In the first five-and-a-half months of 2019, U.S. cannabis companies raised roughly US$1.2-billion in venture capital, more than was raised in all of 2018. That growth, according to a new report from the California accounting firm Macias Gini & O’Connell LLP (MGO) and the cannabis consultancy ELLO, is being driven by maturning companies pursuing ever larger financing rounds.
“For the first few years of the industry’s existence, VC rounds were limited to seed and Series A financings … As successful startups separate themselves from their peers, investors concentrate more capital into those companies to ensure their survival. Several cannabis startups have now crossed the Series C threshold – Eaze, Hound Labs and Canndescent, among others – which has historically symbolized long-term potential,” MGO and ELLO write.
Because the Canadian cannabis conversation revolves around publicly traded cultivators, it’s easy to miss the enormous growth in venture capital financing happening south of the border, and the sheer number of start-ups and ancillary companies that are popping up and securing private investment. Here are a few insights from the MGO and ELLO report, which was informed by data from PitchBook Data, Inc., a private market research firm owned by Morningstar Inc.
Later stage financing surpassing early stage
So far in 2019, more VC money has gone into later-stage financing rounds than into Series A rounds – an industry first.
“Just over $660-million was invested in late-stage rounds through mid-May compared to almost $530-million at the early stage,” according to the report.
“Note also the imbalance between volume and value. The $660-million of late-stage rounds were done through just nine rounds, including $420-million for Pax’s Series C alone. The $530-million at the early stage was spread between 33 financings.”
California, unsurprisingly, is at the centre of VC activity
The amount of VC money pouring into the space in the U.S. jumped from $371-million in 2017 to $955-million in 2018, largely due to the California recreational market coming online.
Sixty-five VC raises happened last year in California, "for a combined $245-million. This year is well on its way to surpassing both numbers, and the $144-million accumulated is already the second-highest figure ever recorded,” the report notes.
“It’s worth noting the sudden upswing in value, which doesn’t solely reflect the number of first financings made. Implicit in that figure is a more mature market, more sophisticated investors and startups and a much larger market in which to participate.”
Little VC activity in Canada
With Canadian pot companies able to raise money in the public markets, and LPs sporting insane valuations, there’s been relatively little VC activity in the country. Last year, Canadian companies raised only $70-million in VC money, compared to the $955-million raised by U.S. firms. The pattern continues this year with Canadian cannabis firms raising $60.5-million in the first five-and-a-half months in 2019, compared to $1.2-billion raised by U.S. companies.
“The U.S. market is currently preferred by investors, despite its legal status. The Canadian startup market will trend higher following its federal legalization in late 2018, but it will still be dwarfed by its neighbor,” the report notes.
That said, the report continues, “while private market investment activity has been dwarfed by U.S. activity in recent years, public Canadian companies still largely dictate the direction of the industry as a whole. Tilray, one of the world’s largest cannabis producers, has recently traded around 300 times revenue. Whether that’s sustainable is one question, but the hype around its prospects is validating assumptions for downstream markets.”
Private Equity buy-out opportunities remain limited
Due to the inherently risky nature of the market, private equity buy-outs remain few and far between, with investors preferring to spread their risk through minority stakes in multiple companies.
“The buyout model relies heavily on predictability, and PE investors have historically been wary to buy companies that face threats from federal authorities. The VC model, by contrast, bakes in certain assumptions around portfolio company failures, and the biggest winners in a fund are often capable of returning the entire fund amount back to its limited partners,” the report notes.
That said, certain segments of the industry could be ripe for traditional roll-up strategies, ELLO’s CEO Evan Eneman notes in the report. These include retail, lab testing and manufacturing.