Private equity is like the concert-goer at a Grateful Dead show years ago:
Suddenly gripped with a curiosity about what that dude a couple seats over is smoking.
“I get phone calls from brand-name PE firms,” David Dinenberg, chief executive of Kind Financial, whose firm provides financial services technology to the cannabis industry, said in an interview. “They’re curious about the industry.”
Private Equities Feeling Out Growth of the Cannabis Industry
No wonder. The business of legal marijuana in the four states that allow sales of recreational sales to adults, as well as the 23 states that okay medical marijuana is projected at $3.5 billion in sales this year, according to a study published by ArcView Group, a cannabis industry research group. With sales projected to grow at least 30% a year, and possibly much more, as more states decriminalize the product, that figure is likely to climb to $11 billion by 2019, the research shows. (That data reflects the sale of just cannabis products themselves, combining both medicinal and recreational applications, but not sales of things like agricultural equipment and IT systems that support the industry.)
“We’re squarely sitting in the growth-equity bucket,” Al Foreman, a partner at Tuatara Capital LP, one of the leading investment management firms focused exclusively on the cannabis industry, said in an interview.
That $3.5 billion figure, of course, is just the proverbial tip of the iceberg. Marijuana sales, including transactions of a product that’s still illegal for recreational use in an overwhelming majority of the country, were pegged at $41 billion for 2013, according to a Rand research report last year. (In many ways, the legal cannabis industry is akin to the gambling industry, inasmuch as legal revenues are dwarfed by illegal sales. For instance, Nevada casinos attracted $119.4 million in wagers on the Super Bowl of 2014, an industry record involving a game, when, according to the American Gaming Association, $3.8 billion was bet illegally on the same event.)
“This is not really analogous to the dot-com boom,” Troy Dayton, chief executive of ArcView Group, said in an interview, contravening the comparison that most cannabis industry professionals make, as a way to describe the dynamism of the growth curve of the legal marijuana business.
“Technology booms are driven by innovation,” Dayton said. “The legal cannabis market is being by the shift in a market from an underground enterprise to an above-ground market.” That said, he added: “It’s a guaranteed market.” Not only can current use be decriminalized, access to legal pot would likely attract a host of customers beyond current recreational users.
“Once retailers have a license to sell the product, we’re not just going to migrate the existing customers to cannabis,” Leslie Bocskor, the founder of corporate finance firm Electrum Partners, a cannabis industry investor, said in an interview. “It’s going to allow a whole new base of customers to enter the market.”
The signal event in private equity’s relationship with the legal cannabis industry arguably came earlier this year. In January, Founders Fund, a leading venture capital fund launched by PayPal co-founder Peter Thiel, agreed to a multi-million dollar investment in Privateer Holdings, a private equity fund that’s investing exclusively in the legal cannabis industry. Privateer has since closed on a $75 million fund dedicated to investment in the legal cannabis industry.
“This was a historic event, not only for us as a company, but for the industry as a whole,” Brendan Kennedy, chief executive of Privateer, said in an interview. “It’s given other smart investors permission to invest in the legal cannabis business.”
Privateer, which has already backed Leafly, a Yelp-like website for marijuana dispensaries, has agreed to finance the rollout of a marijuana brand called Marley Natural, a premium cannabis brand founded by the family of the late reggae legend, Bob Marley. (The joint venture was announced in an appearance on NBC’s “Today” show, another sign of the increasingly mainstream character of the legal cannabis business.)
“The biggest worry is that there’s going to be a race to the bottom with pricing,” Frank Marino, chief executive of MJIC Capital, a provider of equity financing that invests in and owns assets in the legal cannabis industry. “The only way to protect that process is by branding.”
The Privateer-Marley joint venture isn’t the only effort to introduce branding initiatives to the legal cannabis market. Tuatara its name refers to a lizard-like reptile with a crest of soft spines along its back indigenous to New Zealand last month announced that it was partnering with musical icon Willie Nelson to introduce a brand, dubbed Willie’s Reserve, which the firm describes as a premium cannabis lifestyle brand.
“There are barriers currently erected, whether legal or reputational, that keep certain capital sources, whether it’s prospective strategic partners or big capital sources such as hedge funds and pension plans, at arm’s length,” said ArcView’s Dayton. “So right now the opportunities are for smaller investors.”
The modest scale and fragmentation of the industry are perpetuated by the patchwork nature of the legal cannabis industry. Markets are anything but contiguous, for instance Oregon and Colorado, two states with legalized sales of recreational marijuana to adults, aren’t exactly neighbors and it remains illegal for purveyors in locales where sales are legal to transport products across borders where it’s criminal.
That could change as early as next year, experts said. As many as seven states figure to have initiatives on the November 2016 ballots to legalize recreational cannabis usage. Given public support for legalization polls show a majority of Americans support decriminalizing marijuana it’s not out of the question that as much as 70% of the population could have access to recreational marijuana, especially if California, one of the states expected to vote on the initiative next year, supports legalization.
There are still entrenched constraints to industry growth. “Banking, at this time, is an incredible challenge,” noted Leslie Bocskor, founder of Electrum Partners, a cannabis focused investment fund.
Banks with national charters are still constrained by the reality that, as marijuana remains on what’s called Schedule 1, and thus an illegal product under federal laws, any transaction it conducts with pot purveyors could be considered the proceeds of an illegal transaction, and thus subject to seizure.
Philip Wolf, the chief executive of a tourism company named Cultivating Spirits in Colorado, said that, even though he’s currently in a round of fund raising, he’s entirely disinclined to approach a bank about financing.
“I just don’t think it’s realistic that any bank is going to finance me,” said Wolf, whose company arranges cannabis tour events and feature meals pairing fine cuisine with wine and cannabis pairings. (This isn’t a college dorm-mate’s pot brownies. The pot-free food offerings are paired with cannabis products that have a flavor profile that complements the cuisine and wines.)
As a result of the exclusion from the banking system, most cannabis businesses especially those that, in the parlance of the industry, actually “touch the plant,” meaning growers, cultivators and retailers operate on a strictly cash basis. Which, in turn, makes banks all the more leery – “Banks don’t give loans to businesses when they’re uncomfortable with the collateral,” noted Kind’s Dinenberg, and thus creating a vicious cycle.
The lack of access to even rudimentary banking transactions lends a certain, call it, rustic quality to the cannabis industry. “We’re not talking about sales representatives who are exactly pharmaceutical rep quality,” Marino noted wryly.
Dinenberg’s Kind Financial, a financial service technology provider, is selling a software product to the cannabis industry “seed to sale” software, in the parlance that would heighten banks’ comfort level with the marijuana industry, as it would bring more structure to its financial operations via accounting and compliance systems. “We’re aware there are many banks hesitant to work with this industry, and that’s why we’re working to provide a solution.”
Meanwhile, the relative lack of professionalism, as well as the somewhat sketchy and fragmented nature of the business, is effectively one of the great selling points of the legal cannabis industry, from private equity’s standpoint, at least. Industry consolidation, coupled with the prospect of seeing the market expand massively following next year’s elections, offer the prospect of the kind of astronomical growth rates that capital sources aren’t finding in conventional growth industries such as technology and healthcare.
“The way we characterize the growth of the cannabis business,” said Morgan Paxhia, co-founder and chief investment officer at Poseidan Asset Management, a cannabis industry investor, “is to measure it in dog years.”