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Picking Marijuana-Related Investments: Phyto Partners Walks Us Through Its Criteria

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Picking Marijuana-Related Investments: Phyto Partners Walks Us Through Its Criteria
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Over the past few weeks, Benzinga has been sharing interviews with the top venture capital and investment firms operating in the cannabis industry. Among those focused on ancillary businesses that do not touch the plant, we profiled Snoop Dogg’s Casa Verde and Arcview Group partner, CanopyBoulder. Among those willing to get involved in plant-touching ventures, we presented MJIC, which claims it intends to become the “Amazon.com, Inc. (NASDAQ: AMZN) of weed,” and iAnthus Capital Holdings Inc (CNSX: IAN) (OTC: ITHUF), which raises capital for U.S.-based marijuana companies in Canadian capital markets.

Next in our list of industry leaders was Phyto Partners, a VC firm that funds select ancillary businesses in the marijuana space. So, we reached out to managing partner Larry Schnurmacher, who walked us through the organization’s investment philosophy, its criteria, its portfolio companies and its returns.

Related Link: Discussing Snoop Dogg's Marijuana-Focused VC Firm: 'Beyond Wearing The Investor Hat, We Differentiate With A Broad Internal Ecosystem'

Like most of the people running the firms mentioned above, Schnurmacher comes from a financial services and investment banking background, bringing more than two decades of experience working for companies like Morgan Stanley (NYSE: MS) and Oppenheimer Holdings Inc. (USA) (NYSE: OPY). About three years ago, seeking to capitalize on the cannabis industry’s green rush, he decided to start Phyto Partners, a VC firm focused on companies operating in and around the marijuana space, mainly technology companies providing what he considers “business-to-business critical solutions.”

Since Phyto’s investments are usually above the $500,000 mark, it’s current portfolio comprises only 12 companies including New Frontier, Baker Technologies, Tradiv and Wurk. “None of these companies buy, sell, process or market marijuana. They all provide some kind of business-critical solution or service for the cannabis industry, fixing a pain point in the industry,” Schnurmacher told Benzinga during a recent conversation.

Avoiding Trouble

Phyto explained its reason for avoiding plant-touching businesses.

“It’s not about being concerned about the federal illegality of cannabis. If the business metrics made sense, if the investment opportunity made sense, I'd have no issue investing in companies that grow or sell marijuana,” the investor said. The issue for him is that these plant-touching verticals are hugely capital-intensive and heavily scrutinized by the regulators.

“These verticals, especially cultivation and retail, are the most exposed to heavy tax burdens. They do have the potential to face federal prosecution, but that is not the main issue,” he added, pointing out that, in his view, these businesses will face the largest supply-demand pricing pressure, unlike the businesses that, instead, help them conduct their business.

In addition, most of the companies Phyto has invested in can operate in all 50 states in the U.S. and any other part of the world, unlike producers, who are usually limited to just one jurisdiction. Similar to CanopyBoulder’s approach, for Schnurmacher, it’s all about scalability.

The final component to the firm’s investment criteria is the management team. “It’s very important for me to see that these guys have done something successful[ly] before jumping into the marijuana space,” the partner explained.

Another thing he likes to see is other institutional or strategic investors like Phyto participating in the company they’ll invest in. This is why knowledgeable readers will find some overlap between the firm’s portfolio, and those of other funds we’ve profiled. “Most of the times, these companies are going to need multiple rounds of financing before they can stand on their own, so I don’t want to be the only –so called- institutional investor,” he voiced.

Finally, there’s the valuation issue, which is hard to determine in the industry. “It’s important for companies to have a reasonable, understandable valuation and a reasonable business plan,” he said.

Measuring Performance

Almost every time Benzinga asks venture capital firms in the cannabis industry about performance, they explain that returns are hard to calculate, because the closed-end nature of the market makes it very difficult to value a company. However, Schnurmacher recurs to an alternative methodology to assess his hit-to-miss rate.

Related Link: Bigger Than Bingo: Seminole Chief Jim Billie On His New Cannabis Advisory Firm And A Tax-Free Environment

“Every company that has been successful in raising capital after we’ve invested, that’s a mark that I can use because more money has come to the table at a determined valuation,” he said. A higher valuation tends to mean returns are positive; a lower valuation, usually signals to a negative performance.

Using these criteria, four or five of Phyto’s investments have been successful in raising new capital at higher valuations – with one of them standing out in the crowd. Nonetheless, he warned, these are not market valuations, because the equity out there is not stock, and thus, not liquid.

“I see the cannabis industry, and its continued legalization and acceptance as hugely disruptive for many other industries, like the pharmaceutical industry, the healthcare industry, the alcohol industry, the restaurant business. This is not a one trick pony; it's going to impact so many parts of society in a positive way. It'll be much more ubiquitous than it is today," Schnurmacher concluded.

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Image Credit: Javier Hasse

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