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The psychedelics market saw an interesting shift several years ago. Long associated with party drugs, psychedelic substances were now being touted as potentially game changing treatments for a variety of mental health disorders. Driven by changing public opinion, promising scientific research, and loosening restrictions in North America, startups in this space saw a meteoric rise in investor interest.
That all changes about a year ago.
After peaking around March 2021, stock prices began to decrease. In the last six months, top players in the field have seen prices plummet up to 80%. This is worrying news for the many budding startups trying to survive in the psychedelic sphere – especially as they traverse a potential economic downturn.
Still, there is hope, even in a declining market. The key is to conserve cash flow, keep all financial reporting up to date, keep up with regulatory compliance, and always stay alert for potential funding or M&A opportunities. This is also an excellent time to consult with a dependable financial team.
Here’s what psychedelic startups need to know while navigating a shaky market.
How did we get here – the rise of psychedelic startups
As the Cannabis boom was in full swing several years ago, investors began eyeing psychedelics companies. At the time, clinical trials and studies were being released about the use of substances like MDMA, psilocybin, LSD, and ketamine for treating a wide range of mental health issues. Investors quickly picked up on the financial potential in the medical psychedelic sphere, which included a huge treatment population and little competition in the field.
Then stock prices started to dip as businesses saw signs of a significant economic downturn. Psychedelics companies face the same challenges as any emerging industry – these companies aren’t profitable yet and economic instability usually leads to cautious investors, lower valuations and less venture capital funding.
This particular emerging industry is also facing unique issues. Even with several promising clinical trials and an increase in decriminalization, both in Canada and the U.S., stock prices are still declining. Analysts have blamed this on investors – particularly in the retail space – who assumed psychedelics were like cannabis companies, which are mainly sales-driven.
But this isn’t the case. The psychedelic sphere more closely resembles biotech firms, which don’t generate revenue in the first few years. Because of this disconnect, some investors are cutting their losses without taking into account that clinical trials are still preliminary and most psychedelic substances haven’t been legalized in virtually any markets yet.
Even with these setbacks, psychedelic startups can still have a bright future as long as founders switch tactics and prepare for a turbulent market.
How to optimize cash flow in an uncertain market
The most important first step to take during a financially difficult period is to create a plan for cash conservation. At a time when investors are incredibly careful with where they spend their money, it’s vital to control costs – especially if you need fresh funding. Companies who have reviewed and optimized their cash flow tend to fare better with investors.
It’s good to note that any new investments are more likely to come with less favorable terms during an economic downturn, which is another incentive to stretch company funds for as long as possible.
Your financial team can help you conduct a full review of your finances, which includes examining the ROI of all activities. During this review, you’ll be able to identify which activities are worth funding and which can be paused or stopped altogether.
Another step in this process is to conduct an assets review specifically looking for any non-essential assets that can be sold. This includes real-estate, equipment, investments, or patents/trademarks that are no longer beneficial to the company.
Psychedelics startups will also want to update their cash flow forecast using current financial trends as well as historical financial information. Cash-strapped companies should be reviewing their forecast daily or weekly, as well as conducting longer-term reviews monthly. During this review, you’ll likely:
- Analyze your cash burn
- Review discretionary spending
- Centralize control of the cheque book
- Reduce who has spending power
- Review labour costs
- Identify layoff opportunities
- Examine supplier/customer revisions on payment terms and look into government programs/grants
It’s also beneficial to review your investment terms and loan interest to determine which debts should be prioritized. For companies who need to make big purchases, it may make more sense to finance these rather than depleting cash flow. All future financing needs should be planned ahead as well.
Preparing for funding
Part of cash conservation includes the ability to secure funding when it’s available. The most important consideration for companies looking for emergency funding is keeping financial reporting up to date. If you’re approaching a bank, it’s necessary to understand what financial institutions will expect from you and to prepare for the application process.
You’ll have to show you understand the financial metrics banks use. At this point, it’s helpful to connect with your financial team to review common questions lenders will have, such as burn rate, inventory turns, earning sustainability and monthly cash flow forecasts.
