The Family Farm

A Q4 2019 Glimpse into Family Office Investing in Cannabis

In October of 2017, I compiled a notice describing the introduction of Single-Family Offices’ (SFOs) participation in the then-fledgling cannabis industry. In brief, it described my family’s activity in the fight for social justice related to the cannabis industry and how it informed my entry into venture investing in cannabis and co-founding a vertically integrated license in Massachusetts called Revolutionary Clinics. That document was used by law firms, RIAs, Multi-Family Offices (MFOs), and wealth-holder networks around the world as a brief introduction into how potential investors were then flirting with the idea of participation. 

Now, two years later, the gloves are off. Markets have evolved dramatically, and SFOs remain the dominant capital provider to fuel the growth and development of the cannabis industry at large. 

Why SFOs are Driving this Industry

The federal illegality of the US cannabis industry continues to prevent typical nationally-charted banks and traditional institutional capital from investing in plant-touching companies. State-chartered banks have stepped into the void and are increasingly accepting deposits from plant-touching and ancillary cannabis companies with FinCEN’s tacit approval. That has eliminated the need for backpacks of cash being toted by private individuals to pay for services, goods, and taxes. 

That said, without federal protection and banking services beyond deposit-collection, the industry remains reliant on wealthy private investors, whether through direct investment or through private equity funds, to continue to support the industry through its nascent growth stage. Exuberance, whether irrational or rational, in the public markets of Canada, has brought awareness to US investors of the long-term financial potential of well-managed US cannabis enterprises, especially once they are unencumbered by misguided federal illegality. 

The US population is approximately 14 times that of the Canada, and the financial resources in US institutions are orders of magnitude greater. This realization has continued the excitement and commitment of the early-stage SFO investors to provide the critical financial support to the emerging cannabis industry. SFOs eventually need to be taken off the hook by larger pools of capital or the industry will become monopolistic because of the inherent inability of SFOs and other private capital sources to fund the orderly development of such a large industry. 

Nevertheless, SFO investment into the sector has multiplied since I first expressed my thoughts in 2017. According to the Viridian Deal Tracker, a preeminent merchant bank that tracks public and private raises, by week 39 of 2017 there had been $1.8B invested in global cannabis companies that year. By week 39 of 2018 there had been $6.0B, and in 2019 there has been $10.32B to date. 

Viridian’s numbers, while not comprehensive of all investments made as many groups do not disclose private investments, do paint a meaningful picture. Investment in years 2017 to 2018 represents a 3x investment which dropped to a 1.7x increase from 2018 to 2019. That is not without reason. Starting in Q2 of 2019, public companies have experienced significant downward stock pressure that has brought down virtually all cannabis company stock prices by 60% to 90% from their all-time highs in late Q1. 

Unfortunately, that was driven in part by Canadian focused cannabis companies that grabbed the early spotlight with hopes of claiming a worldwide grasp on the cannabis industry that had little hope of actually capitalizing on it for various reasons. Those companies have since reported poor financial results and that spilled over to companies that are servicing the behemoth US cannabis market. US companies are in their infancy, are growing rapidly, and yet have often experienced foreseeable early missteps in leading the emergence of the legal US cannabis industry, which outsizes any other geography’s combined market. 

Those who participated early and saw exponential returns are now placing new bets. Those who recently entered the space during the exuberant times are largely tainted and have become tentative on whether to average down their initial exposure in the cannabis market. That is occurring as the US cannabis industry is being led by ever increasing sophisticated management teams that are gaining traction. Although projections of the cannabis industry vary, there is little disagreement that the legal industry will grow at a rate that is similar to largest expanding industries in US history including cable television and broadband internet. 

SAFE Banking Eventuality

In a way, at the start of Q4 2019, we are resetting. Valuations are adjusted, private companies are emerging as leaders in their respective niches, and a meaningful vote has just occurred. In September 2019 the SAFE Banking Act passed decisively through the House. The SAFE Act is the first step to allow banks to offer services to cannabis companies without annual riders and begins to pave the way for institutional capital providers to feel more comfortable in the security and eventual liquidity of their investments. The 321 to 103 victory of the vote shows clearly the will of the populous who elected the voting officials, providing further evidence of the shift in public opinion towards the cannabis industry. 

There remain, however, many hurdles for this bill to formally pass and more changes that will further propel the industry forward. The removal or adjustment of the 280E tax code, for example, will be another momentous inflection point as it can drastically affect returns, offsetting earnings for unknowing family offices. Meanwhile, high ranking government officials, such as Senate Majority Leader Mitch McConnell, can unilaterally prevent a vote on these bills in the Senate by delaying it past the Congressional sessions’ period resulting in the bill dying without a vote[1]. 

Private investors should consider this period between the initial passing of SAFE Banking through the House and its eventual approval, in this form or another, by the Senate and President as a final chapter of an era when SFOs have the upper hand. The route forward with SAFE Banking is heavily debated, yet most believe by 2021 it will pass either as a vote-acquiring tactic before the next Presidential election or soon following as a revenue and popularity generator soon after the election. Either could be good bets, but what is for sure is: Once institutional capital providers can come into the cannabis space to further professionalize, standardize, and consolidate, they will and on an order of magnitude that will be consistent with any industry with this market potential.

