The industry seems flush with revenues and cash, but there are challenges to navigate!
Just as attitudes to cannabis are evolving, so too is its legal framework. Cannabis, hemp, and their cannabinoids are quickly being decriminalized and even legalized. This quickly changing landscape does create business opportunities in this emerging market, but it still isn’t for the naïve or faint of heart.
One might think that the potentially lucrative benefits from the cannabis markets would cause a mad dash to set up shop or invest in start-ups. However, the reality is that most traditional financial avenues are closed to any cannabis-based industry and many bigger lenders are much more cautious than one might have guessed. This means that for those looking to start a business in this industry, entrepreneurs will need to source funding from family, friends, or going to smaller banks that charge much higher fees.
It seemed for a long while that the grass would be greener on the other side of legalization, but the reality is much different. So what are the roadblocks to cannabis financing, and how should you go about securing funding for your start-up?
Here's what you need to know about this complicated topic.
Roadblocks To Financing
In recent years, it seemed like everyone was looking to seize cannabis opportunities. Even John Boehner — a Republican Party grandee and former Speaker who was opposed to marijuana legalization — has gotten in on the act, sitting on the board of a publicly-traded cannabis company. The industry also seems so lucrative, with just the global CBD oil market growing to $3B by 2026 and the whole cannabis market reaching almost $100B by 2026. However, opportunities to grow your ‘budding’ start-up are much tighter than the news and the size of the market would suggest.
While an emerging market with CAGRs north of 9% would seem to be of great interest to big lenders, there are just too many fears and risks involved. For one, the federal government has legalized hemp but not cannabis, which leaves interstate financial institutions on the sidelines.
Second is that there is a patchwork of state laws and financial regulations around cannabis, cannabinoids, and even medical marijuana. Big lenders could be in big trouble if they run afoul of a state's rules, violate federal laws, and even figure out how to integrate international markets. Each state has different rules for using, growing, and distributing cannabis.
Third is that since the financial interactions in the cannabis industry are done mainly through cash, wire transfers, and one-to-one interactions, there aren’t ways to rate the credit worthiness or reliability. Few of the companies are public, so there is a lack of transparency among companies, and there really aren’t clear and consistent metrics to gauge a company’s potential since the industry and its operations and financials are so unique.
How To Get Funding For Your Cannabis Start-Up
While questions over the different rules in each state may deter big lenders, the growth that the cannabis industry expects to achieve in the coming years is exciting.
Venture capitalists (VCs), for instance, believe the industry is expected to grow to $40 billion by 2021 — a 150% increase from 2017, and they are keen to get stuck in. This offers plenty of reasons to invest. However, you'll need to ask the right people.
Here's where you can get funding for your cannabis start-up:
Friends, Partners, Family And Your Own Money
As I shared in an article in the Tampa Bay Wire, the first place for early-stage money is the 2Fs: family and friends. A VC or angel investor is unlikely to give you funding if you have little more than a plan or an idea to show them, in addition to the challenges mentioned above. In addition, there may be a great deal of misinformation, or even stigma, around the cannabis industry, so this may pose an additional challenge to accessing the 2Fs.
For this first round, you are building on your personal trust with family and friends to get meetings and, hopefully, secure start-up funds— known as the seed round — to test your market and build an MVP. It is important that these arrangements are well conceived to avoid personal versus professional conflicts.
Of course, investing your own money and that of your business partners is also a way to get funding. A combination of entrepreneur, family, and friend money, when possible, is a great way to not just raise capital but also show future investors and partners that there was early belief in the business. The key here will be to retain as much equity as possible!
More Traditional Entrepreneur Streams
Angel investors are an increasingly viable option for those who don't have access to cash around them and are too early for VCs. These seed investors have shown greater knowledge of, and interest in, cannabis-based companies. The main question about working with an angel investor is whether they are a one-time injection of capital or a more long-term commitment to support the business in the difficult early stages. In exchange, angel investors will expect a large return on their investment by asking for an appropriate amount of company equity. They tend to put in a lot of money to sure up the business and give it a chance to succeed. While such investors expect a stake, and even voice, in your firm, many won’t call in debts if your start-up doesn't succeed quickly. This can make them a very attractive option for would-be start-ups.
Other potential streams include specific cannabis funds, such as hedge funds. These investment groups tend to take on certain types of risks within a niche, and more have begun learning the ins and outs of the cannabis industry.
Venture Capitalists
VCs are private equity investors that, unlike angle investors, are rarely investing their own money. Rather, they are responsible for investing a pool of money provided by individuals and companies. VCs tend to invest large amounts of capital in companies, expect larger amounts of equity, but also provide support to help companies flourish.
Since VCs tend to put in so much capital and engage with their companies over time, they need to have a deep understanding of the industry and ways to gauge the health of a company. In the last year, VCs have proven to be more and more willing to provide financing to cannabis start-ups. While they see the risks of such investments, the overall belief is that the market is large enough for multiple players to be viable and worth the challenge.
Your second round (Series A), when you are raising further capital to scale your company up after gaining solid market data that shows an increasing willingness to purchase your product/service, may be a good time to meet VCs for funding. If the product or service you have developed has a market advantage and demonstrates strong growth potential, VCs may well be keen to provide financing.
At this point, it is important to see why developing in the initial stages with your own, or own network’s money. It provides the business time to develop a strong beta or pilot and generate clients and market understanding. These are exactly what will be needed to demonstrate to future investors the company is worth investing in or outright buying.
Final Thoughts
Founding a cannabis start-up is fraught with difficulty. It is a growing industry with unique legal and regulatory challenges and even a degree of social stigma.
Struggling to source funding from traditional streams can be disheartening, but there are many viable streams for funding available. The interest is there. It is up to entrepreneurs to find the need in the market and sell the start-up as the next best thing in cannabis.
Author: Jasdeep Singh
Head of Operations and Marketing
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