How To Raise Capital In The Cannabis Industry
FAS CPA & Consultants
You will need a LOT of money to start a successful cannabis enterprise, mainly because it is a highly regulated industry, which means you will need experienced professionals to manage many of your compliance-related issues.
- Most businesses fail because they run out of cash, albeit for payroll, marketing, or to smooth over legal problems. Cash is the oxygen that keeps a business alive.
Running a cannabis business – mainly a dispensary – is a very tough operation. You will be running a public-facing pharmacy to help patients and consumers learn and get access to cannabis. It will test your tolerance and patience to deal with the public day in and day out – up to eighteen hours per day until the operation runs smoothly.
- It cannot be done alone – you need a team to cover the main functions of the enterprise, especially those tasks you abhor.
- You will require people to handle these tasks:
- Finance and accounting
- Human resources
- Surround yourself with advisors, smart people you trust. You will need them when you come to the point where you need a board of directors.
California is the most extensive legal cannabis market globally, with Los Angeles alone boasting ten million potential consumers amidst a very accepting cannabis culture.
- The extensive cannabis black market is going nowhere.
- For example, even after five years of legal cannabis, Colorado still battles with the proliferation of the black market.
- The bad actors in the market consider getting busted as just another cost of business – this makes it tough to compete with them.
Los Angeles has approximately 400 cannabis dispensaries, and California boasts far more than 1,000. More are opening every month.
- Dispensaries might be relatively scarce now, but what about five years from now? What happens when rite Aid and CVS become licensed to sell cannabis?
- Typically, the massive run-up in cannabis enterprises will peak, and the inevitable collapse will follow, similar to the tech bubble in the 1990s. The collapse will result in a consolidation of licenses and enterprises into the hands of a few smart operators wired to survive in the competitive environment.
- A strong brand drives consumers to ask for your shop, product, or service by name.
- Soon, when Siri, Alexa, and Google Home dominate consumer information, a well-known brand will become one of the most valuable assets any business can have.
Raising Capital For A Cannabis Enterprise
Raising capital for a startup is a hazardous endeavor that requires total commitment. And hitting the jackpot and bringing home the money is but the start of the journey. How you spend the money to find a product-market fit to create value is critical. Once you have the money, the clock starts ticking for you.
- You are attached to your investors for life, or until you sell the business, buy them out or fail. It is similar to a marriage without love – with stricter controls and a more burdensome contract.
- REMEMBER: Your investors are betting on the jockey, not the horse.
The investors are betting on YOU and your team to execute the business plan. It’s an investment in a relationship – merely opening a cannabis business is not a novel idea.
- Be honest when you don’t know
- Ask investors for help when you need it – they have a vested interest in your success, and you can’t scare them off after you banked the check.
- Be open to feedback, and learn new things – don’t allow pride to hold you back.
- Stay humble; the investors have options to get exposure in the cannabis industry, including investments in companies like yours and stocks in larger enterprises, including investing in funds that place bets on their behalf.
- Knowing this, you have to spend a lot of time and effort figuring out what makes you unique.
- In your conversation with investors, what makes you desirable and gives you leverage? Is it:
- Experience or education in the industry?
- Traction on a small scale that is poised to go big?
- Influence in your community where you will build your customer base?
- Vested financial interest because you put some of your cash into the venture?
- In your conversation with investors, what makes you desirable and gives you leverage? Is it:
Institutional investors are merely guessing when they place their money. They have no idea how things will turn out, but they know that one homerun will pay off the fifty strikeouts that go to zero.
Many Ways To Finance Your Cannabis Business
- Put your liquid cash into the enterprise, and borrow from your 401k and your home or sell high-value assets
Friends & Family
- Take cash or investments from your close friends or family
- Amounts of between $100-500k from wealthy professionals like doctors and lawyers r from generational wealth families.
- Not prevalent in cannabis, but still an option once you get around the legalities.
Private Equity or Venture Capital
- Growing in popularity, this is where very high-growth businesses should look for capital.
The Fundraising Journey
- We recommend that your self-fund to start.
- The first series is friends and family for smaller amounts from those who are closer to you. Again, the terms should be favorable and straightforward if they want to get in on the next round.
- Series A should ideally attract someone local who understands the market. This should be easy if you have some traction. Valuation is not the primary determinant at this stage – you have to align yourself with smart money.
- Series B is often the most formidable challenge. It takes a lot of time and patience. What makes it so tricky is the insistence from investors that your company should already have a positive cash flow. It takes a competent operator to change cash into long-term value.
