Committee Blog: Fundraising Basics in the Cannabis Industry — Part 3

By Deborah Johnson, MCA Accounting Solutions & James Whatmore, MAB Investments
NCIA’s Banking & Financial Services Committee
Part 3 of a 3-part series

In our first two blogs we took you from early concept, legal formation and early efforts through the early angel rounds. You have production in place with some equipment financing, getting you to early-stage revenues. Hopefully a smart angel investor is available to you for questions or direction. In the final part of this blog on funding your business, we will present some formal round structures, how you can best prepare for those finance rounds, and some ways to bring your friends along for the ride.

Everything you have done to date is going to be considered in a Series A round. What you have done and who you have surrounded yourself with will be looked at by potential investors. You have put in the work and built strong social capital. You have a diverse and strong team with expertise in your sector. The next level of investor will want to see how you tie it all together. These factors will be considered in light of your Total Addressable Market (TAM), valuation, use of funds, jurisdiction, and many other metrics. At this level a solid accounting team can produce Canna-GAAP (Generally Accepted Accounting Principles) financials to build a credible financial model. Having this current as you move through funding will give investors some level of comfort. As we have discussed, preparation is particularly important.

Alain Bankier, an active Angel investor, points out, “If you have brought on the right group of Angel investors, they are a prime source of excellent feedback, as you prepare your deck, your financials, and your pitch for the next round. Angel investors have seen 100’s if not 1000’s of company pitches and they can help you craft the most compelling presentation and they are your natural allies, as they have already invested and are motivated for you and the company to succeed!”

Long-term planning will help you define the total amount of funding you will need for certain milestones of development. A series of capital raises has some advantages over a single funding event. Each milestone you pass signals a value add to the company, and each subsequent round will be less dilutive. And the investor may see the project as de-risked, increasing their commitment through the follow-on rounds.

For each round there are several types of funding instruments: SAFE agreements, convertible debt, and preferred equity to name a few. Simple Agreement for Future Equity (SAFE) may be an option early in the funding plan. A SAFE note is a convertible security that allows the investor to buy shares at a future priced round. It has no maturity date and no interest rate. As such they are not debt and therefore do not accrue interest. But it also requires C-Corp status as the note goes on the cap table just like stock options. A convertible note is a common way to kick off a formal funding cycle and is dependent on future rounds as a trigger event. As a note it has a term of maturity and an interest rate; often there will be a cap on conversion value and a discount on valuation below that threshold. Once triggered, both of these may convert into shares of the company (or units of an LLC); what those shares are is described in the offering documents, usually summarized in a term sheet outline. These shares can have any number of rights or preferences attached to them. The fact that these are triggered by further rounds makes them a good part of an overall funding strategy.

The alphabet soup of rounds starts after the convertible note. The first equity A round will essentially sell some of the company to your investor; there will be a price, your valuation, and terms. As long as you are executing on the vision you have communicated to investors, each additional round will reflect your progress with a higher valuation and less attractive rights. The business put forth by you and your PowerPoint pals from the first blog in the series was worth a couple thousand dollars. Now you can apply many metrics on your sales, balance sheet, or milestone for a multimillion-dollar value.

Convertible debt and equity rounds are part of your long-term funding plan; so are new target investors. As you hit milestones and rise in valuation, the company becomes attractive to new investor classes. Certain funds have a minimum milestone they need to see before considering an investment. Pre-revenue, post-revenue, cash flow positive, market share, and total sales all have relevant hurdles for certain groups. Seed and angel investors may participate in a convertible note getting you to revenues, while an investment fund will only lead the A round with those revenues in place. If all is right, they will participate in B and C rounds as well; with larger and more sophisticated investors looking at the milestones you are currently achieving. The investors who value your milestone wins will take notice and start to circle.

As the investment in your company grows, the pool of investors shrinks. Although this may change in the near future, the traditional investment landscape is limited in cannabis; fortunately, there are several new and non-traditional sources of funding. Crowdfunding is a trend that has not escaped cannabis; however, the stigma has limited the platforms those in the industry have access to. Crowdfunding via Reg CF is the use of small amounts of capital from a large number of individuals. It is legal to be part of a cannabis business by investing up to $2,000 in exchange for ownership of a portion of the company. Through this method, a company can raise up to $5 million. Sites such as Fundanna, CannaFundr, Start Engine, Kickstarter, Crunchbase, Mazakali, Useed, Indiegogo, and SeedInvest provide platforms to market opportunities. There are various hurdles encountered here as well. Platforms can have banking issues as well. For example, 420fundme was shut down after their bank decided not to work with them. Also, some require the business to be in a U.S. state where cannabis is legal, or they only promote those businesses that impress them. So be sure to understand the sites’ rules and stay on top of regulations.

