When it comes to Europe’s cannabis market, the biggest piece of news this year is what didn’t happen. Contrary to what a lot of people expected, Germany isn’t on the way to legalizing recreational use of marijuana. Instead, the EU’s most populated country watered down its law reform plans after liaising with regulators.
Is Germany’s decision and the precedent it has set bad news for VCs who invest in cannabis startups in Europe? Not necessarily, and it could even be good news for some. According to Oliver Lamb, co-founder of Óskare Capital, Germany’s “push to slow down the legalization of recreational cannabis is positive for the medical and pharmaceutical market.”
“The hybrid recreational-medical experiment has already been played out in North America, and there were a painful amount of lessons learned that it would be reckless to ignore,” he said.
Lamb, like other investors, is wary of the mistakes they’ve seen being made in the U.S.: “The blurred line between the medical and recreational sectors has undoubtedly been to the detriment of targeted medication development,” he said.
“It is crucial to use lessons from paths that others have laid before you. In New York, we’ve seen a failure to do this, with just a handful of dispensaries up and running alongside lax law enforcement, which led to an overt and booming illicit market,” said Matt Hawkins, founder and managing partner at Entourage Effect Capital.
However, some funds are worried that the total addressable market for legal cannabis on the continent is limited and has been affected by Germany’s decision. “The scaling back by Germany has made us more hesitant to deploy capital in Europe,” Hawkins said. “Germany’s process has indicated the entire continent will struggle to create a commercial adult-use market in the coming years and have a limited TAM.”
Similarly, like other private businesses looking to raise venture capital, cannabis startups aren’t immune to the global repricing that investors are pushing for. “European cannabis companies are still overvalued,” said Emily Paxhia, co-founder and managing partner at Poseidon Investment Management.
For founders of cannabis-related startups hoping to weather the slowdown, the advice isn’t very different from what all entrepreneurs are being told at the moment: survive and advance. That’s Poseidon’s motto, Paxhia said.
For cannabis companies that know they won’t survive, finding a buyer seems to be a viable option, as consolidation is expected in the coming months. But whether we are talking about investments or M&A, we are in a strong buyer’s market, Lamb warned.
Read on to find out where these investors see the next opportunity, how they plan to tackle the market following Germany’s decision, and how to best pitch them.
We spoke with:
- Oliver Lamb, co-founder, Óskare Capital
- Emily Paxhia, co-founder and managing partner, Poseidon Investment Management
- Matt Hawkins, founder and managing partner, Entourage Effect Capital
Oliver Lamb, co-founder, Óskare Capital
Is cannabis more legally accessible in Europe this year than it was when we conducted our previous survey last year? Have there been any key regulatory changes at play?
On the medical side, cannabinoid therapeutics and non-cannabinoid therapeutics (i.e., therapeutics that modulate the endocannabinoid system but do so without cannabinoids) are notably increasing in availability.
There are many factors at play that explain this shift, amongst them [being] increases in tailwinds and reductions in headwinds. Today we have more, higher quality clinical data demonstrating the efficacy of these medications for various conditions, coupled with an uptick in highly qualified teams that are bringing these medications to market.
As for the tailwinds, difficulties in patient access have long hindered prescriptions of medications that target the endocannabinoid system (the mammalian regulatory system that reacts to cannabinoids and cannabinoid-like molecules, similar to the central nervous system).
However, we are excited to see a number of technologies and platforms linking specialized doctors with patients in need of these medications. One such example is Leva, whose digital clinic is tackling the vastly underserved chronic pain market in the U.K.
Alongside this, there is a growing acceptance within medical communities of the suitability of ECS-modulating medications for certain pathologies. At a conference in Berlin this month, a founder happily relayed that a recent meeting of general practitioners dedicated two hours to talk about medical cannabinoids. This is a clear indicator of the increasing understanding and adoption of these medications by doctors across Europe.
Aside from watered-down plans to legalize recreational use, Germany imported a record amount of marijuana for medical and scientific use in 2022. Is this taking focus away from the fact that imports are slowing?
Although Germany’s decision was undoubtedly unpopular at companies that bet on the legislation going in the opposite direction, this push to slow down the legalization of recreational cannabis is positive for the medical and pharmaceutical market.
The hybrid recreational-medical experiment has already been played out in North America, and there were a painful amount of lessons learned that it would be reckless to ignore. Specifically, legalizing recreational cannabis in tandem with medical use in North America can be seen to have diminished the incentives for researchers to develop targeted therapeutics for specific pathologies, given the flood of cannabis flower being distributed through dispensaries. That happened despite a preference held by the majority of doctors to prescribe targeted and licensed treatment that does not need to be smoked.
The North American approach also blurred the lines between the recreational and medical markets, strengthening the impression that users of such therapeutics were simply prioritizing pleasure while claiming a genuine need.
