Cannabis industry maturation is outpacing the work of state and federal legislators in the U.S. This is an exciting trend to watch—but this also means that, while cannabis businesses are growing at a rapid clip and major waves of consolidation are taking place across the industry, access to traditional banking resources and capital opportunities remains scarce.
Family offices have emerged as a significant funding source for well-heeled cannabis businesses with a proven track record of success in multiple markets.
Here, Scot Crow, attorney at Dickinson Wright, outlines the fundamentals of family office investment in the cannabis industry.
Cannabis Business Times: Could you briefly explain what a family office is?
Scot Crow: By definition, it's usually an investment company that's been formed—or at least it's primarily anchored—by a single family from their wealth or from some sort of liquidation event that they realized to the sale of a prior business or the aggregation of profits from other business lines that they then put into a family holding company. Those dollars have then been diverted into whatever the industry sectors are that they're looking for: Some go after health care, some [are] real estate-oriented. It really just depends on what the individual family is focusing on.
CBT: Is there a trend across a cross-section of family offices of getting into the cannabis space, especially now that, little by little, markets are becoming regulated and slowly but surely legalized?
SC: For sure. At cannabis conferences, you see more and more representatives of family offices. The reason for that is—you take your typical private equity fund, and that fund has certain guardrails on it with respect to the types of investments that principals can make. There's typically a catch-all clause that they can't make any investment that will be in something that's considered illegal under the state or federal law, which prohibits most private equity—at least the fund itself—from making investments into the space.
That same type of guardrail does not exist with family offices. The families put the money in, and they’re free to do what they want with it; they often have just as sophisticated executives and others that are working with the family office [who] oftentimes come from the private equity space. [Those executives are doing a] continuation of kind of the same role—they just have a single client that they're working for, as opposed to a group of investors that they're trying to get a return.
CBT: Right, I was going to ask how the executive teams are built around these offices.
SC: Typically, these are not newcomers where the family decides they just want to start investing dollars. It’s more … where the family has had a liquidity event, and it's built around the executive team that helped build the family wealth the first time—and then they may layer in investment bankers and other representatives of the office that are really out looking for opportunities to invest. With cannabis, as more and more states have legalized it, what I've seen at conferences I’ve attended is that the flavor of the conferences across United States has changed.
So, five years ago, when we first walked into the space, you would go to B2B conferences, and while they were sophisticated [and] there was a lot of information sharing, it was a very casual atmosphere. Today, conferences—most of the ones that I attend—everyone is now [wearing] dark suits and ties, which tells me, just by looking at the nature of the crowd, that interest is gaining every day with respect to family offices.
CBT: In terms of the shape that those investments take, are they direct investments into individual cannabis growers and producers?
SC: If you’re tracking some of the stuff that’s going on with some of the more well-known names in the space—GTI, MedMen—they are attracting large investments from billionaires that are making huge investments into the companies now that they’ve gone public.
I think there's a misconception in the marketplace that if a company is publicly traded, all the legal risks simply disappear. But that's not true. Take GTI for example, or MedMen as an example. These are companies with U.S. operations that are touching plants. Even though they're being traded on the Canadian exchange, that does not change the illegal nature of what they're doing.
So, if I were to make a direct investment while the company was privately held, I'm at no worse risk—or in a better risk position—than if I'm investing in a publicly traded company. I’m still investing money in what could be considered by the federal government a civil conspiracy, RICO-type claim. So, I'm investing in a criminal enterprise; it's just now publicly traded on the Canadian exchange.
To answer your question, most of those investments don't come directly into the actual [licensed entity]. If you’ve invested x amount of dollars directly into that entity, you have to be designated on the license in most states, and designation on the license can cause a lot of indirect consequences—all the way from banking to impacting your existing business relationships to issues at the border. And as a result, what you see across the country are models that are very similar to the Corporate Practice of Medicine models, where there is an investment vehicle that the dollars are raised into.