- Series C is about traction and product fit in the market. There is fierce competition between your brand and your most aggressive competitors at this stage, and the biggest war chest wins the battle.
- Another possible capital source is a Line of Credit (LOC) for a bridging loan. LOC capital is mainly non-dilutive, and it’s collateralized by your assets, including accounts receivable.
Evolution Of The Cap Table
The capitalization table of your business will change as you proceed through your fundraising journey. When you begin, you own it all, but as you build your team, you have to split it up in an equitable manner.
- Once you take on capital, you have to break off equity for your investors.
- With each successive round of raising capital or hiring key team members, you are diluted and own less and less equity.
- Take note: your ownership percentage will go down as you bring in capital, but the total value of your shrinking equity will rise in value.
You cannot bring in capital without running the numbers to see if you feel comfortable with your end position.
- Do a financial analysis and prepare proforma financial statements to quantify your actual capital needs and your proposed spending plan.
- Using this, you need to answer this question: does it make financial sense to take on capital?
- Do not take on too much money. If you end up giving away too much, it might affect your motivation to grow the enterprise.
- Spend time to develop an effective 280e mitigation strategy if you want a higher valuation.
- At this stage, you have to consider your exit potential. For example, how much could you get for your shares if you choose to exit the enterprise?
- In the cannabis and dispensary markets, the multiples can be anything between 2× and 12×. However, in reality, it tends to level off closer to 3× for dispensaries.
Smart-Money Vs Dumb Money
- Smart money refers to someone who brings more than only money to the enterprise. So the question you should ask is if I take money from this individual, what else can they offer or provide to me and my business?
- Professional services
- Mentoring, coaching, and wisdom
- Access to people and markets
- Access to joint ventures with other companies
- Dumb money points to someone who can write you a check and nothing else. Dumb money becomes smart money for those who know exactly what to do and how to execute at a high level and if they will give you enough space to grow the business.
- In the cannabis industry, we recommend that you stick to smart money. The sector is clicky, and you will need someone to help you get into the inner circles.
Find out all you can about previous deals in the cannabis market, and reach out to the same investors. CrunchBase provides the institutional details and contact information of investors.
- Go to meetups
- Get involved in the local cannabis community
- If you went to university, attend alumni associations
- Reach out to existing networks
- Another option is to go to angel networks.
- Look at AngelList.com for potential investors
- Sometimes you will find investors on LeafWire
- Prospect on LinkedIn. Produce content about your capital raising journey. Reach out to your connections directly and ask them to take a look at your abbreviated pitch deck.
- Joint ventures seem prevalent in the cannabis market. For example, a local dispensary or grower might invest in your new venture based on possible synergies between your operations. It might have additional spin-offs – you might get access to their licenses, operational knowledge, and cash flow.
- Go hard and hit everybody. Your first check might come from unexpected sources.
Beware Of Predatory Financing And Investing
Beware of highly sophisticated investors that take advantage of desperate startup founders. It is prevalent in the industry at the moment. Most of their tactics are not illegal, and they could screw you over in the long term.
- Some operators charge exorbitant fees for closing deals. Make very sure that you cap fees when you start negotiating.
- Some charge penalties when you pay off debt early or sell your company before a specified future date. Make sure you have the freedom to pay your debt early without penalties and are free from any egregious lockup period.
- Do not lend money at a crazy interest rate. If someone offers you credit at what seems like a loan-sharking rate, walk away.
- Beware of targeting and steering. These terms refer to individuals attempting to guide you toward deals or options that make no financial sense for your business. Don’t work with those individuals.
- Adjustable interest rates that explode are dangerous. Look at the proposed terms to find anything that might trigger rate adjustments and their levels. If something goes crazy high, negotiate them away or walk away.
- If the investors expect personal guarantees for a loan with assets like your house, tread carefully. You are taking a massive chance with your life and your assets. Don’t do it if you are not confident that you can pull it off.
- Do not sign away your power to use the full extent of the legal system against them by enforcing mandatory arbitration clauses. Arbitration with no ability to sue robs you of access to the legal tools to protect yourself and your assets.
- In general, you should be wary of side deals. However, sometimes investors paper a good deal just for appearance’s sake and then insist that you sign other paperwork to manipulate the numbers; this is not merely an amendment. Some of these deals can hurt you financially. Always consult your lawyer before you sign anything.
Pitching Your Cannabis Business
Finding investors is only one step – now you have to pitch them your business as an investment opportunity. From prep to closing, the entire process should not take longer than four to five months.
The Stuff You Should Know
- Audience: Why are you pitching to this person? Look for collaboration with their other investments or show them how smartly this investment will expose them to the new industry.