This misconception is not only counterproductive for patients looking for proven treatments, [but] it also detracts attention from the fact that ECS-modulating medications can provide not only far superior side-effect profiles compared to traditional pharmaceuticals such as opiates, but also treatments for conditions that are currently untreatable.
The Czech Republic might end up legalizing recreational cannabis use before Germany, but it is a smaller market. Is it big enough to move the needle and find out what the EU will tolerate?
Peter Lynch once noted that if you spend 13 minutes a year on economics, you’ve wasted 10 minutes. Politics is arguably the same. Influences on international regulation are vast and varied, and even if you have a good idea of the outcome, the timings are just as complicated to predict.
Therefore, as a rule, we don’t bet on regulation. Instead, we invest in what we know: strong teams, innovative science and untapped market opportunities. We select our investments assuming that the regulatory landscape is fixed as it is today. That way, if nothing changes, we know that they can succeed regardless, and as and when things continue to open up, they can be positioned to benefit further.
A prediction I do feel confident in making is that governments and medical communities will continue to gain understanding of the benefits of these medications.
How has your approach to investing in the cannabis sector changed in the last 12 months? What are your expectations for the next 12 months? Is consolidation in the cards in that period?
With regards to our thesis, not at all. We started by focusing on Europe and continue to do so. Likewise, we launched the fund to target life sciences and deep tech investments in the sector, and this remains unchanged, largely due to the fact that our portfolio is performing very well.
It’s also gratifying to see that a number of U.S. funds are now looking to Europe for the next wave of growth in the sector. This is an asset, as we like to syndicate rounds and having stakeholders across the pond is often helpful when it comes to intercontinental expansion.
Here are our predictions for this year, and those we made for 2022 are here.
We’re happy to say that most of our past predictions have come to fruition, and those for this year are on track to do the same.
What advice are you giving your cannabis-related portfolio companies right now in terms of preserving or extending their runway?
Survive, then thrive.
It’s no secret that we’re going through a turbulent macroeconomic environment, but we’ve made sure to conserve sufficient capital for follow-on rounds in our current portfolio with the expectation that market turmoil could easily continue past the end of the year. With regard to investment management, we, like most, have been advising our portfolio to prioritize cash flow over unfettered growth in the short-term.
Whilst capital markets have changed, the underlying value in this sector is stable and continues to grow at an impressive rate, and although there will be plenty of players that drop out of the game before markets stabilize, this is a huge opportunity for companies that are still operating well to capture significant market share.
Is consolidation in the cards for the second half of the year?
Undoubtedly. There are plenty of good assets sitting in some soon-to-be-defunct companies (often paid for by overexcited VCs), and this presents a lot of opportunity.
With that in mind, part of our Senior Advisory team specializes in distressed assets and is ready to jump into action when we spot those diamonds in the rough.
Given that the majority of exits generally come from M&A, this isn’t too unusual, but the environment certainly adds to this.
Would one or more successful cannabis IPOs in the U.K. have any impact on private valuations of European cannabis startups?
There have been a number of “successful” IPOs in the U.K. cannabis sector. It’s the “post public offerings” that have been messy.
The majority of public European cannabis companies were arguably not ready to IPO when they did if they were looking for smooth sailing after going public. However, that’s not to say it was irrational of them to do so. In fact, it was likely sensible for some given the former fever-pitch retail investor sentiment for the sector and the constraints placed on institutional capital sources being able to support businesses with any association to “cannabis.”
With regard to the public market’s effects on private market valuations, there is certainly a strong correlation given investors’ interest in potential exit multiples. These have indeed capped private market valuations in most cases and created a strong buyer’s market.
That said, it is likely that the sector’s private-market valuations will be as affected, if not more, by “vice” mandates of institutional investors (venture funds and their LPs) being updated to classify medical and pharmaceutical cannabinoids as non-recreational. It is highly likely that this will occur in the not too distant future, and when it happens, there will be a significantly larger pool of capital available to fund private market opportunities in the sector.
This, in turn, will very likely increase competition amongst investors and push private market valuations significantly higher to bring them in line with other emerging sectors with similarly high growth rates.
For the time being, however, the buyer’s market remains.
Are some segments of the market too exposed to commoditization for you to invest in them? If so, which ones?
Absolutely: production.
We launched the fund with a red line against investment in cannabis flower production as a result of the anticipation of fast commoditization. We were right to be wary, as this was exactly what happened. There will, of course, be pockets of production that can command premium prices (e.g., EU GMP), but by and large, the massive reduction in price will have hit many growers.
Unfortunately, that price reduction has been coupled with increases in operating expenditures for many, with fertilizer and energy costs being pushed up by macroeconomic and political events.
