Although cannabis is branching out into food and beverage at an unparalleled pace, there are challenges that come with being first movers in this regulatory risky space.
Startup companies have been flooding the cannabis market since the signing of the 2018 Farm Bill legalized hemp and CBD. But the substance is still technically prohibited in food and beverage by federal law. Last year, CBD was approved by the FDA to be in epilepsy drug Epidiolex. Once a substance can be sold as part of a prescription drug, federal law states it can't be sold in food.
Even though the U.S. Food and Drug Administration held its first public hearing on cannabis this summer — and former FDA Commissioner Scott Gottlieb is pushing for regulatory clarity — it could still be years before a legal path to market is established.
That gray area in regulation has led to hesitation from investors, causing some brands to struggle with fundraising.
Cannabis companies have to be careful how they are advertising, transporting and manufacturing products, while convincing cautious investors to put money into their businesses. But as more brands enter the space, cannabis company executives say those hurdles have gotten easier to clear.
"I would probably categorize it as a high risk, high reward situation."
Leader of food and beverage practice, Anchin
Venture capitalists have substantially increased their cannabis investments in the last two years. In 2018, a record $1.5 billion of VC investment in the U.S. went toward cannabis startups. This year has already surpassed that mark by half a billion dollars, with $2.1 billion raised as of November, according to Pitchbook data sent to Food Dive.
Greg Wank, leader of Anchin's food and beverage industry practice, told Food Dive the situation today is "different shades of gray." The FDA hasn't legalized the substance in food, but also isn't taking products off the market. Wank said that has created an "area of risk tolerance" that companies and investors evaluate.
"I would probably categorize [cannabis] as a high risk, high reward situation," Wank said. "The issue for investors is they have a lot of different places they can place their bets."
As brands navigate the ins and outs of this tricky segment, companies and investors say they are finding their way through how to bring in money in this murky regulatory environment.
Getting investors to buy in
The signing of the Farm Bill kickstarted a trend. Now, smaller food and beverage companies are racing to put CBD products on the market. From coffee and cocktails to jelly beans and snacks, a Rabobank report found CBD has been entering food and beverage products at an "astounding pace." But raising money to fund these brands hasn’t been a breeze.
Matt Oscamou, co-founder of CBD-infused food and beverage company Weller, told Food Dive there are "plenty of challenges" around raising money for products with cannabis — and they are likely to continue for quite some time. He said it is important to be upfront with investors about the challenges cannabis brands face.
"I think it is about cultivating the right relationships and finding the right partners that are interested in it — that's the key," Oscamou said.
Earlier this year, Weller raised $3 million in a funding round led by Brand Foundry Ventures. Oscamou said the funding helped the company ramp up its production and marketing efforts, increase the sales team, and grow the brand.
Even though more investments are being made now, there is still hesitation. Currently, Oscamou said it can be different talking to angel investors — who are typically wealthy individuals — compared to syndicate investors — generally VC funds with stricter regulations on what they can do.
Money and credit could be easier to raise in the future if legislation protecting financial institutions providing services to cannabis-related businesses is passed. In September, the House of Representatives passed the Secure and Fair Enforcement (SAFE) Banking Act, but it still needs to be passed by the Senate. The Senate received the legislation in September and referred it to the Committee on Banking, Housing, and Urban Affairs.
Steve Hawkins, executive director at the Marijuana Policy Project, applauded the bill in a statement after the House vote. He said the cannabis industry can no longer proceed without the same access to financial services that other legal companies are granted.
"This decision is an indication that Congress is more willing than ever to support and take action on sensible cannabis policies," Hawkins said. "The passage of the SAFE Banking Act improves the likelihood that other cannabis legislation will advance at the federal level."
William Bogot, a partner at Fox Rothschild, told Food Dive that there will still be challenges to raise money for CBD companies selling food and beverage products since it still remains federally illegal.
Many companies and investors are waiting for the FDA to determine if cannabis is going to be allowed to be sold and under what structures. Until then, he said it is best to consult with attorneys who specialize in the FDA to give advice, which can reassure both companies and investors.
"Most business people don't like onerous regulations, but we don't like to take chances," Bogot said. "The bona fide players, in the long run and the big money, they don't like working in the gray area. They want some certainty and confidence. I think there will be more money with regulation. It will be the bigger money, maybe some of the larger banks, equity funds that have been sitting on the sidelines."
For cannabis-related business founders who already established companies in other segments, raising money is less of a struggle. David Holmes, who started SpikedSeltzer and sold it to AB InBev in 2016, is now CEO of PLNT Blend Beverages, which makes hemp-infused drinks. His track record paid off, literally.
"I had enough folks who trusted me from [SpikedSeltzer]," he said.