At that point, you’re just another rich guy or gal trying to time the market, whereas right now you can drive terms, generate risk aversion through portfolio construction, and multiply returns simply by outpacing and out-capitalizing your competition in a hyper-focused strategy or geography. 

A View from the East

Recently, I’ve been fortunate enough to co-invest with and help direct large family offices in China and Hong Kong on how to consider, approach, and eventually interact within the cannabis industry. The level of direct-investment risk appetite within this community juxtaposed with the Chinese government’s influence of severe illegality of the cannabis plant has created an investment atmosphere there similar to 2014 -2015 in the United States. The presiding sentiment of illegality in the elder generations of family offices and conglomerates in Asia disallowed discussion of investing in cannabis until recently. Now that Thailand has quickly materialized a medicinal program and other small nations are considering the same, Asian families are taking note and considering all aspects of how this will impact their current investments and businesses, as well as considering how they are positioned to participate in the local or global industry to come. 

When the activity was exclusively in the Americas, cannabis discussion was easy to shun. MJ Biz’s Vegas conference would display dozens of vaporizer companies designing and manufacturing direct from Shenzhen and that was the extent of Asian involvement in those days. Today, industrial hemp licenses in mainland China open up the conversation to then learn about what Thailand is doing, followed by South Korea. In exploring those topics, it is natural to wonder, for example: What are the best practices in the United States? What mistakes did Canada make that we can avoid? What is the best equatorial parallel to cultivate commoditized plants and should we be considering an evolution of our choice of crops? 

It’s a slippery slope before this exploration becomes tangible, when funds and operating companies alike will receive inquiry from some of the world’s largest conglomerate families situated in the East, looking west for opportunity. Make no mistake, while Fidelity and alike are not ready to jump, balance sheets from multi-national family offices based out of Hong Kong, Singapore, and beyond will likely have an allocation to the cannabis industry in one way or another very soon. 

If Constellation Brands putting billions of dollars into Canopy and Altria doing the same with Cronos does not wake us up to “real capital” coming into the industry, Asia’s intrigue and certain nations’ activity should light a fire under all of us.

A-Self-Fixing-Record

Often when history is on repeat, there is a sense of dismay out of frustration that society is making the same mistakes over and over. The cannabis industry is in a fascinating position where US states or entire countries have established medical cannabis programs and eventually evolve to adult-use programs. Investors can learn from the myriad mistakes made to date, avoiding a broken record of missteps, to more effectively deploy capital. 

Investors in the US can learn from the irrational focus on international exports and “funded capacity metrics” that misvalued the Canadian market opportunity. Investors in Oklahoma can learn from the immediate commoditization of biomass in Washington and Oregon when hardly any regulatory protections were put in place. Investors in technologies can learn from the ongoing struggle vaporizer companies are facing as black-market competitors ruin the reputation of a particular delivery method when not meticulously built and tested with health and safety as primary concerns. Investors building infrastructure on a shoestring can learn from CannTrusts’ shutdown from cutting corners and deceiving regulators, resulting in a 90% nosedive. The list goes on. 

Where private investors have this lingering opportunity to guide the industry for this last step, likely an 18 – 24 month window, the onus is on each of us to form the market that is informing the future. We have a chance now to learn from the mistakes of the past and help unlock the potential of the leading companies, operators, and emerging concepts. It’s a new privilege to have a dataset of five years of a legal industry – as only now do we have some historic comparables. For a while, investors had been flying completely blind. To place capital into companies with frivolous or short-sighted business plans, even if the direct deal appears comparatively stellar within one’s own deal flow, is doing a disservice to the very reason this industry is unique. The cannabis industry, to me, is the ultimate impact investing opportunity. All at once we can support social justice reform, bring industry back into devastated manufacturing towns, advance personalized, plant-based medical care, eliminate more toxic treatments from our repertoires, and make outsized returns.

That’s a family farm worth staying on. 

G. Ryan Ansin

October 14, 2019

Brief Update on the Home Front: It has been a crazy year here. Revolutionary continues to grow with 160+ employees now and the first building of our campus completely operational. Finishing a growth-stage fund raise there. Beyond Revolutionary, we remain active in the private market, specifically focusing on the ag-tech, heath-tech, and advanced cannabinoid research and genetics verticals. Both groups, one private equity focused and one debt, who I advise are navigating the industry’s recent volatility well thanks to a conservative approach woven into the fabric of the investment theses. Am happy, excited yet tired, and glad for this industry’s next level of maturation made possible thanks to the efforts of so many pioneers paving a bold new path for a healthier community. If you’re interested in exploring together, feel free to reach out to discuss collaboration. We are always seeking likeminded investors and operators alike. We are stronger together.

Resources:

Green With Greed (2018): https://docsend.com/view/73n2dud

Family Offices Investing (2017): https://docsend.com/view/qavpp7b

Viridian Deal Tracker : https://viridianca.com

SAFE Banking Act : https://bit.ly/33usIyd

[1] Recently, there are reports that Mitch McConnell has agreed to meet off the record with some of the leaders of the cannabis industry to discuss the SAFE Bill as well as other concerns of the industry that may pave the path for the legislation being submitted to the Senate for a vote.