Legal pot is still a tough deal for investors

DENVER — With California voters poised to legalize marijuana this month, investors face a choice: jump into an industry whose tantalizing growth prospects are hamstrung by its criminal legacy or wait until federal-level banking and legal restrictions get resolved.

California for decades has been home to a thriving illegal marketplace for black-market cannabis, but a legalization vote on Nov. 8 could dramatically alter the landscape. A state-taxed marijuana marketplace in California could generate $1 billion in taxes, experts say. That’s money that today vanishes into the pockets of black marketers and smugglers. Polls show the measure with significant public support.

“I really believe California really is a watershed moment for this industry,” said Adam Bierman, the co-founder of the national cannabis firm MedMen. The company offers consulting and management services to the marijuana industry, and Bierman oversees the MedMen Opportunity Fund, a $100 million private equity fund focused on cannabis ventures.

Nationally, legal pot initiatives could spell a three-fold expansion in legal cannabis in the U.S.

The marijuana industry is expected to grow at a compounded annual rate of 29% over the next four years, said Giada DeCarcer, the founder and CEO of cannabis-focused analysis firm New Frontier Data.

Scope dwarfed

Despite this outlook, the amount of venture capital investment in marijuana remains low compared to industries that traditionally receive this kind of growth financing. The second quarter of 2015 was the biggest ever. Even then, only about $150 million in capital was invested in marijuana-linked companies, according to PitchBook Data.  A year later, investments for the same quarter sank to $54 million, the financial analysis firm said. About $776 million in capital has been invested into the industry since the start of 2016, according to Viridian Capital Advisors.

In comparison, overall venture capital investment hit nearly $20 billion in the second quarter of 2015, rising to $22.1 billion in the second quarter of this year. Legal pot's slight investment draw was dwarfed by more traditional industries, such as software.

But the potential is obvious: a new study by Colorado economists found that marijuana legalization created 18,005 new jobs in 2015, and netted $996 million in sales and $121 million in taxes, with an overall $2.4 billion economic impact for Colorado alone.

Numbers like these have piqued interest. “We are already seeing an enormous amount of interest from investors and entrepreneurs who recognize the unique scale of the opportunity presented by cannabis legalization,” said Troy Dayton, the Arcview Group’s CEO.  Oakland, Calif.-based Arcview is an investment network that has made $84 million in marijuana-related investments since 2013.

Helping spur earlier investments:  Peter Thiel’s Founders Fund, which in 2015 made a multimillion-dollar investment in Privateer Holdings, the world's first private equity firm investing exclusively in the legal cannabis market. Seattle-based Privateer owns Leafly, a Yelp-like app and website service that works much like a marijuana search engine to connect medical and recreational users with legal suppliers, along with strain reviews. Privateer also backs the Marley Natural marijuana line, founded with the surviving family of reggae star Bob Marley, and Tilray, a Canada-based medical marijuana company.

Also boosting interest: the 2013 announcement by CNN’s Dr. Sanjay Gupta that he believed marijuana has the potential to help sick people. Residents of 25 states already have access to some form of medical marijuana, which users say can help combat nausea from chemotherapy, reduce seizures and potentially replace highly addictive prescription painkillers.

Yet few large-scale investors have shown themselves willing to risk large amounts of capital in marijuana, restrained by the substance’s uneven legal status nationally.

Only cash-based

In many cases, the chartering language of large institutional and venture capital firms prohibits them from directly participating in anything illegal or immoral. There’s a ban on transport across state lines. Regardless of how California votes next month, marijuana remains illegal at the federal level — a fact that translates into “reputational risk” for investors.

Additionally, it’s virtually impossible for people operating in the marijuana space to get bank accounts. In Colorado, Washington, Oregon and Alaska, marijuana-store owners are forced to conduct their transactions in cash, including paying their taxes.

“Banks aren’t going to touch this unless there is clear guidance from the feds that they aren’t going to prosecute, and they want it in writing, which is something the federal government has not been willing to do yet,” said John Kagia, New Frontier’s executive vice president of industry analytics. “So as a result, you end up with $7.5 billion industry that is still largely being done in cash. It’s not sustainable. It leads to enormous security concerns … and operational inefficiencies.”

There’s at least a partial answer to these legal grey areas: real estate.

Pot REIT

Investors reluctant to “touch” marijuana directly are rapidly expanding their property portfolios. Earlier this month, a San Diego-based real estate investment trust announced plans to raise $175 million with an IPO that would fund the purchase of marijuana grow facilities across the country.

Real estate, said Bierman and Scott Greiper of Viridian Capital Advisors, a cannabis-focused investment and advisory firm, is a foothold opportunity for those investors looking for a business model they’re comfortable with.

“There’s a lot of people who wouldn’t touch any of the ‘sin’ verticals,” Greiper said.

Over time, California’s vote may change that. The state’s voters are widely expected to endorse legalization, which will help persuade more large-scale investors to dip their toes into the marketplace. Among those who have backed the legalization effort with cash include former Facebook president Sean Parker, who has put up more than $8.5 million, and Weedmaps, a social network and Yelp-like referral service for marijuana, which has donated more than $1 million.

After Election Day, access to marijuana likely to reach all-time high across nation

A study released last month by New Frontier and Arcview Market Research found that nearly 70% of high-net-worth investors belonging to Arcview's investment group, and who are interested in the marijuana industry as a whole, are now willing to consider investing in businesses that either directly touch marijuana or provide ancillary services, such as real estate, although investment trends have yet to bear that out.

The Arcview/New Frontier survey found that investors have made the bulk of their investments since 2014, when Colorado and Oregon legalized recreational marijuana, and 71% of investors expected to put more into cannabis in 2016 than they did in 2015. The increasing pace of investment is hard to ignore, even if the numbers are still relatively small.

“Whether you like it or don’t like it … it is what it is. This is what’s happening,” Bierman said. “The fact remains: It is inevitable and it is happening before our very eyes.