For some businesses, the gut-wrenching challenge of raising capital marks the first step into the cannabis industry
By Marguerite Arnold
The time has never been better to launch new ventures and obtain private capital, despite the lingering controversy and higher risks associated with marijuana businesses.
“The cannabis industry is falling outside of the standard deviations of what would normally be available,” says Leslie Bocskor, managing partner of Electrum Partners, an investment and strategist firm serving the industry. “This is because of pent-up demand, and the unique situation of having a black market industry migrate into a regulated industry of the size that it is. The result we are seeing is an unexpected availability of capital and realistic valuations for early-stage businesses. And the game has just started.”
That said, it’s important to be aware of the culture of startup capital and the requirements of venture capital firms. There are also some rules of thumb that venture-seeking cannabis startups should follow.
To start, keep the business plan relatively small, advises Chase Wiseman, chief financial officer of Flowhub, a software company that raised its startup capital very quickly.
“In the cannabis industry, the written business plan shouldn’t be more than 15 pages, including the six-plus pages of projections,” Wiseman says. “This will show prospective investors you are focused and you don’t come across as knowing all the answers.”
Scott Jordan, the director of business development for Dynamic Alternative Finance, says entrepreneurs looking to raise capital should be interviewing prospective investors just as much as venture capitalists are investigating them.
“Be prepared to answer and ask questions,” Jordan says. “Have they invested in cannabis before? Who else will they consult with before making a decision to invest? What sort of time frame do they have in mind for a return on their investment? Can they bring any additional contacts, expertise or introductions to help grow the business?”
The fundraising process is difficult, and it takes a variety of skill sets to be successful, Jordan says. It’s critical to have good legal representation from an attorney or law firm experienced at raising capital, reading the fine print and negotiating reasonable terms.
“It generally takes a team and some financial resources to prepare for a pitch to a qualified investor,” he adds.
Wiseman advises an overly conservative approach to projections. He says most sophisticated investors won’t bet on over-inflated market projections.
“I would even go as far as to cut all market projections on cannabis by one-third,” he says. “Do not ever say you are going to capture 30-50% of the market in two years from seed capital, unless you have the cure for cancer. Be reasonable. The last thing you want is high expectations. If an investor concludes that they can make a good return on a whittled down market, or 5-10% of market capture in year one, they’ll make big returns if you surpass your original projections.”
This goes for business valuations, as well. It’s an area that entrepreneurs should carefully consider as they put together business plans and investor pitch presentations.
“Ask any investor or fund in the cannabis space and they will tell you the most outrageous thing they see from companies raising money is the valuation,” Wiseman says. “Want to know a key to raising money fast and not getting beaten up on this issue? Be conservative.”
Some experts say valuations across the industry are incredibly high, and many of them are unjustified.
“We have had direct experience with valuations of marijuana-related companies and have found that there is no rhyme or reason to valuations,” says Aaron Herzberg, partner and general counsel of CalCann Corp, a California medical marijuana holding company. “I have found it particularly shocking how high the valuations are in the penny stock companies that often have little to no real revenue. I’ve seen ancillary businesses at ridiculously high valuations where there is an unproven business model.”
The structure of financing is also a key point to consider. How much control and equity should entrepreneurs be willing to sacrifice for necessary capital?
Jordan prefers to focus on debt-based strategies.
“As long as you repay the loan, there is no ownership impact and no one telling you how to run your business,” he says. “This scenario allows you to keep total control, retain equity and keep your peace of mind.”
Without a doubt, the investment opportunities in a completely new industry — at least in the legal sense — has created a fervor. There is clearly still a great deal of interest in innovative retail startups. However, the entire vertical continues to grow, especially now that marijuana companies are finding more ways to legally operate across state borders. That said, multi-state strategies, particularly for brick-and-mortar or farming startups, are more complicated and pose higher risks to investors.
“Our focus has been on marijuana licenses in Southern California, which is the largest marijuana marketplace in the world,” Herzberg says, pointing to the long-term play of real estate investments that are entitled to dispensary, cultivation or manufacturing licenses.
While some investors may be more at ease with ancillary companies, “it has been a challenge to find investors who understand technology investing and are also comfortable with the relation to cannabis,” says Jeremy Carr, the CEO of Blaze Now, an advertising and data collection platform.
The marijuana industry faces additional challenges. Not only is the industry still federally illegal, but new businesses in general are considered far more risky by investment firms. And the biggest danger of all could be the 2016 presidential election.
“The risk that the market becomes completely illegal depending on which presidential candidate takes the POTUS seat in 2016 also weighs heavily on the consciences of investment banks in the public space,” says Jason Wolf, the CEO of marijuanastocks.com.
Most people see this as highly unlikely at this stage of the game, even if a Republican president takes office. Yet, that chance remains a drag on both industry development and private financing at a time when Oregon and Alaska are coming online and at least a half-dozen states’ residents will consider legalization initiatives in the coming months.
Marijuana Venture editor Garrett Rudolph contributed to this story.