Business compliance and planning
In order to survive in a turbulent market, psychedelic startups need to ensure they’re up to date with changing tax laws and regulations. Again, this is the time to work with your financial team to identify growth opportunities and ensure compliance. A corporate structure review is also helpful to ensure your structure is still useful during an economic downturn.
In fact, companies should be looking into a complete business model review. It’s not likely your original plan took the current markets into account.
Understanding down round funding
Many companies will need to explore down round funding – a type of financing where capital stock shares are sold at a lower price than the per share value in earlier financing. This is a way to infuse some fresh funds into a cash-strapped startup. While some founders may be concerned by how a down round will look to investors or employees, it’s important to seriously consider accepting any and all funds at a time like this.
If companies are opting for down round funding, pay attention to any anti-dilution terms stockholders may have. Some venture capital investors own preferred stock, which may come with anti-dilution protection.
What to know when preparing for an M&A transaction
Some startups may be looking to be acquired by another company during this time. If an M&A transaction is in your future, it’s vital to start preparing now, as this process typically takes 12-18 months from start to finish. While venture-backed M&A transactions have decreased during the economic downturn, a post-recession M&A wave may arrive eventually.
Psychedelics startup founders should start positioning themselves favourably now in order to enhance their attractiveness in the eyes of potential acquirers at that time.
Understand how you’ll be evaluated
Most buyers use a ranked scorecard to assess potential M&As. This scorecard usually includes deal terms, strategic fits, competitive gaps, pros to the merger, cultural compatibility and a section determining how difficult the purchase and integration will be (often called “lift”).
A good strategy is to ensure your company scores well in the “lift” category by increasing acquirability.
Ensure your systems are scalable
Buyers want to know that they could acquire your company and begin to grow without having to put in too much work. Companies with a solid infrastructure have an advantage here.
Scalable companies have cleaned up any messes (such as any legal issues) and are fully current on financial reporting.
Know what buyers want
Buyers will be asking the following questions when considering an acquisition:
- How current are your operating plans?
- Do your plans include the current fiscal year, as well as the next 3-5 years?
- Do your plans have detailed hiring strategies and organizational design?
- Is your IP easily accessible and in digital form?
- Can you meet any regulatory requirements for financial reporting by the acquired company?
Understanding insolvency
While insolvency can be difficult to talk about, some companies will need to consider whether or not they’re able to survive in this turbulent market. A company is insolvent when they have poor or no cash flow and:
- Are unable to pay debts as they come due
- Or are unable to make payments in the ordinary course
- Or their assets are exceeded by their debts (at fair value)
If your startup is headed towards insolvency, there are certain steps you should take. First and foremost, contact an insolvency expert, such as those at our Zeifmans team. You’ll want to pay close attention to your debt and your creditors. Founders are usually able to negotiate directly with creditors. As a founder, it’s vital to re-establish trust with your supply base and investors. Your financial advisors can help this process by reviewing cash flow projections and updated business plans. They should also design a recovery plan that provides incentives to suppliers and new investors.
Restructuring your debt
Companies trying to restructure their debt or infuse new equity into their business have several options. If you’re a larger business with debts that exceed $5M, you can file for protection under the Companies, Creditors Arrangement Act (CCAA), which lets companies seek protection from their creditors while they create a restructuring plan.
Smaller companies can also seek protection from creditors by drafting a proposal under the Bankruptcy and Insolvency Act (called a Notice of Intention), though this method isn’t as flexible as using the CCAA.
Companies at risk of insolvency can also use Reverse Vesting Orders (RVOs) to transfer troubled assets and liabilities to another company (usually opened for this specific reason). This allows businesses to retain licensing in a restructuring.
A helping hand during a financially unstable time
While the psychedelic startup boom has fizzled out for now, many companies still have a bright future ahead. As share prices fall and investors become increasingly cautious, businesses need to conserve their cash flow, maintain their finances, ensure compliance, and prepare for any interested investors.
The most important step startups can take is meeting with a trusted financial advisor. At Zeifmans, we have years of experience helping emerging industries like psychedelics. To speak to our team, contact us here.
