As America’s appetite for cannabis grows like a weed, visionary VCs are backing the smartest, scrappiest entrepreneurs.
Last year, Snoop Dogg and Martha made meals and dance moves together, and the company behind blockbuster brands Corona, Robert Mondavi, and SVEDKA poured $191 million into a Canadian cannabis firm. There’s a cringe-inducing image: not the sight of Ms. Stewart and Mr. Broadus bonding for the starstruck, but the blinding agony of the flight of multimillion-dollar investments—and the substantial economic boosts they drive—to countries where cannabis is fully legal.
Canada’s largest cannabis producer, Canopy Growth Corporation, the recipient of Constellation Brands’ 9.9 percent minority stake, is valued at $6 billion. As long as cannabis remains a schedule 1 class drug, illegal by federal standards, American entrants into the market have zero chance of making that kind of valuation.
Still, there are plenty of market entrants waiting at the gates, and with good reason. In the 29 states where it is legal, cannabis industry jobs are on the rise, supporting nearly 160,000 full-time employees. That’s three times the number of coal industry workers, and equivalent to all of the kindergarten teachers and librarians at work today.
By 2020 the industry expects to employ more people than the entire domestic manufacturing industry, and projects a year-over-year growth rate of 21 percent annually through 2022. The annual projected growth rate for the entire U.S. healthcare industry over that same period is just two percent.
The cannabis industry is profoundly disrupting American business in ways we may not fully comprehend until the many complex legal issues are settled. Promising legislative efforts are giving hope to visionaries and business owners poised to take a big hit of success—even if the market is scrambling to catch up with booming international markets such as Canada and Israel.
Funding for the Future of Cannabis
The market has begun to shift from seed stage to one of careful growth, given the legal restrictions in place. To better understand the issues faced by entrepreneurs and investors, we spoke with Tahira Rehmatallah, Managing Director of Hypur Ventures, a New York based-VC fund dedicated to backing companies in the legal cannabis space.
“We were previously at a stage in the industry where everybody was early because it was a fairly new industry, three, four, or five years ago when businesses really didn’t have any competition,” she said. “Because the market has evolved, you have companies still coming in at seed stage, but you also now have companies that are in their growth stage. They’ve been in the market for awhile; they’re hitting that next level of company growth.
“The (investment) criteria for those types of companies are different. Because there are so many products and services and different verticals in the market now, it’s a bit more difficult to get that early stage funding without having a really unique and distinct approach that isn’t already in the market.”
A handful of years ago, there were no VCs dedicated to funding players in the cannabis space.
“Now you have dozens,” Rehmatallah stated. “That’s a change in the way investors have been working in the space. You used to be able to write a $25K check and be done with it. Now you need millions or tens of millions. A few years ago people weren’t raising that kind of money. Writing a $100,000 check is a lot of work for a VC under the structure they’re in. It didn’t make a lot of sense for VCs, either, and now we’re seeing a shift in that.”
Until recently, small funds were sufficient to get new companies off the ground, and small VC firms could back quite a few new endeavors for a relatively modest investment.
“Now you need a larger amount, not only to provide the capital that’s needed in the space, but also to make the economics work. Management fees sustain the business of investing, but is two percent on $10 million enough if you’re more than one or two people?”
Can’t Forget About the Money, Money, Money
Despite witnessing the demonstrated viability of cannabis businesses, particularly in their ability to create jobs and contribute to states’ fiscal health, most financial institutions don’t provide services to the industry.
Banks have little incentive to support cannabis businesses, particularly since under federal law, industry players are subject to serious criminal liability, including aiding and abetting money laundering. The 2013 Cole Memorandum offered some protection for banks willing to work in states where cannabis is legal, and was followed by guidance from the Financial Crimes Enforcement Network (FinCEN), refining financial institutions’ suspicious activity report (SAR) criteria as it relates to cannabis business.
In January of this year, the DOJ rescinded the Cole Memorandum. As a result, banks that file SARs in accordance with FinCEN guidance are openly admitting to violating federal law. The risks, once cushioned by Cole, are back to being fearsome. Many banks are deeply concerned with the potential damage to their reputations in the current environment. Not so for many of the new crop of cannabis-focused VCs, however.
