are, you know, an ag type product or a commodity. You know, in fact, flower prices continue to decline and that’s all baked into our models. But the part that I think is important to look at is, you’re not really looking to make your margin on the individual flower, which is what we think of as the cannabis products, they call it flower. And that’s when it’s just in its raw form that you go and smoke with or cook with, or whatever the case may be.
But that segment of it is a commodity and is agriculture and is declining from a margin standpoint, no doubt about it. The part that’s really interesting, though, is that as we move, you know, downstream towards the consumer and away from the actual growing of the plant, that’s where you pick up all your margin. And you pick it up and things like brands, and retailers and all of this is very similar to consumer staples or consumer discretionary or alcohol or tobacco. And so that’s one differentiator. And then you also have an industry in which it takes consumer goods, right?
You can, it also touches beauty because the cannabinoids such as CBD are now proliferating around beauty products. The third aspect it touches is nutraceuticals. So people are using different types of cannabis plants in order to not do medicinal changes to their bodies but to do some changes from a nutraceutical standpoint like a vitamin.
Then you have the medicinal component of it. GW Pharmaceuticals, billion-dollar-plus company which uses a derivative strain of THC to deal with one type of medical issue. So we have, you know, pharma and medicine. And then you add on top of it the fact that hemp and cannabis, the actual plant itself, the fibers and the stocks can be used for everything from construction departments to clothes and even Levi’s. Levi’s, for instance, is making you know, hemp jeans. And so it really goes across a, I wouldn’t say majority but quite a slew of sectors in order to have impact.
Patrick: You are having members of this industry, still to this day, coming out of the shadows, and they need somebody to help, you know, walk them through that process I imagine.
Codie: Oh, absolutely. I mean, the due diligence in this space is one of the most critical aspects of it. And you just have to assume, you have to assume that every rock needs to be overturned, that most of the books and records are not going to be complete in and of themselves. If they are complete, they’re probably not done exceptionally well. And, you know, many of the providers, for instance, couldn’t tell you by individual view, what is the margin that they make on each of their underlying products.
And so there certainly is a level of sophistication that has to come into the industry. And inside of that chaos lies the opportunity for those that are diligent. You know, if you’re wanting to come in and make quick, fast money. cannabis is not a great place. But if you were wanting to come in and you have expertise in other similar industries and an ability to do financial modeling. I mean, we’re not talking about really complex Silicon Valley, you know, let’s say advanced data collection or AI. We’re talking about a better than industry with some of the highest margins out there.
Patrick: Who’s your ideal target now for EEC. What are you guys looking for?
What Entourage Effect is Targeting Now
Codie: So from a company perspective, what we’re really doing right now is we are 100% focused on growth equity. And so no longer are we investing in companies that are seed stage, or really early stage because the capital is so needed, that we can de-risk our investments quite a bit.
So when we go on the market right now, what I’m looking for as a company that’s doing 10 plus million dollars in revenue, that has some distressed aspects to them or a real need for capital where we think that we can come in and they’ve already found their product market fit, they just haven’t made it incredibly efficient. They perhaps need some professional management on top of it, and they need capital yesterday. And in those instances, we can really provide huge value and turn around a company to profitability with a quite impressive speed.
Patrick: Well now return over to the business of cannabis. Just as and, you are as of this time right now, one of the foremost thought leaders in this space, that’s why we’re very, very excited to have you here today. What are you seeing? I’m glad also that we’re not having this conversation two months ago because I’m sure it’d be very different from today.
But what do you see as a first-quarter 2020 in the beginning, hopefully, the middle innings of this Coronavirus pandemic. But what do you see for the cannabis industry, either segmentally, product wise, whatever, for the future in the next 12 to 24 months? You did mention something about valuations. But give us a, give us your picture.
Codie: Yeah, I mean, I think every single industry that can be disrupted will be disrupted in the near future. And I think that cannabis is no different. And so what I would expect is more pain. You know, this industry and every other industry is at an unprecedented place today and that is that the economy has officially really stalled. And even though cannabis sales are up, eventually as jobs continue to be furloughed or people are fired, nobody’s going to be spending. And so in my two cents, we have a really unique opportunity right now to take advantage of the fact that there are going to be distressed companies left and right that cannot continue operations by themselves.
That means we are going to come in and we’ve been building a war chest specifically to do this, to take over companies that are in this position and make sure that they can weather the storm and build platform companies that are big enough to while everybody else is buckling down, they can start to sprint. And so what do I expect? I expect not much different than what most economists do, which is that we are going to have a very severe sort of V that’s going to happen in the economy.
And that next quarters GDP numbers are going to be probably some of the worst numbers ever. And the only difference I think that I see is I don’t think the government will continue this for months and if I’m right about that, then we will see more of a V-shaped recovery and these companies will do incredibly well on the upside. And so that’s kind of what we’re preparing for. We’re putting capital to work and markets like this with companies that are at bottom-level valuation and making sure that they have enough capital to buy for the next 12 months and to really sprint as we get out of this unprecedented period.
Patrick: What can you tell us about products? Anything in the research development area on products?
Codie: Yeah, I mean, there’s a couple different things. One, there’s, this is a little bit specific to cannabis, but there’s a company called Cellibre that we invested in. They’re a biosynthesis company, I definitely think they’re worth a look. Biosynthesis, essentially is, you know, for you guys, if anybody else does, say fish oil products, or krill oil products, and you think you’re getting fish oil on this little tablet.
What you’re actually getting is a synthesized version of fish oil that is created using a strain of algae. And Cellibre, which is a portfolio company of ours, is doing something very similar with varying types of plant strains to create different cannabinoids from THC to CBD to CBG to BGA. And if you can imagine that it costs you one-tenth, let’s say, to synthesize in a lab, the same amount of THC or CBD as it does for you to grow it.
You can see the opportunity herein. We think that Cellibre actually is multiple farther along than one 10th the cost with a level of consistency in the product that’s pharmaceutical grade, which means if they do what they say that they’re going to do, companies like this biosynthesis company could be some of the biggest wins we’ve had in the portfolio thus far. So that’s on the science biotech side. The other side, you know, everyday users can think about are the, you know, edibles. The different way that we consume cannabis is fascinating. You know my 93-year-old grandmother has arthritis.
She uses creams from some of our portfolio companies at Harbor Side and Urban Leaf in California to help with her arthritis. You know, we have many of the moms that are investors of us or partners of investors, of EEC who used edibles from a company called Thunderstorm. They have these edibles called Kanna that are microdose very, very low levels of cannabis that help people sleep and with anxiety. So these edibles are going to be the future of cannabis, in my opinion. It won’t be smoking flower, they will be there but we won’t really consume cannabis in either drinks or edibles in the long term for the mainstream of people.
Patrick: That’s a lot to think about. That is just amazing. And really what I wanted to hear and to share with our audience today is just coming into this topic in this subject, speaking with you opens up to all these other areas we didn’t even contemplate. So it’s very, very exciting. Codie, how can our listeners find you?
Codie: So I think the easiest is probably if you want to hear more investing and market news that would be LinkedIn. I’m just Codie Sanchez, CODIE Sanchez, SANCHEZ. If you want to follow along to some of our portfolio companies, I’m probably more active on Instagram with that, which is the. Just my name. And then if you want to learn more about the fund family in our firm, it’s entourageeffectcapital.com
Patrick: Codie, thank you very much for just an action-packed 28 minutes and really appreciate it. I look forward to speaking with you again soon.
Codie: The pleasure was mine. Thank you, Patrick. Hang in there with all this craziness.
Patrick: You do the same.