As the cannabis industry attracts more entrepreneurs, those same people are looking to raise capital.
In this blog post, we will walk you through four main points on preparing yourself to speak and collaborate with investors.
These topics include:
Let’s get started!
Cannabis Industry Context
Let’s discuss the mindset you need to have and understanding the landscape that you will be competing in as a cannabis entrepreneur.
First, it’s imperative that you know that it will take A LOT of money to create a successful cannabis business for a few reasons.
It’s a highly regulated industry, just like the liquor business or airlines. That means a lot of compliance related issues that you will need to hire experienced professionals to manage for you such as lawyers to handle licensing and CPAs to handle your taxes.
Most businesses fail because they run out of cash...plain and simple. Whether that’s cash for payroll, to solve marketing problems, or to solve legal issues; without it, you have no oxygen for your business.
Next, running a cannabis business, especially a dispensary is an incredibly hard daily operation. You are running a public-facing pharmacy that is helping patients and legal adults learn and obtain their cannabis. It takes a high-level of skill and tolerance to work with the public day in and day out. It could be 8, 12, maybe even 18 hours days to make sure your operation is running smoothly.
Another point that we need to stress is that you can’t do it all by yourself. You need to build a team to over all of the main functions of your business; especially the ones you don’t like to do.
We suggest starting to look for people to cover:
Understanding the California Cannabis Market
Now let’s review and understand the Los Angeles and California cannabis market a bit deeper.
California is the BIGGEST legal cannabis market in the world, and Los Angeles is the epicenter for it all boasting 10 million potential patients and a very accepting cannabis culture.
But don’t forget, there is a huge black market right now and it’s not going anywhere. Even five years into legal cannabis, Colorado is still dealing with a proliferating black market. To build on that, the Bureau of Cannabis Control is way understaffed. And one last point is that bad actors are slippery; getting busted is built into their business plan which makes it difficult to beat them.
Currently in Los Angeles, there are about 182 dispensary licenses, and about 900 in California overall and that number is increasing every month. In LA, there will be about 400 dispensaries in the next 12-24 months.
So yes, a dispensary is relatively scarce now, but what about in 7 years? What about when Rite Aid and CVS start to become licensed cannabis businesses? How will that affect the valuations of cannabis businesses?
We believe there will be a huge run up in the amount of cannabis businesses, but then an inevitable collapse will happen similar to the late 90’s tech bubble. This collapse will then lead to a consolidation of the licenses and businesses into the hands of smart operators who know how to survive in competitive landscapes.
If you want to survive, you will have two things to lean on:
With brand, you want people to ask for your shop, product or service by name.
Once Alexa, Siri and Google Home start to dominate how we interact with the world of information, having a brand that people know will be one of the most valuable assets ANY business can have. Or else you will be at the mercy of paying these platforms to own the word “dispensary” or “vape pen”...and it won’t be cheap.
Now that you have a bit of context around the cannabis industry and the California market, let’s dive into aspects of raising capital for your cannabis business.
Let’s start with a 30,000 foot look at the entire process.
It’s a long and tiring process to put on the capital raising roadshow, so be prepared to focus solely on this until it’s complete.
And don’t clap for yourself too much once you actually do raise the money. Raising capital is just one check box, one step in the entire scheme of building a business. Yes, it’s a gate, but the execution of your plans, finding product market fit, and creating value is most important. When you get the money, the clock starts ticking, so don’t let that time pass too fast.
When you take money from investors at any level, it’s like a marriage, but with tougher contracts and more strict controls on your actions. You’re attached to these people for life, or until you sell your business, buy them out, or fail in your business.
But one thing to really understand is that investors are betting on the jockey and not the horse. This means they are betting on you and your team to figure out the best way to execute your plans. They are investing in a relationship, because to be quite honest, opening a cannabis dispensary is not that novel of an idea.
One piece of advice is to be honest with what you don’t know and ask for help from investors when you need it. They are vested in your success and you already got the check, so no need to worry about scaring them off. Further, don’t let pride hold you back from success and be open to feedback...you may actually learn a thing or two.