As such, we haven’t changed our stance on this red line.
What are some things that failed in the U.S. that you hope not to see in Europe?
As mentioned previously, the blurred line between the medical and recreational sectors has undoubtedly been to the detriment of targeted medication development. It is very reassuring that Europe has broadly avoided this pitfall, and so it’s little surprise that the continent is leading scientific research and development in the sector.
Secondly, the lack of harmony between individual states’ legislation has made it extremely difficult for companies to operate across state lines. Again, Europe has thankfully avoided this issue in the medical and pharmaceutical cannabinoid space, as these products and compounds can flow through the already established frameworks for drug discovery, development and trial.
This issue in the U.S. has had the second-order effect of limiting the availability of financial resources for sector operators, with national institutions being unwilling to contravene interstate regulation.
If and when they eventually open, European recreational markets will likely be subject to the same problem, given countries may legalize at varying rates. However, this shouldn’t affect the medical and pharmaceutical market due to it fitting into existing pharmaceutical frameworks.
Do you expect companies you invest in to engage in lobbying efforts and/or support patient associations?
Given that we don’t invest based on any specific expectations with regard to regulatory change, we wouldn’t require our portfolio companies to engage in any lobbying activities.
Ultimately, our responsibility to our investors is to return as much capital as possible within the fund life cycle. Fortunately, by virtue of the fund’s thesis, our investments are extremely supportive of patients, be that through the development of new medications, the preparation of those medications for market, or by increasing patient accessibility.
Are you open to cold pitches? How can founders reach you?
Absolutely. I can be reached at ollie@oskarecapital.com.
Emily Paxhia, co-founder and managing partner, Poseidon Investment Management
Is cannabis more legally accessible in Europe this year than it was when we conducted our previous survey? Have there been any key regulatory changes at play?
Cannabis is becoming more accessible in several European markets. Luxembourg recently became the second European Union member country to legalize the possession and cultivation of cannabis. Medical card administration is also rising in Germany.
Personally, the time I’ve spent in Europe has tamed a bit of my optimism regarding the growth of legalized cannabis across the continent. From my perspective, Europe still appears to be processing how it feels about cannabis. Specifically, Germany seems to be leading the charge, but similar to states in the U.S., each country varies on laws and opinions. I am interested to see how cannabis access evolves in Europe in the months and years to come.
Aside from watered-down plans to legalize recreational use, Germany imported a record amount of marijuana for medical and scientific use in 2022. Is this taking focus away from the fact that imports are slowing?
It’s not unusual to see imports decrease. Growth is easiest at the beginning, but it often becomes more difficult to maintain once it starts to normalize. At the beginning, Canadians likely saturated the market, and the initial high volume of influx led to a decrease in imports.
The Czech Republic might end up legalizing recreational cannabis use before Germany, but it is a smaller market. Is it big enough to move the needle and find out what the EU will tolerate?
Size and influence are commingled here. I’d be surprised if the Czech Republic becomes the sole catalyst of widespread legalization, but we should never ignore the value of incremental change. If the Czech Republic does end up legalizing recreational cannabis use before Germany, it would be an important step forward for normalizing cannabis use across Europe.
How has your approach to investing in the cannabis sector in Europe changed in the last 12 months? What are your expectations for the next 12 months? Is consolidation in the cards in that period?
Poseidon’s perspective hasn’t changed, because valuations of opportunities are not aligned with progress towards legalizing adult use of cannabis. While there has been continuous, incremental growth, with smaller countries legalizing adult-use measures, the status quo remains primarily the same.
However, there are multiple catalysts in the U.S. we’re watching carefully that could be more substantive.
What advice are you giving your cannabis-related portfolio companies right now in terms of preserving or extending their runway?
Be prepared! Halfway through last year, we began to see macro changes being made at the state level, but we didn’t expect to see any changes at the federal level. We used this information and set out to get 24 months of free cash flow and allocate our resources more efficiently.
The cannabis industry twists and turns each and every day, so it’s best to prepare for the future in the best way you know how.
Is consolidation in the cards for the second half of the year?
Due to the lack of capital flow, consolidation will likely persist throughout the industry for financial sustainability rather than strategic or creative growth.
Would one or more successful cannabis IPOs in the U.K. have any impact on private valuations of European cannabis startups?
No, I don’t believe that would be the case. As I mentioned above, European cannabis companies are still overvalued.
Are some segments of the market too exposed to commoditization for you to invest in? If so, which ones?
Yes, most notably, cultivation. I’ve invested across the entire vertical in the U.S., and we tend to focus on retail and/or finished goods. It boils down to the basic macroeconomic concept of supply and demand.
Additionally, genetic improvements do not prevent commoditization, and it hasn’t worked well across the global supply chain.
