Investing in the cannabis industry

Emerging sectors like the cannabis industry have often attracted investors hoping to be among the first to capitalize on the potential growth and high returns of what they believe are untapped markets or products that may be popular in the future.

While it’s true that some new sectors have been successful for some investors, such as those who invested early in internet-based companies, the chase for the next big investment can lead investors to speculate on trends and bet on industries and products with no proven record or history of success.

The cannabis industry in particular has grown quickly in recent years as a number of jurisdictions, including Canada and certain U.S. states, have explored new laws around the sale and use of cannabis. In Canada, this initially began with the legalization of cannabis for medicinal purposes, which prompted a number of companies to express interest in entering the market and approaching investors who were keen to get in on what they believed was the next big thing.

Cannabis regulation in Canada may continue to evolve over time as the federal government plans to legalize its recreational use. Because of this, many cannabis companies are promising investors the opportunity to capitalize on the potential for considerable future growth. A number of companies are looking to expand into the U.S. where some states have authorized sale and use of cannabis for medicinal or recreational purposes, even though it remains prohibited at the federal level.

Investing in a cannabis company comes with a number of risks that could negatively affect an investment at any time. There remains a large amount of uncertainty in this emerging sector, especially as laws and business models continue to evolve.

Some investors may see others flocking toward an emerging sector and can be compelled to follow out of fear of missing out on an opportunity. However, behavioural insights into the way that people make decisions about money has shown that investors who follow other investors’ behaviour are more likely to invest in speculative bubbles that could burst. If that happens, investors could stand to lose some or all of their investment.

Businesses in the cannabis industry

The rapid expansion of the cannabis industry has created opportunities for a number of new companies to develop products, technologies and services beyond just the cultivation and distribution of cannabis itself. There are now a number of businesses operating under the umbrella of the cannabis industry, even if their business does not actually grow or sell cannabis products directly, making it possible to invest in a cannabis company without investing in the cultivation or distribution of cannabis itself.

Some examples of businesses operating within the cannabis industry include:

  • Agriculture technology: Businesses that support the innovation and development of equipment required to cultivate cannabis, such as automated fertilizer systems, greenhouse technologies and improved lighting systems.
  • Ancillary products and services: Businesses that offer products that complement the cannabis industry as a whole, which can include products like a cannabis breathalyzer to laboratories that test cannabis products. This also includes companies that provide insurance to cultivators as well as those that create consumer packaging for products.
  • Biotechnology: Businesses that focus on the pharmaceutical applications of cannabis by developing treatments to target illnesses and diseases.
  • Consulting services: Businesses that respond to the complexity of rules and regulations around cannabis between different jurisdictions. They may provide services to assist with licensing, zoning or advising on operational processes.
  • Consumption devices: Businesses that create products that people use to consume cannabis.
  • Cultivation and retail: Businesses that grow and sell cannabis, and are often the types of businesses that most people think of when discussing the cannabis industry.
  • Cannabis products and extracts: Businesses that sell cannabidiol products, edibles, topicals, drinks and other products.
  • Holding companies: Businesses that typically own a considerable number of voting shares in a variety of cannabis companies, allowing them to influence the management and affairs of the companies held.
  • Industrial hemp: Businesses that provide products using industrial hemp, which is different than cannabis and may have numerous applications and uses, including creating consumer products like paper and clothing, as well as building materials, fuel and foods.
  • Organic farms: Businesses that provide organically-grown cannabis to other companies or sell to consumers directly, relying on the increasing demand for organic products and services to drive the business’s growth.

Investing risks

All investments come with some amount of risk. Generally, the higher the potential return of an investment, the higher the risk. There is no guarantee that you will actually get a higher return by accepting more risk. Learn more about the risk-return relationship.

When you invest in the cannabis industry, you’re exposed to different types of risk that can affect your potential return. Some common risks include:

No guarantee of success

Despite the rapid growth of companies in the cannabis sector, there remains no guarantee that their businesses are profitable or will be in the future. Many cannabis companies are hedging their success on the future distribution and sale of their product, despite the fact that many rules and regulations around distribution and sale are still in the process of being established.

Some early medical cannabis companies were not successful, with some often failing to provide investors with adequate disclosure about the barriers to entering the industry (such as licenses required to grow cannabis) and other work needed to create a profitable business. While these disclosure requirements have been addressed by Canadian securities regulators, the risks of investing in this emerging industry still remain. As with any investment, there is no guarantee that an investment in the cannabis industry will provide any return or income.

Government regulation

The governments and regulators in many of the jurisdictions that are exploring new cannabis laws have yet to fully establish the framework for how and where cannabis products can be sold. For example, there may be some restrictions on the stores that are permitted to sell cannabis, as well as rules about branding and advertising that could affect a consumer’s ability to find and purchase products. These sorts of challenges can affect a company’s ability to sell its products and make a profit, which in turn could reduce the value of your investment in the company.

As regulation continues to evolve and the cannabis industry grows, new companies will enter the industry and compete with existing cannabis businesses. Increased competition may compel a company you have invested in to adjust its business model, adjust the prices of its products, or make other changes in order to stay competitive. This may affect the value of your investment.