It’s also important to know that institutional investors are guessing when placing their money. Investors don’t know how everything will play out, but they are making bets...and many of them. They know that one homerun will pay off the 47 strikeouts that go to 0.
Lastly, don’t think that you’re their only option to get into the industry. Investors have many options to get exposure to the cannabis industry including investing in companies like yours, into stocks of larger companies, or even contributing to larger funds that place bets for them. Stay humble.
Knowing that there are many options, you should really take the time to consider what makes you special. Ask yourself:
Types of Investments
There are many ways to raise capital for your cannabis business and those are:
Traditional Fundraising Journey
Now let’s explore the stages of a typical investment journey.
It is highly recommended that you self-fund to start out, but if you can’t then it’s time to look elsewhere.
First is friends and family. These are usually smaller and easier to close, and the terms should be simple and favorable for them to get in on the next round.
Then you have Series A which should hopefully be someone local who understands the context of your market. These should be relatively easy as well, especially if you have some traction. At this stage, valuation is not everything...you also need to see what smart money you are aligning yourself with, and we will get to that later.
Then you have Series B which is usually some of the hardest money to raise, and it takes time and lots of patience. It’s hard because investors will continue to ask, why are you not cash flow positive yet? It doesn’t take a hero to lose money every month, but it takes a savvy operator to take cash and turn it into long-term value.
Finally you have Series C and beyond. This is all about traction and product market fit. Usually you’re going out to raise this round because there is fierce competition between you and other brands, and the person with the biggest war chest (and great deployment of capital) will likely come out on top.
Another potential capital raise is a Line of Credit (LOC) which is largely non-dilutive capital that is collateralized by your assets such as Accounts Receivable. You may see these also called bridge loans.
Evolution of the Cap Table
Above is an illustration that shows how the capitalization table changes over the different parts of your fundraising journey.
As you can see, at the beginning or formation of your business, it starts out with you owning everything. Then as you build your team, you need to split things in some reasonable way.
Now, as you start to take on capital, you need to break off equity for your outside investors if you’re not self-funding your business. And with each successive round of raising capital or hiring new key team members, you continue to get diluted down and own less and less equity than when you started.
It’s important to know that you won’t always own a huge chunk of your business (or maybe you will), but you give up equity in exchange for capital that helps you make your company more valuable. While your percent ownership may go down, your total value could (and should) go up over time.
Understanding the Financials of This Transaction
Before you take on capital you need to run the numbers to see if you really like the position you’re putting yourself in.
You will need to do a financial analysis and produce Pro Forma financial statements which will help you quantify how much capital you ACTUALLY need and how you will use those funds. It also helps you answer the question: Does this even make financial sense to take on capital? Some businesses raise too much money and end up giving away too big of a chunk of the business only to lose their motivation for growing the company.
Once you know more about the financial nuts and bolts of the capital raise, you then need to look at your exit potential. What can you really get?
In the dispensary market and cannabis as a whole industry, we are seeing multiple land everywhere from 2x to 12x, but more toward the 3x for dispensaries. But note, more and more dispensaries are opening every month which will eventually drive these multiple down.
The multiples are typically based on Net Income instead of gross because of the extreme tax burdens that cannabis companies have. If you don’t have a good 280e mitigation strategy, then you will surely see a lower valuation compared to someone who has gone with an offensive tax strategy.
Now once you know the total exit value, you need to factor in your percentage of that exit.
Let’s look at an example.
Gross Revenue = $2.5MM
CoGS = $1.5MM
Gross Revenue/Margin = $1MM/40%
Additional Expenses and Taxes = $725,000
Net Income = $275,000
Multiple = 4x
Total Business Value = $1.1MM
Your ownership = 51%
You get $561,000 at sale of business
Smart Money vs. Dumb Money
You may have heard the term smart money or dumb money, but I want to explain it.