What are some things that failed in the U.S. that you hope not to see in Europe?
I hope to see more prudence around structuring and valuations so companies can nurture and grow. It’s vital to protect and preserve capital in a profitable business.
Do you expect companies you invest in to engage in lobbying efforts and/or support patient associations?
Yes, I do. Anyone who stands to benefit financially from the legalized cannabis industry should support patient associations and engage in lobbying efforts.
Poseidon has donated money over the years to several organizations and associations, including the NCIA, DPA and Marijuana Policy Project. We have also fiercely advocated for the legalization of cannabis at the state and federal levels.
Are you open to cold pitches? How can founders reach you?
I don’t reply to every email, but I do read them all. Founders can submit their pitches through our portal.
Matt Hawkins, founder and managing partner, Entourage Effect Capital
Is cannabis more legally accessible in Europe this year than it was when we conducted our previous survey last year? Have there been any key regulatory changes at play?
There has definitely been movement. While adult-use legalization in Germany has been scaled back to the non-commercial market, their medical market is slowly but surely expanding.
Other influential European countries like Italy and the U.K. have progressed their medical programs, while Luxembourg has just voted to decriminalize and join the likes of Spain and Malta. There will be more to come. For example, Switzerland recently launched a pilot program, and the Netherlands plans to launch a pilot later this year.
Aside from watered-down plans to legalize recreational use, Germany imported a record amount of marijuana for medical and scientific use in 2022. Is this taking focus away from the fact that imports are slowing?
Growth should be accelerating in developing markets — regulation that opens up access to Germany’s medical market will determine how quickly imports increase. We’ve seen the same in the U.S. — overall growth slowed recently due to the lack of federal regulatory movement, which stifles development. The growth continues to come from new states coming online and expanding.
The Czech Republic might end up legalizing recreational cannabis use before Germany, but it is a smaller market. Is it big enough to move the needle and find out what the EU will tolerate?
Any form of adult-use legalization in Europe will move the needle, as every EU country needs to adhere to UN and EU laws. Monitoring what the Czech Republic deals with will be interesting and could [draw] a line in the sand for others to follow.
Of course, German legalization would be a much more significant statement given the massive economic impact of such a major market.
How has your approach to investing in the cannabis sector in Europe changed in the last 12 months? What are your expectations for the next 12 months? Is consolidation in the cards in that period?
Germany scaling back its plans has made us more hesitant to deploy capital in Europe. A key metric for any investment is TAM, and Europe’s largest market’s TAM has been limited. Germany’s process has indicated the entire continent will struggle to create a commercial adult-use market in the coming years and have a limited TAM.
Consolidation is absolutely in the cards. Companies have spent significant capital in preparation for a sizable commercial market in Germany. As the chances of that happening fade, companies might not be able to support their operations without consolidation.
What advice are you giving your cannabis-related portfolio companies right now in terms of preserving or extending their runway?
It is critical to minimize burn when capital is scarce and expensive.
Would one or more successful cannabis IPOs in the U.K. have any impact on the private valuations of European cannabis startups?
Perhaps, in the short-term, but in the long-term, fundamentals are the driver of ROI (being cash-flow positive, generating EBITDA, scaling with cost-efficiencies, etc.). We have yet to see evidence that these are in place.
Are some segments of the market too exposed to commoditization for you to invest in them? If so, which ones?
It depends on a location’s competitive and regulatory landscape. Broadly, operational segments all form part of a vertical integration chain that can collectively represent more attractive investment opportunities. Given “races to the bottom,” vertical integration helps generate cost and scale efficiencies and are especially critical in more mature and competitive markets.
What are some things that failed in the U.S. that you hope not to see in Europe?
It is crucial to use lessons from paths that others have laid before you. In New York, we’ve seen a failure to do this, with just a handful of dispensaries up and running alongside lax law enforcement, which led to an overt and booming illicit market.
On the other hand, Missouri, which legalized adult use in November and launched sales in February, is a great example of how to learn from other markets. Supply and demand is initially in favor of businesses to allow them to develop sustainable operations. Over time, we expect Missouri to systematically expand to balance market dynamics using insight from the markets that have launched before them as their guide.
The hope is that Europe looks at both the successes and failures of U.S. state markets when building their programs.
Do you expect companies you invest in to engage in lobbying efforts and/or support patient associations?
Supporting the advancement of cannabis legalization is essential to this movement. One of the core reasons we are all in this industry is because we believe this is an important social issue. Walk the walk, of course, when funds allow.
Are you open to cold pitches? How can founders reach you?
We are open to intros, as opposed to cold pitches. Intros not only add a layer of confirmatory analysis to our diligence, [but] they also show that the person reaching out has a robust network and ability to reach people, which is key for all entrepreneurs.