The REG A(+) is crowdfunding’s big sibling. This is an investment vehicle that is exempt from registration with the SEC that allows the general public and not just accredited investors to join the round up to $50 million in a 12-month period. GAGE, a Michigan vertical, successfully funded their recent expansion with a Reg-A. If you are talking to investment banking firms, this could be a good late-stage option to secure a large round of capital.

As you prepare to fundraise and have a clear understanding of where your business is in its lifecycle, you can put together the best capital raise for your project. Cannabis is a relatively new industry, and its murky legality means that roadblocks are likely. Be prepared to exercise all of your financing options. When raising funds for equity, all of the investors are looking for a liquidity event. So, whether your company eventually goes public or there is a merger or acquisition, they are not looking to invest in a so-called “lifestyle” company. As legality is resolved, many companies that are now on the sidelines looking in will be looking for opportunities to acquire and appear “established”. This is your window of opportunity to build a great brand, gain traction and be ready for when that happens.

Member Blog: Four Innovative Tips for Funding Your Marijuana Dispensary

by Gary Cohen, CEO of Cova

It can be tricky enough to find funding for a new business in any industry, but marijuana businesses are at that much more of a disadvantage. Strict regulations, less-than-favorable taxation laws, and straight-up illegality of federal funding stack up against those looking for their starting dollar in the industry.

Without having this backing, dispensary owners need to be creative and resourceful and draw upon the support of private investors to fund their dispensary goals.

Financial planning and sourcing of funds should be a large component of the business plan. Demonstrating an understanding of the scope of start-up costs for a dispensary includes:

Licensing/application costs
Working capital requirements
Cost of inventory (e.g. initial flower, edibles, accessories)
Technology costs (e.g. Point-of-sale system, server costs)
Real estate (e.g. mortgage payments or rent)
Staff training and compensation
Marketing and advertising

While budding cannabis entrepreneurs do have a limited number of funding options, there is still hope. You just have to know where to look.

Self-Funding

Many marijuana start-ups have invested a lot of their own savings into their businesses, recognizing their funding limitations. Speed in the industry is essential, but you may need to take a little extra time to raise your own capital before you turn the “Open” sign on.

Friends & Family

Crowdfunding is becoming increasingly popular for a variety of causes, and reaching out to like-minded individuals in the community who support your vision, and are willing to give you a boost in funds, is not at all unheard of. While there may be limitations in the ways you can publicly crowd-fund, you may be able to hold private events to raise money from your friends and family, as well as those in the community.

Partnerships

The “green rush” that marijuana legalization has caused makes finding potential partners, with similar goals and larger bank accounts, easier to find. There are so many facets to success in the industry, and valuable partnerships can take some of the strain off your own venture. After all, two heads are often better than one!

Cannabis-Specific Investment Groups

A great indicator of progress for the legal cannabis industry is the number of cannabis-specific investment groups that have cropped up across the country, giving entrepreneurs a helpful resource. In fact, last year, these groups provided 18% of marijuana funding.

Learn How to Fund Your Marijuana Business:
While the situation for marijuana startup funding may seem grim, more and more investors are beginning to recognize the marijuana industry is thriving with opportunity.

Covasoft has put together a helpful resource to understand the various strategies in the marijuana business. Download our eBook today to learn about willing investors, ready to make a change in the legal marijuana market.

Let’s talk Cannabusiness.
DOWNLOAD: https://www.covasoft.com/how-to-open-a-cannabis-dispensary-ebook

In a career that encompassed a dozen start-ups, Gary Cohen has held leadership roles with Verizon and AT&T, has managed technology-oriented research practices for Nielsen, Milestone Group and ITG/MScience, and led software/internet ventures Shoptok, Birdstep and Handmade Mobile. He has also been on the boards of several tech start-ups, including Onavo (acquired by Facebook), OpenSignal, Cenoplex and Adello. Gary has a Bachelor of Science in Finance and a Master of Science in Marketing.

Cova enhances the cannabis retail experience for both consumers and dispensaries through an integrated solutions platform (POS, ERP, CRM, eCommerce, Digital Signage and Dropship). Over 19,000 retailers with complex retail environments currently run Cova’s solutions in North America. Cova’s solution built for the legal marijuana industry focuses on compliance, UI, UX, reporting and a much better dispensary experience. Cova is headquartered in Denver, CO.