New Rules for VC – The Role of Venture Capital in Cannabis

While researching and conducting interviews for my book Cannabis Capital, I interviewed over a dozen cannabis investors and found that of the 125 or so investors, there are really only about 30 true venture capital funds investing in Cannabis today. Many investors are family offices or managing private capital, those investors tend to gravitate to larger investments and have financed very expensive build outs of dispensaries and vertically integrated MSOs, have acquired licenses and groups of licenses, and have shown to be comfortable  investing in real estate, agriculture and infrastructure.

Family offices, unlike funds, don’t have perpetual deal cycles. A fund manager will constantly be deploying capital where family offices, although capable of making sizable investments, won’t continue to make investments and instead will want to manage and see the investments they have made perform and produce a return.

Traditional venture capital firms are not investing in cannabis for a variety of reasons, from macro regulatory concerns to fund governance that precludes them from investing today. This leaves only a handful of cannabis venture capital (“CVC”) who manage committed funds and will be investing on a continual basis.

In addition to this dynamic, many of the funds who started out as venture capital funds, are raising larger and larger funds and re-defining themselves as private equity funds. I can imagine that the management fees are very attractive on a larger fund, but there is a reason that VC and PE are separate strategies in mature markets. VC funds invest in pre-revenue, earlier stage companies and will make smaller investments typically for minatory stakes in the companies they back. Private Equity funds focus more on buyouts and control transactions when private companies reach a large enough scale in terms of revenues and profitability. These are two distinct investing disciplines with venture focused more on entrepreneurial leadership and private equity focusing more on synergies, roll ups and financially driven transactions.

This creates a problem for entrepreneurs. Traditional VC wont, or can’t invest and the few established CVC funds are moving to investing in later stage companies. This also creates opportunity. We need to redefine the role of venture capital for the cannabis markets.

The role of traditional venture  capital is to finance innovation and disruption in mature markets. The cannabis economy is still nascent and the entrepreneurs who are building great companies today are largely iterative in adapting legacy business models to the cannabis marketplace.

Let’s take dispensaries for example. A dispensary is a retail business. To be a successful retail entrepreneur you need to identify the right physical locations to operate from, manage the  operations through systems and technology like inventory management, point of sale systems and cash management, they need to market and manage a brand effectively and have a large workforce to hire, train and manage. The innovation in this type of business then is to identify the opportunity through regulations to have cannabis as your core product in a retail location. This is the same approach in that healthcare + retail (pharmacies, walk in clinics, radiology centers), food service + retail (fast food, coffee shops, fine dining) and automotive + retail (dealerships, service centers, auto part stores).

The innovation then is to adapt the core operating principles of starting, running and growing a business that operates in the cannabis market. If we explore this even further, these are not always the types of companies that traditional venture capital would look to invest in.

I predict that within 5 years many of the established venture capital firms will start investing in companies in the sectors they have traditionally invested in, that also then happen to be cannabis companies. For example, a fund that has historically invested in software as a service, will stay in that industry and be open to investing in cannabis companies within that vertical.

What are the new rules of cannabis venture capital? It is critical to the success and expansion of the cannabis economy that we redefine the role of venture capital for cannabis. Just like retail is being redefined, so is CVC being defined. CVC is less about investing in disruption and all about investing in establishing well run companies that are cannabis centric.

I also believe that there won’t always be new cannabis funds setting up shop at the pace of recent years. Once traditional VC starts investing more the cohort of funds that are operating today will likely remain small and likely see further attrition. These funds, of which my firm is one, will be Cannabis first and industry second investors, where traditional VC will stay industry focused and cannabis second investors.

This may not seem as sexy as investing in a doc.com company but we all know how that market came crashing down. We have built our CVC fund to be the only true value added financing partner for entrepreneurs that is focused on investing in iterative and foundational business in cannabis today. We back best-in-class entrepreneurs and this is how we are leading the way to redefine the role of venture capital.

Bonaventure Equity is the only CVC fund that is founded by, and for entrepreneurs. We not only provide capital,  but also access to our platform that includes a dedicated operations and finance team to help build lean companies and support the management teams, access to our deep regulatory and policy relationships, an international and high impact advisory board and ongoing event series and access.