Smart money is someone who brings you more than just cash. You need to ask yourself, if I take money from this person, WHAT ELSE can they offer or provide to me and my business?
Some examples include:
Dumb money is simply someone who can write you a check, but provide little to nothing else...other than a headache when they keep asking you when they will be getting their return back on their investment.
But, dumb money can be smart money if you know exactly what to do to execute at a high level and they give you the space you need to grow your business.
It’s a balance, but we suggest always going for smart money, especially in cannabis. It’s quite a clicky industry and you need to have someone be your evangelist to get you into the inner circles.
Where to Find Cannabis Investors
Once you have a business plan, pro formas and pitch deck, now you need to find investors.
You can start by researching prior deals in the cannabis space and reaching out to those investors. Crunchbase is a great place to find many of the institutional deal details as well as contact information for the investors.
You can also go to meetups or get involved in the local cannabis community. Another idea is going to alumni associations if you went to university or reach out to other existing networks; maybe even reaching out to your local church!
There are angel networks out there and you can even look at AngelList.com to find potential cannabis investors. We’ve also seen a few investors on LeafWire.
You can start to prospect and make connections on LinkedIn, and then produce content around your capital raising journey. Even reaching out to connections directly and asking if they want to see your abbreviated pitch deck is a potential way to engage investors.
Lastly, one type of deal we’ve been seeing more of is Joint Ventures. This is where an existing dispensary owner, grower or manufacturer would invest into your new businesses because they see some synergies between the two operations. This is quite creative because it can also give access to their licenses, operations knowledge, real estate and cash flow.
You just need to go hard and hit everyone and anyone up. You never know where that first check will come from, and it may come from the most unlikely meeting at a happy hour, a wedding or even on the train back from your day job.
Aspects of Predatory Financing and Investing
One thing you see often in this stage of the industry is predatory financing or investing where more sophisticated investors take advantage of desperate startup founders.
While most of these tactics are not illegal, they can surely screw you over in the long-term so you need to keep your eyes open for these tactics.
Pitching Your Cannabis Business
Once you find potential investors, your job now is to pitch them your business and the investment opportunity.
The fundraising process is quite long, but if you prepare it could be about 4-5 months from prep work to closing the entire round.
Here are some basics of how to prepare for your pitch:
Let’s also cover some miscellaneous tips around fundraising.
Again, BE PREPARED. Practice your little heart out so that you could go into your pitch at a moments notice.
Time kills all deals, so create urgency when meeting with investors. You don’t want to keep them on ice and think it will keep the deal fresh. They have options and want to feed off your excitement.
Get solid advisors who can introduce you to investors and guide you through the process. It’s tough to do this alone, and having someone by your side will give you extra confidence in the room.
Search for investors locally first. This makes it easier to meet with them in person because travel cost will be low, but also in cannabis, this is still a local endeavor...at minimum a state by state game until cannabis is rescheduled.
Go for the “No” as fast as you can. Don’t let investors string you along saying maybe or that they need to take to more people. Put pressure on them and show that you’re serious about your time and your business.
Rejection is part of the process. Once you get the first “no”, don’t let it crush your confidence. If you’re doing this right, you’re talking to 100-500 people and most of them will tell you no, so grow some thick skin and keep moving forward.
Try not to use an agent which is someone who takes a percent of the money you raise in lieu of making introductions for you. This is different than an advisor and agents may pressure you to take deals that are not in your best interest just so that they can make a commission.
Lastly, get a lawyer to review and make sense of all the terms and deal language. Your job is to get investors to the point of yes, and then you hand the deal off to the lawyers to hash out before you sign the dotted line. If you sign a deal without fully understanding every clause, you may be shooting yourself in the foot before the race actually starts.
Preparing a Business Plan and Pitch Deck
When meeting with investors, you will need to create a business plan and pitch deck. We don’t want to write too much about it here, so instead you should review the video below which will walk you through EVERY detail about what to include, how to make it interesting and what to avoid.
Shorter decks are better. Don’t create an entire book about every detail!