“The groups that I work with are much more involved in operations on a daily basis and working with management teams of companies because it is so complex, and because there are so many issues. One of the things that we like to contribute to our companies are these additional resources or connections or abilities to navigate some of these pitfalls that companies face when it comes to things like banking and regulatory compliance,” Rehmatallah admitted.
“We want to make sure that all of our companies are compliant, above-board, and in the best possible position from an infrastructure standpoint, so we are very happy to assist with those types of things. What we invest in across various companies is also focused on regulatory and compliance, so we do have tools we can offer other companies that may not have been leveraging our own portfolio. It’s a strategy as well. We want to have our portfolio companies leverage each other because that’s how they can grow and benefit from each other down the road.”
Hypur’s stated strategy is “to invest in companies that are known by consumers, competitors, regulators, and investors as trusted members of the cannabis community.” Despite the best efforts of the Sessions DOJ, the cannabis industry is here to stay.
Perfecting the Pitching Game: Venture Capital and Cannabis
Regardless of how long it will take to create a navigable financial landscape for cannabis operations throughout the U.S., Hypur Ventures gets torrents of pitches from hopefuls, many of whom haven’t yet perfected the knack of tempering enthusiasm with demonstrable evidence.
As in every new industry, rookie mistakes abound, particularly when it comes to proof of concept.
“They don’t have a lot of information on why this product will succeed,” she explained. “It’s not as much “I believe” as “here’s what we have done to prove this out.” It can be in the crudest format, but not having that information makes it really difficult because then you’re leaving it up to the investor to imagine – especially if you have a physical product. To be able to show that or some physical form of that, even if it’s at a really early stage, is really important.
“If you have a deck that has some pretty pictures but you need $10 million to get it done, it’s hard for an investor to bank on that.”
Pie-in-the-sky valuations are another sticking point that Rehmatallah often sees in newbie pitches.
“You can tell me this is your valuation but you have no data to support it, or using multiples that aren’t relevant given the industry you’re in, or your comping yourself to something that’s much further along. The reality is that, for business valuations in the private market, you’re worth as much as what that first investor agreed to. That’s what your valuation is.”
She added, “You have to be realistic and understand that you have a lot of things to consider when going for valuation, and coming straight out of the gate and saying that you’re a $10, $20 million company conveys the wrong image about who you are as an entrepreneur with what’s happening in the space.”
Accepting feedback, however harsh, is key. “Oftentimes people get so tied to their ideas that they get very sensitive about getting feedback from investors. But every meeting you have that’s a no is a really good learning opportunity. You can take that feedback and make it better every single time.
“You’ll hear it from people all the time: they’ll get 100 no’s before they get a yes, or 200. That’s fine. That’s how it goes. Nobody’s perfect when going out there and pitching for the first time. And that’s just part of the learning process, and you get better every time you do it.”
Demonstrate the ability to execute. “You could have a really good product but we need to see who is behind it, who has the ability to make this come to life. Maybe that’s one person or five. Teams change over time and have to change as they’re bringing things to market, but the end product is just a piece of the story. The entrepreneur, the team, is the other piece of it. Make sure you have the right people in the room to talk about what it is that you want to do.”
Consider operations, logistics, and financials. “I like to see that entrepreneurs are thinking about creating a strong foundation. Oftentimes you have a really good product and an aspirational entrepreneur, but they have no real strong backbone. That’s often what holds up companies who are trying to sprint to get a lot of stuff done. Show that you have laid out a framework for what needs to happen and why that’s important. Thinking about things like insurance and legal often happens a little too late but should happen much earlier to save a lot of headaches.”
Be realistic. And scrappy. “You’d be surprised at people who come in with financials and the numbers don’t make any sense. You need to gut check that stuff. Don’t put in salaries for your top people for $150k; that’s not scrappy. Entrepreneurs have to be scrappy. That’s what helps to create these businesses, and it’s really important to see that there’s somebody who can think in that way. You have to make a lot of hard decisions, a lot of trade offs.”