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- As the cannabis industry matures, winners have begun to separate themselves from the pack and position themselves as leaders in their categories.
- VCs are taking notice. They said they’re shifting their investment dollars from early stage firms to growth stage companies that already have a proven track record.
- According to data from PitchBook, VC investment in cannabis startups cratered this year, as the cannabis bubble burst and investors pulled back during the pandemic.
- Many investors told us they’re still open to new exceptional startups, however.
- Business Insider talked to six VCs who say that for a startup to get their attention, the company would need to have solid leadership, an idea that would completely innovate or create a category, and the ability to scale quickly, among other qualities
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The crowded cannabis market has thinned out since its boom in late 2018, and investors are becoming more reluctant to invest their cash.
So far this year, VCs have invested about $512 million in cannabis companies, a sharp decline from the $2.1 billion they put to work during the first nine months of 2019, according to data from PitchBook. And the money has shifted somewhat away from early-stage companies to later-stage businesses.
In the first quarter of 2020, VCs invested $71 million into angel- and seed-stage startups, or 46% of the total. In the second quarter of this year, that amount fell by more than half to $32 million. This quarter, angel and seed-stage firms have raised about $39 million, or 20% of the total funding.
Read more:Here are the top 14 venture-capital firms making deals in the cannabis industry, and where they’re looking to place their next bets
Many investors told us that they’re still open to startups with short track records. But with limited capital in the cannabis space, newer companies are facing the challenge of competing with their seasoned counterparts for a share of the pie.
Business Insider reached out to six VCs to ask them about the investment trends they’ve seen in cannabis over the years, and where they’re seeing capital flowing now. Investors said that companies that have positioned themselves as the winners of the industry are gathering investor dollars, while early stage companies are struggling to gain traction.
For a startup to grab their attention, investors told BI, the company would have to have several qualities that would convince them to go in on an investment that may take years before exits appear on the horizon.
Some listed a solid leadership team or an idea that would completely innovate or create a category. Others talked about the ability to scale quickly and model that would be able to withstand industry downturns.
Altitude Investment Management partner Jon Trauben says it’s going to be hard for startups to get traction.
Altitude Investment Management is currently raising capital for its second fund which is targeted at $150 million.
Partner Jon Trauben says that there are plenty of opportunities to invest in more established companies, so he doesn’t plan to focus on early-stage firms.
“We’ve gone through this huge startup cycle,” he said. “I don’t believe in large measure that the next great cannabis company is being dreamed up in somebody’s garage. I think it exists already.”
This makes it a hard for newer companies entering the field to raise capital, said Trauben.
“It’s not to say that there’s never a new opportunity that looks great and looks really interesting, but I think it’s going to just have to be so profoundly interesting to take mind share away from focusing on the portion of the industry that is working,” he said.
There are sectors within cannabis that have opportunities for growth, Trauben added, like West Coast brands that may grow their footprint in the coming years, biosynthetic production, and advertising.
Patrick Rea, the CEO of CanopyBoulder, says that during pitch meetings he looks to see whether the company “understands acutely what the cannabis industry wants.”
Patrick Rea, the CEO of CanopyBoulder, says that his firm has shifted its focus toward growth stage companies since the start of the coronavirus pandemic. CanopyBoulder has raised around $20 million in total, according to Rea.
CanopyBoulder is constantly searching for more companies to invest in, said Rea, but he added that the pandemic will reduce the number of new startups being former.
“I think we’re going to see fewer startups launched in this time and more startups that are finding success rewarded in this time,” he said.
Among pitches from new companies, Rea said that CanopyBoulder is focused on team, product, traction, and most importantly an acute understanding of “what the cannabis industry wants and needs and what they’ll pay for.”
Morgan Paxhia, managing partner of Poseidon, says startups should prove their focus and ability to innovate or create an entire category
The shift toward investments in later-stage companies over the past year or so has made it challenging for new companies to get a solid footing in the industry, according to Poseidon Asset Management’s managing partner and cofounder Morgan Paxhia. The firm has raised over $100 million to date and currently has around $150 million on hand.
Paxhia said he sees a lot of funds reserving their capital for existing investments where there may be a near term exit, which would help investors have more cash on hand for future deals.
There’s also less innovation now among startups than there was before, he said, especially in the tech space.
But still, startups that have the ability to “innovate in a category or almost create a new category” are of interest to Poseidon, Paxhia said.
Paxhia pointed to one of Poseidon’s portfolio companies, Sublime, a California-based pre-roll company, as an example of a startup that did just that.
The company evolved the consumption experience, flavor profile, and quality of the product, he said, which shifted consumer’s preconceived notions of a pre-roll product from “really low quality joints” to a more enjoyable product.
“The thing that’s really interesting about cannabis is that nothing is set in stone yet,” he said. “These are still extremely early days.”
Salveo Capital managing partner Michael Gruber says he’s focused on his current investments.
With 21 portfolio companies, Chicago-based Salveo Salveo Capital is focusing on its current investments, according to managing partner Michael Gruber. Four of Salveo’s companies have been acquired or gone public.
There’s more risk that comes with investing in a new innovative company, said Gruber, who added that right now, as a whole there’s less appetite for risk in the industry.
“Most things have been tried,” said Gruber. A new company looking to gain investment dollars right now would have to have “proven something out first.”
For a startup to grab his attention, Gruber says that the makeup of the team— their past experiences, knowledge, and understanding of a particular area — are important, as is the potential market size for the idea they’re bringing to the table.
But for a startup to gain investor dollars at this point in time, Gruber said the terms of the deal are critical.
“To get involved in some new startups, I think the deal really has to be good,” he said. “I think there has to be a structure that makes sense that both protects from the downside as well as provides upside.”
“I think that’s what will be required for a lot of investors to get active with sort of newer startup companies in this space right now,” he continued.