With regulators still barred institutional capital from investing in the legal cannabis industry, Entourage Effect Capital sees the space ripe with opportunity.
Anticipating legalization in the next three to seven years, the Dallas-based private equity firm is in the process of raising its third and largest fund, eyeing an initial target of $150 million.
"This is the first time that private capital could get ahead of an investment opportunity like this in front of institutional capital," said Matt Hawkins, founder and managing partner, "It's always been, historically, that the institutional capital leads the parade and private capital gets the second bite at the apple. That's not the case here. What everyone's focused on is building scale, to get to that point… to have a meaningful exit when the 10s of billions of dollars enter the game."
Entourage's first fund, launched in 2014, raised around $25 million and was focused largely on seed-stage and early-capital investments since Hawkins said the industry was still in its fledgling stages at the time. Its oversubscribed second fund closed in 2019, raising about $60 million, focusing on Series A investments between $3 million to $5 million. Hawkins said the third fund would focus more on growth-stage equity investments between $10 million to $20 million.
"The first fund was at the very beginning stages of the industry in the United States so that smaller checks can move the needle," Hawkins said. "We're now at a point where we're making later-stage investments in companies… to create scale in advance of legalization."
The firm kicked off its fundraising effort for its third fund in Oct. 2019, at the time saying it would bring its managed assets to about $250 million when fully subscribed. Already, Hawkins said Entourage has made five investments out of the fund and anticipates 10 and 15 more.
Hawkins said Entourage invests in companies "up and down the value chain" of the legalized cannabis industry, with its portfolio of about 70 companies ranging from cultivation and retail to science and technology. Like with other funds, Hawkins said with the third fund, Entourage looks for businesses looking to scale with strong management teams and a large market opportunity. To date, Hawkins said the firm's portfolio has seen more than 20 monetization events.
"The opportunity to make the outsized returns are what's there right now," Hawkins said.
Just this year, Entourage has made at least three investments. In April, the firm joined a $30 million Series B round for Chicago compliance solutions startup Fyllo. In September, it led a $20 million funding round for California company Hound Labs to scale the production of its cannabis breathalyzer product. In October, it followed that, joining an oversubscribed $11.5 million Series A round for San Diego cultured cannabinoid platform Cellibre.
"It's not a large amount of money for private equity, but for cannabis, it's a lot of money," Hawkins said.
Entourage was founded in 2014 as Cresco Capital Management after Hawkins noticed the high yields businesses were paying for real estate in Colorado to refinance mortgages out of commercial debt. He saw an opportunity to provide funding and underwriting to other industry adjacent companies with a "first-mover" advantage. In 2019, with the launch of the most recent fund, the firm changed its name to avoid confusion with the cannabis lifestyle brand Cresco Labs. With a team of about nine, the firm has additional offices in Fort Lauderdale, Florida.
Hawkins said the pandemic has provided a boost to the cannabis industry as it continues to mature. Considered an important business in many places, he said businesses in the space had time to experiment with things like delivery and curbside pickup. He said there is still a shortage of capital due to the lack of institutional capital. However, when that does change, and larger players, including those from the tobacco, alcohol and pharma industries, enter the space following legalization, Hawkins said Entourage would look to work with institutions as an operating or investment partner.
"It's just gotten to a point to where it's one of the few bipartisan issues. It exists. Why not tax and regulate it, bring some money in and probably reduce crime in the process?" Hawkins said.
