How Cannabis Companies Can Turn Valuation Discounts Into Transparency Premiums with ESG Frameworks

Many cannabis companies are monitoring Environmental, Social and Governance trends so that they may mitigate risks and establish compliant policies at the enterprise level.

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Many cannabis companies are working to understand Environmental, Social and Governance (ESG) trends so that they may mitigate risks and establish compliant policies at the enterprise level.

The growing impetus behind the current focus on ESG is not only to comply with new regulations and meet consumer and employee demand, but also to increase the capacity to attract capital as many investors are looking to invest in companies with ESG initiatives in place. Given increased demand for ESG action from businesses, many cannabis companies are uniquely positioned to benefit from highlighting their current ESG efforts and incorporating additional ESG practices.

ESG is in the headlines, but it is more than just a fad.

At its core, ESG is a process for evaluating longer-term environmental, social and governance risks that are often considered when implementing traditional risk management strategies. This evaluation includes everything from a company’s treatment of employees and contract labor to its potential unintended impacts on the communities in which it operates. This can encompass product safety and labelling, carbon emissions, water consumption, as well as a company’s adoption of meaningful diversity, equity and inclusion programs. The list is long, but it is also important and cannabis operators are poised to take advantage.

Because the nascent legal cannabis industry often finds itself needing to overcome public and policymaker misperceptions and abide by strict regulations, many cannabis companies have already incorporated ESG-like policies and good governance into their business model.

Growers already analyze their environmental impacts. Brands are required to know the sources of their ingredients and to track their quality. Cannabis product labels are scrutinized for misrepresentations. Because cannabis companies are typically less corporately established entities and because many have evolved from a non-traditional financial background, cannabis companies already also tend to be more diverse and concerned about social justice. By converting de facto ESG policies into express, well-formulated and executed ESG policies, allows companies to add value and position themselves for stronger growth in the marketplace.

Many cannabis companies seem to simply be too busy. The fact that ESG reporting is itself still rapidly evolving makes ESG frameworks hard to adopt, but this challenge is not unique to the cannabis industry.

Constrained access to capital and the industry’s general immaturity are both causes and effects of this lack of capacity. But if a cannabis company accurately markets its ESG framework, it can attract affordable capital or enter new markets that are looking for socially conscious businesses. Cannabis corporate leaders often prioritize alternative capital sources, such as family offices, hedge funds and individuals to attract investment, but many of these capital sources want to know that they are investing into businesses that are ESG-conscious.

The cost-benefit analysis of embracing ESG in the cannabis industry, however, is rapidly shifting. In addition to consumers actively seeking out brands with meaningful sustainability and social responsibility ethos, as more private equity and hedge fund investors enter the space, and with institutional money starting to come off the sidelines, the companies with the best risk management systems will attract valuation premiums. And as more opportunities become available to compete for local licenses, those companies already boasting systematized and certified ESG disclosures will have a substantial competitive advantage.

So, What’s Next?

Like addressing your company’s cybersecurity and protecting your consumer’s privacy (a critical piece of ESG), the best time to start implementing an ESG program is yesterday, but the second best time is right now.

Companies can start this process by making a board committee or high-level executive responsible for aggregating the information necessary to identify ESG risks and opportunities. This might entail polling key stakeholder groups and investigating opportunities to measure, report and communicate the company’s material ESG factors, risks and opportunities.

Here are examples of existing operational practices or industry conditions that could be readily conformed to meet ESG metrics:

  • Because cannabis cultivators are subject to some of the most thorough testing and environmental regulations of any agricultural crop in the world, they already know how to anticipate, measure and minimize their environmental impacts. Companies, toward the goal of reporting and risk mitigation, can document how they are anticipating supply chain risks, including, for example, the risk of wildfire smoke damage to the flower, or ensuring vendor inventory to reduce delays in critical product inputs, and the steps they are taking to mitigate against those risks.
  • Successful cannabis companies tend to have well-developed stakeholder identification, community relations and stakeholder management policies given that good relations with neighbors is critical to maintaining their operating licenses., Cannabis companies, toward the goal of reporting, could implement programs to better understand the issues that are most important to their stakeholders and to collect and document their ongoing feedback in order to take steps to meaningfully respond to stakeholder concerns.
  • Cannabis companies and municipalities continue to grapple with social justice concerns, including how to advance equity given the disproportionate impact of cannabis-related arrests and convictions on communities of color (ACLU’s recent report found that “Black people are still more likely to be arrested for marijuana possession than white people in every state”).  As part of efforts to respond to these inequities, many jurisdictions reward companies with diverse ownership and/or leadership teams and many companies are responsive to their socially aware consumer base. Cannabis companies can not only respond to various jurisdictions’ thresholds for diverse leadership, but document meaningful progress in diversity, equity and inclusion, including employee engagement, retention and equitable compensation throughout the company.

Any cannabis company looking to adopt more formalized ESG measures should include the company’s general or outside counsel in the initial stages of this process. They are often uniquely able to articulate ESG risks and help adopt a framework for proper incorporation into the company’s corporate governance, including protocols and policies. Getting sued for making a misrepresentation or violating a consumer protection statute defeats the purpose of marketing ESG success. ESG-related public claims and statements (this includes marketing and labelling, anything related to environmental impacts or sustainability) should be carefully researched, documented and contain proper disclosures to inoculate companies from potential ESG-related risks.

The focus on ESG is gaining momentum. Early adopters of ESG will need to be cautious as standards continue to develop, but they will likely be the first to reap the benefits of meeting increased consumer demand for ESG programs and attracting the attention of larger investors looking for entry points into the growing cannabis industry.