Legal considerations

Cannabis companies must abide by all the laws and regulations of the jurisdictions in which they operate, which can vary from country to country. Should laws change, the company may be required to adjust its operations to comply with the law or risk having legal action taken against it. In some cases, this may mean ending its business.

In the U.S., some states have authorized the sale and use of cannabis, but it still remains illegal under federal law. Authorities in the U.S. could choose to enforce federal law at any time, putting any company with cannabis-related activities in any U.S. state at risk of being prosecuted and having its assets seized.

Investing in a company that does business in a place where the law either prohibits cannabis or is unclear about its use puts your money at risk. If legal action is taken against a company in which you have invested, you could stand to lose your entire investment.

While laws and regulations around the sale and use of cannabis in Canada are changing, there are still a number of rules in place to guide the way that cannabis companies operate. If a business does not comply with these rules, it could have legal action taken against it and you could stand to lose your investment.

Pricing and taxation

Government-mandated pricing and taxation on cannabis products may also pose a risk to the success of a cannabis company. Cannabis products, especially those intended for recreational use, should be priced below their black market value in order to attract consumers. If the government prices cannabis products too high, or if black market dealers undercut prices of products available in stores, the companies growing and selling the products may not be able to sell enough product to make a profit.

Inflated share prices

Opportunities to invest in new cannabis companies or existing companies expanding their business into the cannabis industry have generated a high level of interest among investors looking to get in on a new trend with the expectation of quick growth. However, these investments can be highly speculative, and the cost of an investment in a cannabis company may be based on the expectation of its future success rather than its current performance.

In some cases, companies that have simply announced their intent to develop a cannabis business have seen an immediate rise in their stock price, before there is even a viable business in place. Investors who buy shares in these companies risk paying an inflated price for an investment that may never increase in value.

Dilution

As the popularity for cannabis-related products grows, companies have to scale up their operations to meet the demand, which may include building larger facilities, buying additional equipment and hiring additional employees. This can cost considerable amounts of money, and if a company doesn’t have the funds required to expand its operations, it may choose to raise money by issuing additional shares.

When companies issue additional shares to raise money, it comes at the expense of existing shareholders, whose percentage ownership decreases proportionally to the number of new shares created. This is known as dilution. If you hold shares in a company that continuously raises money by issuing more shares, your investment will decrease in value.

High operating costs

The costs associated with developing and operating a commercial cannabis company can be considerable. Growing and selling cannabis requires specialized and large-scale agriculture facilities and enormous amounts of power and capital in order to operate. Construction and energy costs can greatly increase a company’s overhead, and as companies scale up in order to meet demand, the costs of constructing new buildings may undercut profitability, especially if there are significant cost overruns or construction delays that impact a company’s ability to produce and deliver its product.

As an investor, you should understand the company’s business plan and how it intends to earn a profit, as well as the related risks, costs of doing business and time it may take for the business to become profitable. There is no guarantee that a company will be successful in generating profitsProfits A financial gain for a person or company. Equals the money left over after you subtract your costs from the money you made.+ read full definition or increasing its stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition value.

Getting information before you invest

If you are considering investing in a cannabis company, you should first take some steps toward researching the investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition opportunity and considering how the investment will help meet your financial goals:

  • Review disclosure documents. Companies offering investors the opportunity to investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition are required to provide specific disclosure documents, such as a prospectusProspectus A legal document that sets out the full, true and plain facts you need to know about a security. Contains information about the company or mutual fund selling the security, its management, products or services, plans and business risks.+ read full definition, listing statement or an offering memorandumOffering memorandum A document describing the business of an issuer. This document is designed to help potential buyers make an investment decision when they are considering exempt-market securities.+ read full definition, which contains information about the business, its management, operations and business risks, including the nature of its operations in specific countries and states, as well as how it complies with laws in each jurisdiction in which it conducts business.
  • Read official materials. Annual reports, management’s discussion and analysis, news releases and other official company materials can provide information about whether the company is making or losing money, information about its financial statementsFinancial statements Reports that sum up a company’s financial data and tell you how it is doing. The four basic statements are: the statement of financial position (balance sheet, statement of profit or loss (income statement), cash flow statement, and statement of changes in equity.+ read full definition and comments from management on how the company has performed, as well as any industry trends or events that may have affected the company’s operations.
  • Speak with an advisor. Advisors can answer questions about particular investment products and assist you with selecting investments that can help you achieve your financial goals. Find out what to expect from an advisor.
  • Learn more. Explore more articles, tools and resources on GetSmarterAboutMoney.ca to learn more about investing, including the risk-return relationship, understanding the exempt market and what it means to diversify your portfolio.
  • Contact the Ontario Securities CommissionOntario Securities Commission An independent Crown corporation that is responsible for regulating the capital markets in Ontario. Its mandate is to provide protection to investors from unfair, improper or fraudulent practices and to foster confidence in fair and efficient capital markets.+ read full definition if you have further questions or concerns. If you have a question about investing, you can contact the Ontario Securities Commission or ask us a question.
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