Cover Story: Raising Capital

American Hustle

U.S. companies willing to work at it will find plenty of opportunities to raise money in today’s capital markets

Raising money in the U.S. cannabis industry today is far different than it was one year ago—and unrecognizable from three or four years ago, when the United States had barely 20 medical marijuana markets, and Colorado and Washington were the only states selling recreational cannabis.

Back then, little capital was available to cannabis companies, and the investors were outliers on the risk-tolerance chart.

“The risk factors three and five years ago were so much greater, and the types of people investing were different. A few years ago, you were talking about real gamblers, penny stock people. It was a whole different risk tolerance and personality back then,” said Sheri Orlowitz, a former U.S. Department of Justice prosecutor who founded Artemis Capital, a cannabis-focused private equity firm in Washington DC.

“Today, you have far less risk,” she added. “There is a ton more legitimate money out there now.”

Indeed, while family offices and high-net-worth individuals are still heavily involved in cannabis investing, marijuana companies have a significantly broader selection of investors to appeal to, such as angels, venture capital and private equity firms.

Marijuana Business Magazine spoke with cannabis executives behind successful raises, as well as investors and other industry experts to get their insights into raising marijuana money in 2019 and beyond.

Opportune Time to Raise Cash

These experts agreed now is a good time to raise money—for a variety of reasons.

“If you’re considering raising capital for expansion, do that today, while there’s opportunity,” said Cresco Labs Chief Financial Officer Ken Amann, who’s helped the Chicago-based, multistate marijuana operator raise $250 million in private funds in the United States and list on the Canadian Securities Exchange.

“I think we’re in a good environment right now,” he added. “There’s plenty of capital out there. People are excited about the growth opportunities, so take advantage of that now, while you can.”

It’s also true that many more marijuana companies are competing for that money. Additional investors have joined the space in recent years, and some of them are less willing to take risky bets.

Factors such as these affect valuations, deal structures and other aspects that entrepreneurs need to consider when raising capital.

In fact, raising capital remains fundamentally difficult—even in the best of environments. Being successful requires planning, strategy and, often, outside help.

Planning Is a Must

Planning and preparation are key. “A good target is that it takes about four months to complete a capital raise, and about half that time is planning,” Amann said.

One critical step is getting your financial records in order so they can be:

  • Audited by an independent firm.
  • Used in calculating financial projections, valuations and other figures that will form your pitch and that investors will want to know.

“Before any liquidity event like this—a debt raise, an equity raise—companies should really start thinking about getting the books and records audit-ready,” said Anson Augustine, an audit specialist with the cannabis practice at Marcum, a national accounting firm headquartered in New York.

Unless your company has in-house counsel with capital-raising experience, you will likely need to hire a business advisory firm to draft subscription documents and investor questionnaires to help you assess whether interested investors are accredited or not—that is, whether they meet certain income and net-worth qualifications. That’s important because issuers tapping nonaccredited investors must provide them with disclosures that include things such as balance sheets and descriptions of the securities and risks.

Issuers don’t need to send such disclosures to accredited investors, which makes the capital-raising process easier for the company. “We only focused on accredited investors,” said Cresco Labs’ Amann.

In case you’re putting together a private placement, you’ll also need counsel to draft a private placement memorandum, a document that discusses the management team, business plan, applicable securities laws and other details.

Locating Investors

Finding investment firms willing to invest in cannabis is getting easier. But for startups and young companies seeking venture and private equity funding, friends and family, wealthy individual investors and family offices serving deep-pocketed investors remain the most common sources of capital.

Establishing relationships with those people can take several meetings over many weeks even before you make
your pitch.

“There’s nothing more powerful in terms of building investor confidence than meeting with somebody, not asking for money and (then) saying, ‘Here’s what we expect to happen over the next three or four months, and I’ll see you in three or four months when things come to fruition.’ That’s what I’ve learned in the private equity space. You don’t ask for money,” said Joe Puglise, chief operating officer at the Denver cannabis consultancy Medicine Man Technologies and previously a partner with the Beekman Group, a private equity firm in New York.

“Things that come to fruition” can include hitting sales or other financial projections, closing an acquisition or hiring key talent.

“Then you go back in a few months and say, ‘You remember all those things we said are going to happen? They all did. Now, let’s talk about what we think our needs are going to be going forward,’” Puglise said. “Now you have an investor who believes, and it’s a heck of a lot easier to raise money at that point.”

Cresco regularly taps its employees to generate investment leads. When Cresco wants to raise money, executives send memos to middle managers, who then inform the employees in their departments that the company is conducting a raise. Employees also are told they can invest—as can friends and family. Cresco also provides incentives to employees who find investors, but company officials declined to say what those perks might be.

Investment Firms Help

While marijuana companies overwhelmingly rely on family and friends as well as family offices for capital, attracting an established investment firm can make it significantly easier to round up individual investors. That’s something to be mindful of, should the day arrive when marijuana companies can list on the major U.S. stock exchanges.

“U.S. investors want to see sponsorship. When I used to be a tech banker, tech investors used to ask, ‘Is Softbank in the deal? Kleiner Perkins?” said Hadley Ford, CEO of New York-based iAnthus Holdings and a former technology banker at Goldman Sachs. They want to know: “Who are the adults at the table, the sophisticated private investors who have done the work, vetted the management team, kept them on track going forward?”