- Business: Explain what makes your enterprise unique in the cannabis industry.
- Comparable: Study your competition and prepare to discuss their strengths and weaknesses.
- Industry: You have to understand the critical success factors for your industry, and you must become an expert on your target market.
- Needs: How much do you need, and how will you spend it? If your potential investors like your concept, the subject will come up.
- Numbers: You should be able to speak quickly and confidently about the metrics of your planned operation. Master the financials and fully capture the data required to explain how much cash you will have to burn through and for what.
- Practice: Practice pitch repeatedly. Tighten up your pitch. Please do it again, and repeat.
- Strategy: Explaining strategy is all about grasp, detail, and articulation. Spend much time mastering your strategy pitch. Then, concentrate your expression with practical terms and a specific strategy for execution.
- Strengths and Weaknesses: Highlight your team’s competencies and be entirely open about where you need assistance.
- When you meet with your investors, you have to create a sense of urgency. Time is a deal-killer. They should feed off your excitement to ward off other options.
- Don’t do this alone – find experienced players to coach and advise you and introduce you to advisors. Feed on your advisor’s confidence.
- Try local advisors first. Cannabis is a local endeavor, and it will keep travel expenses low.
- Investors often string entrepreneurs along. Do not hang on to investors who offer a maybe or need to ‘talk’ to more people. Go for the no, and go for it fast. Pressure them – it will show them how serious you are.
- Your first ‘no’ should not impact anything but your motivation to pitch to the next candidate. You should pitch to between 100 and 500 people before you are done, so get rid of any thin skin you still carry around. Keep going.
- Beware of agents remunerated by a p[ercentatge of the money your raise from the investors they bring to you. As a rule, they are less inclined to advise you and will often pressure you to go for deals that are not in your best interest for the sake of commission.
- Get a lawyer, and let him shadow you. He has to review and sign off on all the terms and language of the deal; your job is to get the investors to say yes. Your lawyer has to make the deal and clear everything before you sign on the dotted line.
Preparing A Business Plan And Pitch Deck
You need a business plan and pitch deck when you finally meet with your investors. Make it as short as you can without leaving anything out. Include these slides in your pitch deck:
- The problem
- The solution
- The business model
- Market overview
- Marketing & selling
- Cost and pricing model
- Social impact
- Competitive advantage or critical success factor
Once your investor says yes, the real work begins. First, you must make the best deal for your company.
Negotiating is not a science. You have to adjust your approach to fit with whomever you are dealing.
The Negotiating Agenda
- Ownership equity and valuation
- Money invested
- Distribution of revenue
- Financing type
- Voting rights
- Board seats
- First refusal rights for next round
- Payback period
- Your job responsibilities and participation in the venture
- Your claim to the real estate, when applicable.
The purpose is to create a win-win for all parties. Unfortunately, sometimes you have to leave money on the table to create a long-term business relationship. As you negotiate terms, make sure that you set precedents for future deals. You have to understand every aspect opf the agreement fully.
- Before you start, you need to know what you want.
- How much money do you need?
- How do you want to value the same?
- Research similar deals before you sit down with investors.
- You have to find out everything you can about your investor before you can create common ground. Create a human connection.
- Remember, the negotiations might be turned over to other people at a certain point, for example, when you get your term sheet. At this stage, it is typically turned over to the lawyers to hash out the details.
Tools and Techniques
If you start high, you will have enough to ‘give up’ as you go along. The other party wants to feel that they have won a few rounds too. Done well, this will bring you right to where you want to be.
- You have to understand the other party’s position before you can make logical arguments against it. You will need particular reasoning to explain why you should get something the investor has never given up, ever.
- Do not be stiff – use humor to break the tension. People want to deal with others who make them feel good. Humor is often the emotional bridge that ties people together.
- People like dealing with those who are like them – hence, use shared language to seem familiar to them. For example, learn the lingo of your industry and the financials to create more common ground.
- Never bluff. If they call you out, your deal is dead, and your credibility is shattered. Instead, negotiate with a positive attitude and always in good faith. If the other party believes that you are pulling the wool over their eyes, negotiations will sour, and it could kill the deal.
- You have to ask questions continuously until you have the complete picture of all the aspects you are still negotiating.
- Never argue for your limitations, and never for the other side. Instead, shoot, and see what happens. Never come in low to make a deal seem like a ‘no-brainer.’ Negotiate, and show your confidence.
- Be patient – negotiations are emotionally intense. No one will develop faith in you and your idea and hand you a lot of their money if you do not show patience.
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