The potential slides you will include in your pitch deck are:
Negotiating Your Deal
After you pitch an investor and they say yes, the next step is negotiating a deal for your company.
You should understand upfront that negotiating is an art, not a science. It’s ok to adjust your style to best fit who you’re negotiating with. There is no one method that is best for every situation.
Let’s review a few of the items that are actually up for negotiation.
The purpose of any negotiation should be to create a win-win for all involved parties. It’s okay to leave money on the table because your goal should be to create a long-term business relationship. It’s important that as you negotiate certain terms that you are setting precedents for future deals so fully understand every aspect of the deal!
To prepare for your negotiation, you should know where you want to end up before you start. That means knowing how much you want to raise, at what valuation and every other term in the list above. If you’re doing a deal that you’re unfamiliar with, then research other deals in the space before you start negotiating.
If possible, learn something about the person with whom you’re negotiating so that you can build common ground with them. People negotiate with other people...this is not a mechanical process, so don’t be scared to create that human connection.
Also, be prepared for the negotiation to be turned over to someone else once you reach a certain point such as getting your term sheet. When you reach this point of the deal, it usually gets handed over to lawyers to make hash out the details and make the deal ready for each party to sign.
Negotiating Tools & Techniques
When engaging in a negotiation, you should start high, but be reasonable. This will give you room to ‘give up’ things and make the other party feel like they have won something. It’s a bit of psychology, but if done correctly, you will land at or near your intended targets.
Next, understand the opposing party’s position so you can logically argue against it. You need to ask yourself and find proper reasoning behind why you should get something they have potentially NEVER given to other deals.
Don’t be so stiff in negotiating. It’s okay to use humor to break tense moments. People want to work with people that make them feel good, and humor can be that emotional bridge that ties the two parties together.
Use shared language so that you seem similar to them. People really want to work with others that are similar to them in as many aspects as possible, so take the time to learn the lingo of your industry and of financials so you can create even more common ground.
Don’t bluff because you will likely get your card pulled. This is simple. If you bluff and they call you out, it will destroy your deal and potentially your credibility. To build on this, negotiate with a positive attitude and in good faith. If the other party senses that you are trying to pull one over on them, it will sour negotiations and potentially kill your deal.
Ask questions during the negotiation to get as much color and context to what the other party is thinking and where they stand at on any deal points you haven’t agreed on yet.
Don’t negotiate for the other side. Try to shoot your shot and see what happens. Don’t just come in low on something to try and “make the deal a no-brainer” from the get go. Make sure you actually negotiate and show that you are confident in your abilities.
Lastly, have patience. These deals can be emotionally intense. Think about it...you’re asking someone to believe in your idea and give you a million dollars. That’s a big sum of money and they aren’t going to just give it away freely.
Get to Work
We have walked you through four key aspects of becoming investor ready, and hopefully this has helped you gain the confidence necessary to secure funding for your cannabis business.
If you need help with preparing your business plan or pro forma financial statements, then please reach out to us today to get started.
One of the elements of a good business plan is performing market research to determine your target customers. Pricing, marketing, and product selection all depend on who your key consumer groups are – and what they’re interested in purchasing in the adult-use legal cannabis market.
In some ways, consumer data is extremely limited due to the government’s classification of cannabis as a Schedule I drug. Government research that is typical of other industries is simply not performed on the cannabis market. As a result, most data we have about cannabis consumers is limited to gender, residence, and spending amounts. This can be useful in valuing your cannabis business for investors, but is less helpful for cannabis marketers hoping to build a customer persona.
While the demographics vary among cities and districts, some early trends have emerged that can help inform your cannabis business offering. Here’s what you need to know about the key cannabis consumer groups in 2018.
Who is the typical cannabis customer?