But Holmes said it was somewhat challenging getting investors who bought in to the company's mission instead of "just the rent-seeking, make-a-ton-of-money-right-now" type who just want to make money quickly and get out. He said he wants funders to help grow the brand, the idea of hemp-infused products and the consumer base.
"We are cultivating a consumer who is interested, so I want to serve them and make it possible for them to buy the product," Holmes said.
Risks and rewards
Despite the challenges and risks in making a big bet on this space, there can be big potential financial rewards to investing money and R&D in this growing category early on.
"I think there is going to continue to be very, very strong interest because the potential in most people's minds is that this could be a huge category," Wank said. "And I think there's a lot of hope that sooner or later it will be more clearly accepted, and therefore become an incredible opportunity."
The global cannabis market stands at $150 billion today and legal sales are expected to grow to represent 77% of the total global market by 2025, according to a recent Euromonitor white paper.
"Right now you have an opportunity to really create the brands of tomorrow. And then in the right legal environment, you're able to monetize it for your investors."
Interim CEO, BR Brands
Sat Joshi, interim CEO of BR Brands, a CPG platform that partners with and invests in brands in the cannabis sector, told Food Dive it's a very attractive industry from a growth rate standpoint. However, there is a lack of available funding.
"Most traditional financial providers — whether it's banks, credit unions, insurance companies, money managers — due to the federal illegality, they just don't have an appetite to actually provide capital to the space," he said. "So you've got a lot of demand for that capital because of all the growth, but the supply to capital is very, very limited because all the traditional providers to capital are absent from the industry. Like with anything else, if you've got a lot of demand for something but not enough supply, fundamentally, the price of that good is going to go up. ...It just means that the returns you can generate on investing capital in this industry are tremendously high relative to most other industries out there."
BR Brands has partnered with and invested in several companies, including Défoncé, a manufacturer of high-end cannabis-infused confectionery products, and Rebel Coast, a manufacturer of alcohol-free beverages infused with THC. The platform is funded by Rose Capital, an investment firm focused on the cannabis industry, in which Joshi is also a senior investment partner.
Joshi said there really aren't any national brands, particularly in the edible cannabis space, so there is opportunity for smaller brands to really grow. There is also opportunity to deploy capital into an industry in which many are unwilling to invest in.
"Right now, you have an opportunity to really create the brands of tomorrow," Joshi said. "And then in the right legal environment, you're able to monetize it for your investors."
Joshi said BR Brands is able to mitigate risk by following state regulations. In California, for example, all products have to go through a rigorous lab testing process, he said. For investors, companies performing lab testing and following regulations carefully can mitigate risk.
Many investors are seeking legal advice to help decide whether to back cannabis brands in this regulatory climate. And lawyers are getting familiar with the ins and outs of the cannabis industry, helping to ease minds, stop bad business plans and transform investor dollars into profits.
Kendall Almerico, a securities attorney for cannabis grower Goldenseed, told Food Dive "everyone should do their homework" before getting into this business as investors and businesses. The first thing to do is get all the documentation available about the company and its practices, read the business plan and talk to an attorney who knows the industry and its risks. He also said to make sure company is legally operating in the state it is in.
Almerico said investors should be wary of risks and understand the laws, but cannabis companies are operating now without fear of being shut down because there are more laws that allow them to operate.
"While there may be some technical argument that owning a stock in a company that sells cannabis might be federally illegal, I kind of look at it like, if I am driving 5 miles an hour past the speed limit, I'm technically breaking the law, but the reality is no policeman is going to pull me over and give me a ticket because everyone's doing it," he said.
He said people who own cannabis companies face bigger legal risks than investors, but under the law every investor is supposed to be treated the same.
"The reality is that it would be one of the silliest things ever done by the federal government to come in and start arresting investors. Who are they going to go after first? The company. Investors are so far down the line. While there is risk, the risk is extremely minimal, in my opinion," Almerico said.
But some think the risks outweigh potential rewards for investors.
"Reminiscent of the recent bubble in cryptocurrencies, retail investors are piling into pot stocks as the fear [of] missing out in the marijuana gold rush reaches a crescendo," Robert Johnson, a professor of finance at Heider College of Business at Creighton University, told Food Dive. "Unfortunately, individuals committing funds to these securities are sold on the cannabis story and are ignoring investment fundamentals."
Johnson said investors and companies should recognize cannabis is a commodity like anything else. As the substance is legalized and mainstreamed, more growers will plant it. As more cannabis is supplied, its price will fall, he said.
"Who knows which company will ultimately prevail in the cannabis sweepstakes? But, even if cannabis is here to stay, there is no guarantee that it will ever be a profitable business. My advice is to stay away," Johnson said.