Like some family office fund managers I’ve spoken to, you might be weighing a cannabis industry investment strategy. Some believe there’s extraordinary money to be made, particularly in the burgeoning U.S. market. But exceptional returns come with substantial risk, and most wealthy individual and family office investors don’t have the background or belly to play in the current market.
The hype around cannabis makes me suspicious of a coming bubble. However, the root of the investment theory is sound: commercialization is replacing the multi-billion dollar black market with a multi-billion dollar legal industry, giving investors an unprecedented opportunity to gauge its size and certainty.
The risk comes from the legal status of marijuana in the U.S. While the states are trending toward legalization, marijuana is still illegal under federal law. Another issue is the black market itself, which is likely to continue for some time and compete with the legal enterprises that bear high regulatory costs, including license fees. Investors could easily find themselves afoul of federal law, and without proper due diligence, among business partners with black market ties. For a cautionary tale, read up on Harmony & Green, a Colorado-based grower that was raided by the DEA and alleged to have transported marijuana across state lines.
A Bifurcated Investment Opportunity
Rick Kimball, managing member of Samphire Capital Management, has made seven cannabis industry investments, including one that has already been sold. Mr. Kimball cautions that investors must do thorough research into the complexities of the law and the industry, and extra due diligence into the operations of potential investment targets. “If you have the resources to do the research and can stomach the risk, these are the fanciest returns we’ve seen in a long time,” he says.
According to Mr. Kimball, there’s a bifurcation in cannabis investment opportunities—those that do and don’t touch the plant. “If you have ERISA pension money or a charter that says you can’t invest in a company which is violating federal law, then you probably can’t invest in something that touches the plant,” he says. “Anything to do with growing, extracting or dispensing could have regulatory consequences.”
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Instead, he points to investment opportunities that don’t touch the plant, such as professional services, ag-tech and broader technologies. Services such as branding, packaging, payroll systems, CRM and data analytics have value because they provide licensed cannabis industry players with enhanced business operations and a competitive advantage.
Operational Focus Key to Long Term Prospects
The operational sophistication of the licensed industry players is a key metric for investors with a longer view, who see large multi-national tobacco, pharmacy and other Forbes “Global 2000” types acquiring the top cannabis brands when (and if) the federal law changes and marijuana is legal.
IDPE is a Washington, D.C.-based single-family office in the process of closing cannabis investments that it expects will produce significant cash flow in the short term, while preparing for the potential of greater returns when larger players are expected to enter the market through acquisition. “Ultimately, the real key is ‘who are the operators’,” says Brad Love, a senior advisor to IDPE. “The team that’s following the best practices will be prepared for the future. We don’t want CVS to come to our place and think we’re a rinky-dink mom-and-pop operation.”
That philosophy is paying off for licensed operators such as Chicago-based Verano Holdings, which recently announced $120 million in financing, including an $88 million equity investment by Toronto-based Scythian Biosciences Corp. (Scythian has since been renamed SOL Global Investments Corp.) That investment is significant, in part because Canada is establishing the blueprint for the financial structure of a legal cannabis industry.
“We’re building our business to be one of the best in the country,” says George Archos, Verano’s chairman and CEO. In describing his company, Mr. Archos emphasizes its focus on business fundamentals, including the medicinal value and quality of the product, the strength of the team and a focus on operational efficiencies.
Opposition in Colorado
Those success stories aside, not everyone is enamored of the potential for legal cannabis, including Bob Troyer, the U.S. attorney for the District of Colorado, who recently wrote an op-ed in The Denver Post decrying the impact of commercialization in that state.
There’s resistance in the medical community, too. “It’s clear that legalized marijuana is the second version of big tobacco. It’s ‘Big Tobacco 2.0’,” says Dr. Christian Thurstone, medical director of STEP, one of Colorado’s largest youth substance abuse treatment clinics, and an associate professor of psychiatry at the University of Colorado School of Medicine.
The same profit motive with big tobacco exists with marijuana. You get 80% of your profits from 35% of your customers who use daily. Heavy use stems from those who began using marijuana in adolescence, the time when the brain’s reward circuit develops. Our pre-frontal cortex, the part of the brain that can curtail this behavior, doesn’t develop into our mid-20s.”
Dr. Thurstone leaves room for the potential of FDA-regulated legal marijuana derived drugs, but has this warning for cannabis industry investors who are evaluating its long-term potential: “Think about the states and cities suing opioid makers as well as tobacco companies.”
Developing a “Sixth Sense”
The cannabis industry investors I spoke with for this article described a kind of “sixth sense” that needs to be developed in order to spot potential problem investments. Mr. Love referred to investments IDPE turned down because “enough warning lights went off, including crazy valuations, short-term fuse, or an overly complex structure.” An investor would have to really focus and dive deep into the nuance of commercialized cannabis to develop that level of perception. From my perch, it may be more prudent for wealthy individuals and family office funds to get to know the market and players in this early stage, and look for opportunities in the next round, when the law is more settled and companies with strong brands and other business fundamentals begin to emerge.
And I suspect many risk-averse family office-related investors will continue to talk about having a cannabis strategy at the family office conferences, but keep their focus on safer investment opportunities with steady returns. Says Rob Wray, a retired U.S. Navy rear admiral, who met with a number of family offices while seeking financing for his startup, BlueStar SeniorTech, “I rarely saw them motivated by a return on investment—they seem more motivated to avoid losing money. They seem to spend a lot of time going to meetings with other family offices, but I never saw the investments that resulted.” And that’s a topic for another column.