High Times: Marijuana Investors See Green

Nothing is more attractive to an investor than a business with a competitive advantage, an entrepreneur focused on new markets, an industry on the upswing, or a regulatory shift that will remove barriers. When it comes to one emerging industry exhibiting all of these characteristics, along with a few side effects, investor appetite certainly seems to be growing.

The majority of Americans now say they favor legalizing marijuana usage. Consumption of marijuana (with a doctor’s prescription) to treat medical conditions is legal in 24 states and the District of Columbia. In Washington, Colorado, Alaska and D.C., you can also light up on the street or snack on a cannabis-spiked treat quite legally; a similar measure, approved by Oregon voters, soon will become law there, too.

Even though the federal government may still deem marijuana an illegal drug, opportunities to finance cannabis-related businesses are becoming increasingly attractive, even fashionable. Perhaps it’s precisely the industry’s status as a legal gray area that makes risk-tolerant investors willing to back the “potrepeneurs” leading the charge. After all, doesn’t conventional wisdom declare that along with above-average risk comes above-average returns?

Already, the data suggests that the fledgling marijuana industry may be one of the fastest-growing in the country. In 2013, its revenues totaled $1.5 billion, according to industry consulting group ArcView Group. By 2014 they had jumped to $2.7 billion – a 74% increase – with the vast majority of those sales (82%) coming from the medical marijuana “subsector”. ArcView predicts that this year, sales will hit $3.5 billion and nearly $4.5 billion by 2016, when ballot initiatives could end up legalizing pot in as many as six states, if national advocacy groups have their way. And by 2018? $8 billion.

Once you consider the ongoing push towards legalizing recreational use of marijuana and the fact that the 2014 figures only reflect two of the states that have done so to date, that $2.7 billion starts looking like the tip of a very, very large iceberg. No wonder, then, that wannabe marijuana entrepreneurs flocked to Las Vegas last November to attend an ArcView-sponsored conference designed to introduce them to investors who might be interested in funding their projects. Inside the four walls of the conference center, all kinds of projects were discussed: lighting and efficient water systems for grow facilities, making childproof containers, developing tasty marijuana edibles, or creating Internet apps that will do everything from rating particular variants to enabling you to order up a home delivery (think, GrubHub for pot).

While some of the first signals of financial interest in the marijuana business have come from those who double as activists, the industry is increasingly becoming ripe to more traditional providers of capital. No surprise that the first institutional investor to move into the cannabis industry was none other than venture capitalist Peter Thiel, well-accustomed to investing in edgy companies that defy being placed in genres.

The target of Thiel’s interest was Privateer Holdings, a Seattle-based company that, in turn, owns interests in several marijuana businesses: Leafly.com (the Yelp.com for pot buyers), a Canadian medical marijuana growing business, and Marley Natural (which Privateer hopes to turn into the first global marijuana brand, sold wherever the products are legal later this year), named after Bob Marley. (Privateer, in a coup, won the rights to use the late reggae legend’s name on the pot products for 30 years.)

Privateer is far from alone in the ultra-respectable world of private investment vehicles targeted at the cannabis market, most of them still trying to keep at least one step away from the plant itself, as marijuana hedge fund Poseidon Asset Management promises its investors (each of whom must cough up a minimum of $100,000). Even so, investing in “ancillary solutions, products and services that only serve the Cannabis industry” was enough to generate a 67% return for its investors in 2014, a pretty impressive upside relative to the 11.74% return earned by the Standard & Poor’s 500 Index.

It’s all a big change from buying something in a Ziploc bag from a guy whose last name you don’t know in a corner of a seedy-looking bar on the wrong side of town.

If you want a glimpse of the future, and the investment opportunities and risks that lie ahead, a good place to scrutinize is Colorado. The first state to legalize recreational marijuana, it is light years ahead of other states in developing a business infrastructure. (In Alaska, for instance, it’s still impossible to make a living – legally – by selling cannabis, even if it’s legal to use it simply to get high.)

Small businesses abound in the Rocky Mountain state, like Nancy B’s Edible Medicine, where you can taste a Mile High Macaroon. Some of these, such as individual grow operations or dispensaries, likely will stay small. Others may dream of building national cannabis brands. Then there are the name-brand entrepreneurs who are likely to apply their rapid-business-growth resumes to the industry. Incomers like Tom Bollich, founder of Zynga, the online gaming company, settled on Colorado as the place to develop and market indoor engineering-based agricultural equipment that can cut the cost of power and water required to grow cannabis. Because he’s selling technology, not cannabis, he can easily attract capital, he figures.

Once, the biggest risk of investing in cannabis was the obvious one: that the business was completely illegal. These days, assuming that you live in a state where some form of pot is now legal, or are sticking to the “service” and “infrastructure” side of the business, there are fewer reasons to worry, beyond the normal business risks associated with investing in any brand-new or transformational business idea.

That doesn’t mean that it’s risk free, however. While the process of legalizing cannabis may feel as if it is gaining momentum, it also is encountering resistance. Nebraska and Oklahoma, for instance, have asked the Supreme Court to overturn Colorado’s legalization of marijuana, claiming that it has caused drug crime in their states to soar.

Of course, there are some investment opportunities that will be more risky than others, or whose upside is going to be greater than others. For now, the closer a business gets to actually handling the plant, the more problems it’s likely to encounter, even in a state like Colorado where what it’s doing is perfectly legal. For instance, federally-regulated banks are wary of doing business with these companies. Some do so – on a strictly hush-hush basis and with lots of extra oversight and paperwork – but it’s a headache for those companies and their investors. At the other extreme, Bollich figures that even if the trend reverses itself, he can sell his technology to other agricultural enterprises.

There may be (legal) fortunes to be made in the cannabis industry, just as ArcView predicts, and big-name investors like Peter Thiel expect. But while it’s an intriguing and fast-growing business, and one that is rapidly shedding its shady reputation, this isn’t a conventional market, dependent only on the ability of smart entrepreneurs to develop products that meet the needs of their demanding customers. As long as the federal government views marijuana as a damaging substance, betting that marijuana edibles will be as big or bigger as organic foods might be a risky bet.

Then again, taking bets is what investing in growing businesses is all about.