When iAnthus raised $50 million in May 2018, the multistate marijuana operator sought lead investor Gotham Green Partners for that role. “They made a lot of great investments and made their people lots of money. We needed money, but I could have gotten money almost anywhere—at that point we had created a lot of momentum. It’s what (Gotham CEO) Jason Adler and his team brought to the table,” Ford said, noting the New York-based private equity firm helped iAnthus land new hires, identify acquisition targets and refer U.S. public investors.

If you’re successful in your first rounds, it’s easier to get those investors to reinvest in later rounds—and they may also provide additional leads.

“Every investor you get will introduce you to at least one or two more over the next couple years. It’s networking. Now we’re doing much larger capital raises against dedicated cannabis funds and family offices. We might reach out to them and say, ‘We’re doing a Series C.’ We’ll send them a one-page teaser that describes the team, the idea, the opportunity, the context,” said Adrian Sedlin, CEO of California cannabis cultivation company Canndescent, which raised $23 million over two rounds in 2018 and was raising another $50 million when this magazine went to press. “If they’re interested, they might sign our (nondisclosure agreement). Then we’ll send them a pitch deck, and I’ll either meet the investors to present or do it over the phone.”

Perfecting the Pitch

What makes a successful pitch? For most investors, it begins by being impressed with the people and their backgrounds.

“When I see people that have overcome huge obstacles, huge problems, and they keep on going, that’s a real indicator of someone who has the grit and determination to do what they need to do in the startup world,” Orlowitz said.

What makes a good pitch?

According to Sedlin, having a great team should be the first priority. In addition, he said, pitches should leave investors feeling you:

  • Are trustworthy.
  • Are smart.
  • Have a good idea.
  • Will make them money.

“That’s where the entrepreneur needs to be focused,” Sedlin said. “You don’t prove you’re smart by reading a rehearsed narrative. You convince people you’re smart when you can answer questions on the fly.”

Credibility is the biggest concern of Larry Schnurmacher, managing partner at Phyto Partners, a Florida-based marijuana investment fund. The best way to prove credibility, Schnurmacher said, is to present what he calls “realistic” financial projections for the company.

“Most of the time it comes down to if I find the entrepreneur credible and super-knowledgeable about how the industry is changing. A lot of times, it’ll come down to how realistically they value their company that has very little revenue, doesn’t have a proven market yet and hasn’t shown how it’ll stand up to the competition,” Schnurmacher said.

“I can’t tell you how many deals I see with $3,000-plus per-pound wholesale prices of marijuana. Same with CBD. A little tincture bottle is not going to cost $130 in a couple of years. There’s going to be a huge price compression. That’ll be a negative disruption, and when people don’t have that in their plan, it makes everything else less credible.”

Venture Capital versus Private Equity

Startups with little histories to show should approach venture capital firms, while businesses with operating histories can approach private equity shops. “In the venture capital world, it’s all about the future,” Orlowitz said. “In the private equity world, there’s a greater emphasis on past performance. It’s all about your numbers and what they were in the last three to five years, and that’s what really drives valuations.”

When Cresco was calculating its valuations, the metrics it used were multiples of revenue and EBITDA, or earnings before interest, taxes, depreciation and amortization. Other factors that go into valuating a company are often the highlights of the pitch, including the strength and experience of the leadership team as well as how much market share the company already has and its strategy to gain more.

Beyond the strength of your team and the credibility you’ve established through realistic financial projections and valuations, several other factors must go into a pitch:

  • The size of the market you’re serving.
  • The market share you’re aiming for and your plan to capture it.
  • Your competitors.
  • What makes you better than the competition.

“These are all questions that can be translated into numbers and put into a model. But the numbers themselves can be very subjective,” Orlowitz said.

CEDING Ownership

Having your pitch accepted by investors is a big step, but the work of negotiating the deal remains. And if not done carefully, that could unravel any agreement, cost you control of your company and trigger other misfortunes.

When presented with an offer from investors, perhaps the most important question entrepreneurs have is how much company control they must cede to get the money.

“When raising money and taking capital, entrepreneurs should focus on whether a transaction is accretive and not just dilutive. It’s better to own 10% of a billion-dollar company than 100% of a million-dollar company,” Sedlin said. “Entrepreneurs should manage and understand dilution, but the more important idea is if the new capital will create growth that drives the price/share upward.”

“In my experience, entrepreneurs tend to focus too much on dilution and the fact they will own less of their company. Most entrepreneurs need capital far more than they need a couple hundred basis points of ownership. It comes down to answering the question: ‘Will taking capital at this valuation allow me to increase the value of the existing shares?’”

Sedlin offered his own company as an example: If people value Canndescent at $100 million, the dilution on current investors would be 40%—in other words, their ownership in the company would decrease by 40%. After comparing that outcome to selling the company today, Sedlin said he would “probably” conclude that it makes more sense to sell the company than risk running the business with additional partners who interfere with managing the company.

“But if the valuation were for $200 million, then the dilution’s not that bad,” he added. “And if I can get the right terms around it, it makes a lot of sense to continue as an independent company as opposed to selling now.”

To make these decisions, work backward, Sedlin advised.

“You say: ‘If I get this money from this group at this price, am I likely to make the overarching pie more valuable and each of my shares more valuable?’ If the answer is, ‘I’m going to drive my shares from $10 per share to $10.20 per share in the next three years,’ then you conclude it’s probably not worth your time,” Sedlin said. In other words, it would be better to sell the company and move on to something else. “But if the money you take in takes you from $10 to $40 a share in nine months, that’s different. That’s what entrepreneurs need to be thinking about.”