How to win over investors

Columns - Money Talks

Are you seeking funding to launch or expand your cannabis business? When you approach investors for capital, it is important to understand the basic and some not-so-basic best practices that can help increase your chances of success.

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November 18, 2015

Here are the most important dos and don’ts for raising capital in the legal cannabis industry. As with most aspects of this market, these guidelines are not black and white, and, as you’ll see, some may fall into a bit of a gray zone (especially with variations in state regulations). However, following the lessons detailed here should help you attract investors who are aligned with you on your project vision and desired outcome. After all, as you’ll also learn from this column, finding the right investor isn’t just about finding the one with the deepest pockets.

It’s also important to be aware that investing in facilities that “cross the green line” (those that deal directly with cannabis) involves different considerations than investing in ancillary companies (those that don’t “touch” cannabis directly). Added risks and more legal nuances exist, so investors who are interested in this area will be looking especially closely to be sure they are working with the right teams.

But before even considering the following dos and don’ts, the No. 1 thing of which you should be aware is that it is essential to work with qualified legal professionals to ensure that everything about your business or proposed business is in good standing. So many regulations dictate the ins and outs of raising capital in this industry that having the right legal minds lending a hand is an absolute necessity.

Do

Do: Be the smartest guy (or girl) in the room.

Know the political and legal landscape of your state, county and municipality. Take the time to understand the nuances that exist and work with local groups to get a sense of the industry’s next phases. For example, make sure you learn the legal guidelines around indoor vs. outdoor cultivation, vertical integration, etc. How will the product then be distributed to dispensaries or patients? What is legal there?

Know the tax regulations and how this can impact margins. In Washington, many producers’ businesses (on the adult use/recreational side) were significantly impacted by high taxes. The tax regulations have changed, making it more lucrative, but they certainly made for a rocky start.

Investors feel more secure investing when they know that their founders are taking the steps to understand these guidelines.

Do: Consider the zoning guidelines carefully.

It can be difficult to find locations/properties that are zoned appropriately to support cultivation facilities. Some investors may not know this, but others will, and they will want to know that you have taken the steps to select the right location. Zoning experts can help with this, depending on the location. Investors also will like to see that a group has partnered with a solid legal team with experience in this area.

Do: Consider margin and price compression.

Investors want to be sure that a business will remain healthy as the industry grows. They often review margins with heavy scrutiny and consider price compression, as this can quickly take a business from profitable to unprofitable. Obviously, healthy margins are better. Taking steps to protect and preserve those margins, and making those steps part of the plan you present, is appealing to investors.

Do: Consider energy efficiency.

Key to the bottom line and sustainability, energy efficiency is becoming increasingly important to investors. The early days of adult-use legalization showed a rush to market, and many producers/cultivators did not properly outfit their facilities to handle future price compressions. High energy costs make expenditures all the more difficult to manage when trying to maintain profit margins. Investors will look for investments in energy efficiency and sustainability as a smart and forward-looking practice.

Exploring energy credits and the benefits of having more efficient equipment and facilities also will show a strategic team. Investors will likely appreciate this level of detail and will likely see the built in cost savings as beneficial to the bottom line in the future. (See the feature article “20 Ways to Reduce Energy Consumption and Costs” on page 70.)

Do: Showcase the team on the project.

What’s your unfair advantage? Who are the key team members lined up to make this cultivation project a success? Investors care about these credentials and will want to know in whom they are investing—especially because this is critical when the project inevitably hits a roadblock. When companies face difficulties, any issues or weaknesses with the team will be revealed. They say a rising tide lifts all ships, but as the tides begin to change, only the best teams will survive and may even thrive.

Consultants can be helpful to your business and enticing to investors, but only if they have a proven track record in the ability to get licenses and to build out successful cultivation sites. Also, investors would want to know that the expense for a consultant makes sense for the project's scope. They do not want to see a site start off with an unnecessary financial burden.

Investors like to know why a team is getting into this and what they hope to gain. It is a good way to gauge alignment and how well the investors will work together with other investors and with the core company team.

Do: Know the guidelines around raising capital for your state.

Can this be an equity or a debt investment? This is key and will dictate which investors are more likely to be interested. (An equity investment gives an investor an ownership stake in the company and, at times, a share of profits. A debt investment is essentially a loan with a high return on the investment.)

Some investors are not interested in debt. However, debt may be the only potential investment structure for cultivators in some states where an investor must be a resident to make an equity investment. (And your search for investors can become quite limited if you must find one in-state.) Other states force cultivators to be non-profit collectives, which cannot take equity investments; this situation may therefor require a debt investment.