In most cases, the investors aren't investing directly into the license; it's held by two or three founders of the company, and there are tons of restrictions and other anchors back and forth to make sure that they don't run off with the license. But they don't make a direct investment, particularly with businesses that are touching product. The rules are a little a lot more relaxed, with respect to tech companies; companies that are providing lighting, fertilizer; those types of companies don't have to have specific licenses, and investors are free to make their investments directly into those companies.
CBT: From a business perspective, in terms of attracting these investments, are these just those major companies that we’re talking about? A GTI or a MedMen? And are they typically receiving interest and investments from multiple family offices, or is this often a one-on-one relationship?
SC: I think if you would have answered that question five years ago, it would be an anomaly where you would be fortunate to be able to get a family office to make an investment. They'd have to have been a forward-thinking family office that was directly interested in the industry. But today, because of the returns the market is seeing, there are more family offices that are probably pursuing these opportunities. The problem is just there's a huge learning curve in this industry as to what is a legitimate investment.
There are a lot of growers across the country that don't have the ability to scale [and] may think they do, so it's fraught with failure if you don't know what you're doing. I think the family offices are taking it slow and trying to educate themselves on what a good cultivation center looks like or good dispensary or whatever the investment is. There's just not been a lot of knowledge, industry-wide. I think as that curve gets flatter and flatter, you'll start to see more and more family offices enter into this industry. And if the laws change with respect to the bills that are in front of Congress right now, [like]the STATES Act—if that passes, that really eliminates all 280E and all the banking issues, and that, in my opinion, will open this industry up.
CBT: For smaller or mid-sized cannabis businesses, maybe with a single license in the medical marijuana market, let’s say, is there space for them to go out and attract this sort of investment interest?
SC: There is a space. Most of that money’s being raised through Reg D offerings. Quite honestly, that's how MedMen and GTI and others started. They had to raise money somewhere; there was no banking solution, there was no wealthy backer—so you go out and syndicate and raise money and launch your operation that way. As you start to scale, you start to attract bigger investors that are looking to take down larger pieces of the company.
CBT: What does that attraction process look like? Is there a way for businesses to actively showcase themselves?
SC: I have a lot clients that face this issue, which is: They put in an application and they believe they have a successful application—and these are even in states where there is no cap on the number of participants—and yet they don't have a flagship cultivation site or dispensary. What they have is a concept and an idea. And just like any business, it's very difficult to raise funds in that environment. What you see is if they can overcome that hurdle and get their first operations up and running, it becomes easier to raise funds because you now have a track record that you can look to. You have financials that you can look to. And there's something that investors can come in and see and touch. If you look to expand into the next state, it becomes easier to do because you can use your flagship as a place to show people: ‘This is what we produce. This is the result that we’re seeing. Here’s the next opportunity in this marketplace.’
CBT: Once this relationship begins, what’s an example of a challenge that a cannabis business should consider?
SC: This issue with family offices is like any large investor: If they're writing a large check, you can expect that there's going to be more negotiation about what their rights are going to be going forward into the investment vehicle. Their controls and guardrails that they’re going to put over the business may not be something that, ultimately, as a small cannabis company you want to take on. You may wait to push that down the road to a later time.
If you're raising money on a syndication basis, you control what the rules are. Somebody investing $50,000 to $250,000, or even up to $1 million, on a $15-million raise really isn't going to get any special rights with respect to any sort of control in the business. It’s a passive investment. Family offices tend to like to write larger checks, and oftentimes those checks come with guardrails around what the business can do going into the future, because they want to protect the size of the investment.
And quite honestly, while a lot of the candidate businesses you’re starting to see today are starting to become more sophisticated in general, these were mom-and-pop businesses that began particularly on the West Coast. I think the Midwest is developing differently because it's coming more from an investment standpoint—it's attracting more sophisticated people to the industry than it did when it first started.
I think that's the thing that's interesting: You see a lot of executives of some pretty powerful companies that are now leaving their positions to pursue positions in the cannabis space. Again, that brings legitimacy to this industry and opens up the floodgates for more and more family offices and investors to say, ‘OK, it's time to take a serious look at this industry.’
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