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Rising Legality Aside, The Budding Cannabis Industry Isn’t Drawing As Much VC Interest As You’d Expect

January 1, 2018 went down as a watershed day in the cannabis industry as recreational adult-use was legalized in California.

With recreational cannabis use being legalized in eight states, those who have bought cannabis illegally in the past and those left out because of illegality may be brought into the fold of a nascent (legal) industry.

And according to The Economist, California has the largest market for recreational cannabis and a study by the Agricultural Issues Center at UC Davis predicts that “sales from recreational cannabis will eventually reach [$5 billion] a year.”

However, legalization doesn’t just mean flowers and happiness for cannabis businesses. As industry players prepared for recreational legalization in their largest market, they also anticipated political and regulatory challenges. With that in mind, let’s take a look at how the fourth quarter shaped up for the cannabis industry in terms of startup activity right before weed went legal.

Inside The Numbers

Over the past six years the U.S. cannabis startups funding amounts have been tumultuous.

Cannabis startups saw their venture capital totals jump from 2013 to 2014, when dollars raised by companies in the space shot from $9.7 million to $186.7 million.

During the same period of time, recreational cannabis use was legalized in Colorado and Washington state. Unsurprisingly, a full 25 percent of those funding rounds in 2014 were directed toward companies based in Colorado.

The California law legalizing use of recreational cannabis, though enacted on January 1, 2018, was voted into law in late 2016, and could account for the notable increase from the nearly $142 million raised in 2016 to the $225.3 million raised in 2017.

The quarterly numbers for 2017 are less conclusive. We see an increase from the first to the second quarter in both number of known funding rounds, from seven to 22, and known dollars directed into the space, from almost $10 million to about $73 million. The second and third quarters saw similar results in dollar amounts raised, with an increase in number of known funding rounds from 13 to 22. The fourth quarter saw a slight decrease from nearly $75 million in quarter three to about $68 million, as well as a slight decrease in known funding rounds from 22 to 19.

(Of course, it’s important to note that deal counts and dollars amounts may be underreported due to the myriad of legal concerns surrounding the distribution of cannabis and cannabis products.)

With new businesses and room for growth, funding rounds in 2017 consisted of mostly early-stage (Series A and B) and seed-stage ventures. Quarter four, specifically, consisted of 30.8 percent early-stage and 23.1 percent seed-stage ventures.

A Closer Look At Q4 2017

One company that dove head first into the cannabis industry is Colorado-based MJardin. The company raised $20 million in equity financing in late December. MJardin is an operational management company which provides cannabis businesses with assistance in areas ranging from cultivation processes to plant cultivation software and growing materials. It also has its own subsidiary investment arm, MJardin Capital.

Another notable investment round in Q4 was a Series A for Denver-based Baker Technologies. The round raised nearly $8 million in funding and was led by cannabis industry-focused firm Poseidon Asset Management. Baker provides a point-of-sale platform designed to help dispensaries connect with customers and manage internal business processes. Customers can set preferences, sign up for email and text alerts, and order through its online portal.

According to Forbes, Baker Technologies CEO Joel Milton stated that he had its sights set on California the “largest market in the country.” The funding round helped Baker Technologies to open an office in Los Angeles to increase its presence in California prior to legalization.

San Diego-based startup, Weedguide, also raised $1.7 million in a seed round in October. The online platform educates consumers about the process of buying cannabis and connects both medical and recreational consumers to dispensaries in their areas. Spokesperson Sarah Daily calls Weedguide the “one-stop-shop, a single destination that provides access and guidance to the entire cannabis experience.”

Investment was also directed into spaces not dealing directly with cultivation and sales. Ohio-based Cannasure Insurance Services raised an undisclosed amount of funding through a private equity round backed by Krauter and Company. It has capitalized on the stigma surrounding the cannabis industry by providing insurance packages to cultivation centers and dispensaries across the United States.

Federal Disapproval Hampers Growth

Despite a massive potential for growth with adult-use legalization, mainstream VC firms are hesitant to invest in cannabis companies. According to the Wall Street Journal, illegality at the federal level has made it difficult for many cannabis businesses to attract investment from non-industry-focused firms.

Furthermore, some venture firms have been reluctant to invest in light of Attorney General Jeff Sessions’s attack on state legalization of adult use. On the bright side, this struggle has given way to the creation of industry-specific investment firms like MJardin Capital and Poseidon Asset Management, which are eager to invest in the growing cannabis industry.

As far as a potential federal crackdown is concerned, Weedguide representative, Sarah Dailey, told Crunchbase News that she believes “one of the most harmful things right now to come out of Sessions rescinding the Cole memo is just the overall uncertainty that has descended on the industry.”

But she is happy with the overall response from state attorneys who she says are “vowing to fight against what certainly seems to many like federal overreach.”

CEO Joel Milton also expressed confidence to Crunchbase News. “We have to wait and see until Sessions makes his announcement, but we remain optimistic about the state of the industry,” Milton explained.

Like Dailey, Milton is also confident that states will stick by their constituents’ decisions in the face of federal backlash. Benefits of recreational legalization like job creation and tax revenue are major incentives for resistance by state governments.

Some dispensaries and medical users in California are frustrated with the high tax on cannabis and rises in prices brought on by expenses for licenses and compliance. Some fear that tax rates at this level will cause businesses to lose potential buyers to illegal vendors.

But Milton told Crunchbase News that he is optimistic about the tax situation. “Legalization provides the consumer transparency of pricing,” Milton explained.

As more states join the wave of recreational legalization, the cultural stigmas surrounding its use will likely begin to change. One can speculate that U.S. citizens will be less tolerant of federal backlash resulting in more funds from mainstream VCs being directed into emerging companies in the industry.

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