In a survey conducted by the Cannabis Consumers Coalition, the majority of respondents were between ages 21 - 35, which is not necessarily surprising. Interestingly, the second biggest group of cannabis consumers was 45 years or older, meaning cannabis consumers are likely to be professional adults. In fact, the study discovered that more than 58% of cannabis consumers are between the ages of 21 and 55. The perception that cannabis consumers are college age, unmotivated stoners is likely misguided. Cannabis customers are more likely to be working professionals, parents, and with some level of disposable income.
Aligned with the shift in age toward older cannabis consumers, the average household income of a cannabis customer has also risen. The Cannabis Consumers Coalition research indicates that cannabis consumption transcends economic class, with customers at all income levels partaking in cannabis consumption on some level. Inform your product pricing with the following data from their survey: the majority of cannabis customers have combined household incomes of $26,000 - $55,000.
What do we know about the gender of cannabis consumers? While movies like Dazed and Confused have widely popularized the impression that most cannabis consumers are male, this survey suggests the gender gap is much more narrow. Companies like Whoopi & Maya have popularized cannabis as an alternative therapy for women. Women hold nearly 30% of executive leadership positions in the cannabis industry – a significantly higher percentage than the nationwide average. When designing your marketing material, take into consideration that women make the majority of household purchasing decisions, and in the cannabis market, they will be a powerful consumer group.
Medical v. Adult-Use Cannabis Users
Though recreational cannabis is only legal in about half of the states, it’s an important trend to track for new cannabis entrepreneurs interested in entering the market. This statistic can help you understand the deeper motivation behind your customer: are they making a purchase because it’s a medical necessity, or for recreation? How frequently can you expect someone to make a repeat purchase? Diving into your customer behavior has implications for inventory management, loyalty programs, and pricing.
Data from the National Institute of Health reveals that the majority of customers partake in cannabis use for recreational reasons. Their national sample showed that among those consumers who lived in states with medical cannabis legislation, 17% used cannabis for medical reasons and 83% used it recreationally. However, those who do use cannabis medically do so with more frequency and regularity than those customers who purchase cannabis for recreational use. A good business practice would be to take medical consumers’ needs into your marketing plan, even if your primary target customer is a recreational user.
California’s Key Cannabis Consumer Groups
California has the potential to become the world’s largest cannabis market, making it a good bellwether for understanding developing consumer trends. Early studies by market research firm BDS Analytics indicates there are three key consumer groups across the state. Primary consumers in California are 39 years old and have used cannabis or cannabinoids in the past six months. A secondary group deemed “acceptors” by the study are 49 years old, and while they haven’t recently used cannabis, they would do so in the future. California’s “rejecter” group is an average of 56-years-old and are not likely to consider cannabis use.
It’s worthwhile to note that while rejecters and acceptors aren’t recent users of cannabis, that doesn’t correlate with disapproval of legal adult-use cannabis. The study showed that tolerance and acceptance of cannabis is becoming more common, and in fact, Californians are becoming more interested in the potential health benefits of cannabis use. This further reinforces the case for continuing to include medical-use customers as part of your business plan and marketing strategy.
For more insight into how to build your cannabis company, get in touch with one of the experts at GreenGrowth CPAs.
Starting a cannabis company can be a tough sell when trying to raise capital from traditional funding sources. The newness of California’s industry combined with the unknown of funding a new (drug!) business leads to a level of risk unappealing to many investors. In a previous post, we’ve covered different ways you can find an injection of cash for your business. And this week, our experts have a new way to make your business more attractive: real estate.
Use Real Estate as an Investment Opportunity
There are two instances where purchasing real estate can be leveraged as an investment opportunity.
The first, most simple way? Use your real estate as a business in and of itself. Purchase a property in a green zone-compliant area that you can use to operate your business. Then, approach investors with the chance to become part owners in the building, rather than your business.
The second way is to offer a similar investment opportunity on different locations owned by your business. If you plan to open multiple locations but need to raise the capital to purchase the locations, have an investor take ownership in individual properties.
Both examples are a win-win for investors and entrepreneurs. For investors who may be wary of the risk associated with the cannabis industry, real estate is a much safer investment option. For cannabis entrepreneurs, you maintain full ownership of your business. Making an investor a part owner in your real estate rather than your business lets you make decisions as you want and grow your company with more autonomy.
