The Big VC Con Game
Our large, growing cannabis sector is attracting the attention of many Venture Capital (VC) funds.
This interest will accelerate once interest rates decline and funds look to deploy their ‘dry powder’’ (i.e. investment capital) currently sitting in bank accounts. Moreover, the passing of SAFER and Rescheduling will provide further impetus to jumping into cannabis.
Cannabis leaders, however, should understand how venture capital works before embracing them as funding partners. A VC’s modus operandi is not necessarily a good fit with CapEx hungry, naive cannabis firms. Here’s why:
1. A Potemkin Village
Many self-proclaimed VCs are not true VCs who have kickstarted world-class firms. They might have a pool of capital but lack investment experience, connections and knowledge of the weed industry. Dealing with these tire-kicking , knowledge-starved VCs can be a long, frustrating and ultimately unsuccessful exercise.
2. Long odds
Few companies secure VC funding because (with some exceptions) cannabis fundamentals do not match their deal criteria. Unlike tech or life sciences, there is little patentable IP or sustainable competitive advantage to invest behind. And margins are low compared to other investable sectors. Your business could still be funded but it would have to stand out from the crowd, which is very tough.
Most financings are with founders with previous exits, close connections or are tag along investments with other canna-experienced funders. Cannabis leaders are often not plugged into these networks.
3. Valuation games
VCs need to show big investment returns to their limited partners - and to justify their management fees. To do this, VCs play a valuation game. Their investment secures a boatload of penny (or sub-penny) shares at low valuations. Later funding rounds at higher share prices (i.e. paper valuation increases) display their investing prowess. They then count on a future sale or IPO in a frothy equity market to harvest their cash.
Predictably, the VC’s are incentivized to find an operator (i.e. a sucker) where they can cut themselves a really sweet valuation deal with advantageous liquidity terms. Inevitably, the investee will get hammered on valuation, terms and their cap table, and potentially be hamstrung strategically. If you doubt me, check out the psychedelics industry.
To be fair, not all VCs meet the above description. Nevertheless, leaders need to be mindful of the challenges with this funding channel.
Smart and honest cannabis VCs will seek out what matters today – profit and free cash flow. Get that. Have leverage.
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