However, there are ways to work with different capital-raise structures. It might be worthwhile to ask investors what types of investments they’ve done in the past to gain some additional ideas. Most importantly, as with any business endeavor, seek legal guidance in this area.

Do: Outline for the investor how they will get their money back, plus returns.

How and when will the investor see a return on investment (ROI)? It is key to outline this information and show the timeline for anticipated returns. This will vary depending on the investment structure (debt or equity) and the stage of the operation (early or capital expansion, etc.).

It also is key to show the investor what the end goal is, and when it is expected, as some investors are looking to get their capital back, plus returns, on a certain time horizon. (Setting expectations and communicating frequently is key to having a good relationship with investors.)

Sharing any experiences you have had of successfully exiting projects and returning capital plus returns is a great approach as well. Having references readily available will help investors feel more comfortable with you and your business as a prospective investment.

Don't

Don’t: Assume anything with politics or legal guidelines.

Assumptions are difficult to make in this industry—and just because something worked in one state, does not mean it will work in another. For example, in Colorado, cultivators can grow cannabis and then sell it to processors to make extractions; processors can then sell to other companies for use in edibles or oils, etc. In San Jose County, Calif., however, the entire production chain must be vertically integrated, from start to finish (which will, again, likely change with new regulations).

Investors like to know that founders have taken the time to research and understand the legalities/politics in their key areas; without this, their confidence in the project will quickly erode.

Don’t: Skip steps or take shortcuts with property selection.

As investors do their due diligence, they will likely discover if a location is inappropriate or not ideal for cultivation. They will likely want to see some support for the work that has been done to determine why the site you have chosen is an ideal site for cultivation. Being unprepared to show the efforts around site selection can waste everyone’s time. Also, this type of shortcut may prevent these investors from considering future opportunities with your team if they have lost trust.

Don’t: Lose sight of existing/ potential competition.

What competitors do you have? Outlining the existing and potential competition is key. Investors know (or believe) that competitors are out there. The more they can see that a team has explored and evaluated the competition in the existing playing field, the more they will trust that the project has been properly considered.

Who will be coming into the game once it is federally legal? What other markets may enter or impact the playing field? What does this mean for your cultivation business? It is key to consider and share with investors what the competitive landscape might look like in the future. Investors are most likely considering this as a part of their evaluation process, and they will be concerned if the founders or the team are not paying careful attention to competition in the market.

Don’t: Forget to include details about use of proceeds.

Some founders fail to include the way the funds will be used when putting together a capital raise. Investors will want to understand how the capital will be put to work. Take the time to outline financials and the use of proceeds, so that the investors can see that the “ask” (or amount of money requested) makes sense.

Don’t: Forget to do background checks on your own team.

Investors will likely do credit and criminal background checks on everyone involved in a project. Many people in the cannabis industry may have arrests on their records. This is very common among some of the most well-known leaders in the space.

However, it is better to share this candidly with investors when they get closer to finalizing the deal, as opposed to letting the investors discover this on their own and questioning if it was being hidden from them.

Since a team is operating in this area of state-legalized, but not federally legal territory, it is just good to know what they’ve experienced and what history they might bring to the table. Better to be prepared.

Don’t: Waste time seeking investors who are not interested.

Short and bittersweet, some investors just do not aspire to invest across the “green line.” They are likely to be a tough sell. Raising capital is difficult and time- consuming, so it is better to focus efforts on investors who are looking to or already participate in this area.

Don’t: Inflate numbers or projections.

If you overstate your current financial status or expectations, it will sound an alarm for savvy investors and will create an air of concern around the project. Also, over-promising and under-delivering is a critical mistake—this will cause the relationship with investors to be a frustrating experience. Trying to explain missed results and earnings is distracting and can set a negative tone for the whole project.

As my business partner says, UPOD is key! Under Promise and Over Deliver! It is better to “stress test” financial models by running various numbers (from very strong to very weak sales, or very affordable to very costly inputs) and to know worst-case scenarios going into the capital raise than to focus on only the potential positives. This is a good exercise in business preparedness and will be useful in tough moments down the line anyway.

Following these dos and don’ts will hopefully help you align the best investors and teams. As I said, the guidelines are not hard and fast, and are not all-inclusive (there are pitch decks and many more considerations), but they can be great steps to help you prepare to raise capital and to run a business more effectively.

About the Author: Emily Paxhia is founding partner and director of relations for Poseidon Asset Management. Paxhia spends her time analyzing cannabis companies and building relationships with entrepreneurs and investors. With 10-plus years’ experience working as a brand consultant and researcher, her work spans multiple categories and industries. Her clients have included McKinsey, Time Warner, Viacom, HBO, Participant Media, Comcast, the Independent Film Channel and American Express.