Leasing vs Buying: Green-Zone Property
Does this mean you should make an effort to buy a property rather than leasing it? There are pros and cons to both options. We’ve outlined some of the biggest points to finding real estate previously on the blog. Should you have more specific questions, we’re here to help.
This is a very specific instance where our experts have found ways to make your company successful. Get more advice on how to build your business and join California’s billion-dollar cannabis industry when you consult our experts.
Last week, we covered how to find an investor for your cannabis business. It can be hard to find a cash infusion in this industry – many banks won’t issue loans due to federal regulations against the legal sale of cannabis. Instead, look for private equity firms, crowdfunding, or non-specific business or personal loans you can use to get your business off to a running start.
Hopefully, this will lead many cannabis companies to connect with angel investors, private equity firms, or venture capitalists. If you fall into that category, how can you be prepared for the future influx of opportunities from cannabis companies?
There are a few things to seek when evaluating cannabis companies from an investor standpoint. Cannabis companies come with a lot of inherent risk: the industry is new, regulations are still evolving, and there is a lot of cash involved. Bad record-keeping, poor cash control, and outright fraud are just a few of the things many investors worry about. Ask these questions to determine if a cannabis enterprise is worthy of investment.
Does the company use a cloud-based accounting system?
What’s wrong with a traditional accounting system, like keeping track of your sales and purchases in an Excel spreadsheet? A few things:
Cloud-based systems are more secure, mobile-friendly, and easily auditable. Keep tabs on your investment with a cloud tool that lets you quickly review invoices and receipts. Cloud software is more secure: if a laptop is stolen, the data stays safe. A cannabis business can limit the actions an employee can take by deploying different user roles, and make sure that only certain people can enter cash flow transactions. Ask for transparency from a cannabis business to ensure that your money is being used as it should be.
Does the producer or extractor use a robust system of measurements?
Cannabis producers or extractors work with lots of raw material. The end product is like liquid gold: so throughout the process, it’s important to have controls in place to minimize waste. Ask to see evidence that the ratio of final product to raw material makes sense. Can the cannabis extractor/producer demonstrate tight production controls? Can they show the use of standardized measurements at multiple points throughout the process? Can they show that they have taken steps to safeguard against fraud? These are all things you can look for when at an onsite visit to a cannabis operation.
Have they done their due diligence on third-party vendors?
Make sure anyone you’re entering into a partnership with has cleared their third-party vendors. Cannabis businesses have lots of secondary partners – from suppliers to distributors, it’s important to make sure these vendors are fully licensed and aboveboard. Ask a cannabis company for copies of their partners’ California cannabis permits, records of vendors’ physical addresses, contact names and numbers, and any mutual business references that can be checked. See that the cannabis company keeps vendor agreements with every partner on file.
Does the canna-business use a system of checks and balances?
Checks and balances can be as simple as separating staff roles for different accounting functions. Fraud is easy when one person handles all the bookkeeping functions: things such as processing customer payments, managing petty cash, keeping accounting records, or paying invoices. The cannabis business should have at least two people to manage these functions, and keep their accounting and cash handling separated. It’s also recommended that they also keep separate systems for inventory and manufacturing accounting.
Some companies might find it helpful to use a tool like Clover or Xero to keep an eye on their employees. Tools like Clover Payments Plus can give you as the investor better insight into things like cash in and cash out, sales, employee management and scheduling, and inventory tracking, and more.
Do they have up-to-date records?
Keeping up-to-date records show that that the cannabis business is the real deal. Here are just a few things to ask for:
Depending on the unique cannabis operation, get specific on what other permits, records, and local licenses you need to see. Do they have municipal permits? Do they use a system of dual signatures to control cash flow? Does the cannabis company have the right insurance?
If you have any questions, we’re here to help. Don’t hesitate to reach out to California Cannabis CPAs!