Let's be blunt

Insights from Canada’s cannabis industry

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As Canadians get ready for the nationwide legalization of recreational cannabis this summer, EY is looking at the issues that are likely to arise in this new and untried sector. In this edition of our series Let’s be blunt, we explore what governance will look like for cannabis licensed producers (LPs). We sat down with seasoned corporate director Deborah Rosati to get her take on the potential shape and scope of directors’ responsibilities.

Deborah Rosati EY: Risk management has a broad definition in the cannabis sector. How are boards defining risk?

DR: Risk is a broad word that means many things to many people; you have to be consistent in how you apply it. Where does risk belong on the board? I don’t think that all risk should be the responsibility of the audit committee, but rather the full board.

Boards have to take a step back, since they have an oversight role, and look at risk management in the broader sense. But because risks come with opportunities, it’s important for boards to undertake a SWOT (strengths, weaknesses, opportunities, threats) analysis. What does it mean to go international, for example? What does it mean to enter the US?

In the cannabis sector, there are numerous risks that are still unknown and have yet to be determined — everything from supply to capacity to growth is still being defined. And because the risks are constantly changing, you want to make sure risk is always on the board’s agenda.

Companies in this sector are starting at ground zero in so many ways, so from my perspective they don’t have to have a full-blown ERM framework in place, a chief risk officer, and so forth. These business leaders should seek out third-party advisors who have the expertise.

Ultimately, it’s going to be management that’s going to lead the company through risk.

EY: Are boards expecting management to invest in establishing sound practices, organizational design and infrastructure to support their strategic objectives?

DR: The strategy defines where the company is going. If you don’t get the production efficiency and supply chain right from the outset, you’re going to get left behind.

Companies need to have a chief operating officer and ensure they have the quality and controls in place. This is a highly regulated industry — when you look to Health Canada to renew your licence, you have to have your operations in order. It’s really no different than tobacco or agriculture. It’s a controlled crop. So companies need to have quality engineering and quality control. There will be key performance indicators against which they’ll be scrutinized and measured.

Even though this is a new sector, companies will need a defined organizational structure and to establish solid operational processes. Boards, for instance, look at succession — does management have the right hiring and employment practices in place? They need to if they’re going to grow.

From human resources to finance to engineering to procurement, the LPs that will blossom will be the ones that have the foundational pieces right, because the sector is growing so quickly. Cannabis leaders have other sectors they can look to for leading practices.

EY: Why would a director choose the cannabis sector? What advice would you give other directors who may be wary?

DR: Even though the sector is going mainstream, many directors are leery about putting their reputations on the line by getting involved. It’s similar to the tobacco industry — some people are going to question your wisdom.

It was the same for me at first. But I’m an entrepreneur, so I’m attracted to opportunities. And with that comes the potential for rewards. I just see it as a business with high-growth possibilities, and those are opportunities that I’m attracted to.

Part of what tipped the balance was when the big banks got behind it. BMO and CIBC have both led financing for cannabis companies, and former TD Bank CEO Ed Clark is going to become chair of the LCBO, which is going to be retailing cannabis in Ontario. So that lent some credibility and respectability to the sector. And eventually I think that will help break down some of the reluctance of other directors to get involved.

One piece of advice I have for directors is to seriously consider where you are in your career. This is a high-growth emerging industry — the demands on your time are going to be huge. If you have a young family, for example, are you going to want to invest the long hours it’s going to take? You have to hit the ground running. Where you are with respect to risk, time and reward?

For those thinking about it, it’s a new industry for sure. You have to consider whether you want to be a part of helping shape and influence the industry, or whether you want to wait until it’s more mature.

You also want to do your due diligence in the industry. Roll up your sleeves and understand everything about it. A newly public company is going through cycles for the first time, so it’s not the type of board you’d join if it’s your first time. These companies need experienced directors with diverse experience — think capital markets, pharma, packaging, branding and so forth.

Plus, these boards are going to be small. You’re going to be working with people who are brand new to the sector. Is it the right culture fit for you? Are you working with people you can trust and respect?

Cannabis companies need to have truly independent board members who understand good governance processes. It can be hard to get the right qualified individuals, but they’re out there if you dig a little deeper and look a little harder. The appetite is better than it was a year ago.

EY: The growth trajectory of companies in this sector is astronomical. How are boards gaining comfort in management’s ability to manage the risk that comes with growth at an unprecedented pace?

DR: Yes, the high growth brings unknown risks.

Even the production lines have sort of evolved over time and become more sophisticated. And that means it’s essential to measure results — capacity, output, building out new facilities and staging them, hiring and revenues. There are lots of financial metrics.

You need to know the budget and where the company stands on the budget. Where does it stand on actually getting up and running? Where is it on people? Any functional area, from quality to HR, it’s important to have the right metrics in place. If something’s not in the right place, step back and ask, why aren’t we there?

When it comes to expanding beyond Canada, there are so many international markets. You can’t go into them all at once, you need to be strategic. Is it, say, a licensing deal? A joint venture? There’s no standard template, so you need to have good local partners on the ground in the other markets to ensure success on the international front.

Since Canada is the first country to legalize recreational cannabis on a national scale, other countries are coming here and there’s licensing going on. We have the opportunity to become a world leader — the question is, can we sustain it?

Chances are that the sector will see rapid consolidation, and there will be fewer players even three to five years from now. Those that really secure the channels are the go-to organizations. Companies are jockeying for position as we speak. Do you grow organically or do you merge? There are lots of different options — from financing to tax structures to expanding internationally — and there’s no precedent. So you have to make informed decisions and hope you’re asking the right questions. You’re hedging on so many fronts of the business, you’ll have to course-correct along the way.

EY: Does having a sound governance structure and risk management program contribute to a competitive advantage?

DR: Companies want to be viable for the long term and corporately socially responsible. Putting the foundational processes in place is key. You’re in an environment where change is constant and you’re defining it, so you want to get it right today. Getting the right people, the right issues and the right structures in place is critical.

The cannabis sector has the ability to learn from other sectors and learn from their experiences — both leading practices and the pitfalls — to get the best of all worlds. The industry isn’t going to be leading edge from a tech perspective, and it’s hard to predict what it’s going to look like in just the next few years.

Cannabis company leaders are embracing technology, applying what’s already there and seeking innovation. Technology impacts so many areas for these organizations, from unique varieties that are being developed to unique product offerings that technology is pervasive in, even how facilities are run. Everything you’re doing on the technology front you want to be repeatable and sustainable.

This interview has been edited and condensed. (12 July 2018)

The views of the third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.