New federal rules allowing small businesses to tap ordinary folks will give upstart marijuana companies a sorely needed alternative to traditional sources of financing such as angel investors and venture capitalists.
The Securities and Exchange Commission’s new rules tied to crowdfunding could create a tidal wave of fresh financing in the cannabis industry.
The rules, which took effect Monday, permit individuals to put $2,000 or more per year – the allowable amount is based on annual income and net worth – into a small company in exchange for a stake in the business.
Companies can now raise up to $1 million annually this way.
Previously, only deep-pocketed “accredited” investors with an income of at least $200,000 per year, or a net worth of at least $1 million, could purchase an equity stake in the lion’s share of private companies.
While the new rules will open up crowdfunding to more companies and more individuals, entrepreneurs must do their homework to use this financing method successfully.
“It’s a giant opportunity with limitations,” said Leslie Bocskor, president of Electrum Partners, a cannabis-focused investment advisory firm in Las Vegas.
Jeanne Sullivan – founder of Sullivan Adventures, a New York investment advisory firm – said that crowdfunding is “not a game for the uninitiated,” adding that companies interested in this financing method need to do some due diligence.
“You have to get professional help if you don’t have experience with something like this,” Sullivan said. “You have to do it right. You can’t just log on and say I’m raising money.”
Crowdfunding sites like Kickstarter and Indiegogo have existed for years, but in general companies and entrepreneurs have only been able to offer individuals a reward (such as one of their products), not equity, for their monetary contributions. Other crowdfunding sites like AngelList are only open to accredited investors.
Some cannabis-related companies successfully utilized crowdfunding before the recent rule change, though they are few and far between.
Eaze Solutions, a San Francisco-based provider of technology that optimizes medical marijuana delivery, raised part of a $1.5 million infusion to fund its expansion via the crowdfunding site AngelList in 2014. And Loto Labs, in Redwood City, California, raised more $218,444 via Indiegogo to fund production of its Evoke vaporizer.
The rules will make it easier for companies to raise money this way, opening up what is – in effect – venture capital financing to ordinary investors.
They also offer a regulatory framework for companies to raise money via crowdfunding, but without loads of red tape. For instance, companies seeking funds for the first time – or those that are looking for less than $500,000 – must provide financial statements, but they can be unaudited.
“Angels are very risk averse to these early-stage companies,” Sullivan of Sullivan Adventures said. “This could give some of these early-stage companies a chance to get to some of that first funding so they have a chance to build their team, to build out.”
Bocskor of Electrum Partners noted that, in general, businesses previously had to rely on “rich relatives or angel or venture networks.” Now they have an alternative.
“In the cannabis industry, that is an incredibly powerful tool at this particular time,” he said.
He added that the industry’s recent explosive growth will probably accelerate even more following this November’s elections, when at least a few more states are expected to adopt legalization ballot measures.
“I believe some portion of the enormous amount of money needed to fund this expansion will come from equity crowdfunding,” Bocskor said.
Not every cannabis company should rush to a crowdfunding platform.
Sullivan points to cannabis cultivators and retailers as examples of businesses that may want to think twice before crowdfunding.
“Grows are the types of businesses that would have better luck seeking money from angel investors who have domain experience,” Sullivan said. “Find people that want what you have. And in a grow or in the more technical aspects, find people that specialize in the area.”
Investors also are seldom drawn to retailers. Besides, retailers are better off funding expansions with their own revenue, Sullivan said.
What companies does she think would make good crowdfunding candidates? Think infused products manufacturers, content companies, and ancillary firms.
“A lot of edibles could make an exciting story. Those are perfect,” Sullivan said.
Infused products are alluring to the average person, and it’s easy to imagine how they can be packaged, distributed and scaled.
However, some crowdfunding platforms have rejected cannabis companies, including well-known sites like Kickstart and Indiegogo.
Luckily for cannabis entrepreneurs, a small number of cannabis-centric crowdfunding platforms have emerged or are trying to emerge, including Cannafundr, Potfundr, WeCanna, and CannaDabbaDo.
Do it Right
If a company does decide to try crowdfunding, it should do so carefully.
Cannnabis companies should hire branding and marketing experts to help them craft their message and create a persuasive pitch, one complete with videos or other visual content.
“You have to tell a story about how you’re going to execute. But there’s a little more entertainment value than what you would have if you were pitching an angel investor,” Sullivan said.
“Crowdfunding is a little more media-centric,” she added. “It’s about creating an interesting video that gets the listener interested in what they’re building, and those kinds of visual connections are really important in crowdfunding.”
The presentation should cover several key points, experts said. These include:
- Highlighting the team’s strength
- Creating sizzle around the product
- Showing how the company plans to scale the business and distribute the product
- And demonstrating that the team understands the company’s financial ins and out
“The team. The product. Can this play into a large marketplace? What are the financial opportunities around the business as it scales? And highlighting one’s competency. That’s what’s critical,” Sullivan said.
It’s also a good idea to review previously successful campaigns.
Moreover, it important to be aware of potential pitfalls, including added scrutiny.
“Cannabis and crowdfunding are two industries that already get a lot of scrutiny by themselves. Put them together, and there’s going to be even more scrutiny,” Tom Quigley, CEO of Gluu, an online B2B marketplace based in Tampa, Florida, said.