October 6, 2015
Interviewed by: David Snow
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The Marijuana Opportunity

As the federal government eases restrictions on the use and sale of marijuana and becoming more in line with states’ legislation, and creating an enormous opportunity for private equity with ancillary businesses servicing the nascent industry.

As the federal government eases restrictions on the use and sale of marijuana and becoming more in line with states’ legislation, and creating an enormous opportunity for private equity with ancillary businesses servicing the nascent industry.

The Marijuana Opportunity
With Kris Krane of 4Front Ventures

David Snow, Privcap:
Today, we’re joined by Kris Krane of 4Front Ventures. Kris, welcome to Privcap. Thanks for being here.

Kris Krane, 4Front Ventures:
Thanks for having me.

Snow: You invest in an interesting and burgeoning market, that is the cannabis market—marijuana. I can tell you for certain that you’re the first investor I’ve had on this program that invests in that market, so I’m very interested to hear all about it and where you see the opportunities to grow capital. Why don’t we start with an overview of the market itself?

Krane: There are four states that have fully legalized marijuana, plus the District of Columbia. That would be Colorado, Washington, then this past year, we had D.C., Oregon and Alaska were added to that. Oregon had actually just implemented their program. Alaska will be doing so next year and D.C. doesn’t have a market to speak of. They legalized possession and small-scale cultivation.

But this is a much larger market than just those states where it’s legal for adult use, or what some would call “recreational use.” We have, I believe, 32 states currently that have legalized for medical purposes. And in about half of those states, there are legitimate markets in play today. Even with adult use being legal in Colorado and Washington, the largest state market—still by a fairly wide margin—is California, which has existed as a largely unregulated medical market, although that is about to change. They finally passed state regulations.

So, there are legitimate opportunities for investment in the market in these legal adult-use states. But you could also look to states like Arizona and Massachusetts, Nevada, and Maryland, which will be coming online here any day now.

Snow: Your firm, 4Front Ventures, both advises cannabis-oriented businesses and invests. Talk about the range of businesses involved in this space, if you could categorize them.

Krane: Sure. There are a number of businesses involved in the cannabis space. The primary businesses, so to speak, would be what we call “direct-to-plant” businesses. Those are companies or businesses that get licensed by a state agency typically, although in some states they’re throw open. Those are typically not the ones we look at from a business opportunity standpoint. But these direct-to-plant businesses are things like cultivation facilities and infusedproducts manufacturers (the labs that essentially extract a cannabis oil out of the plant and turn it into all sorts of different products). Then, of course, [there are] dispensaries—the retail facilities that dispense the medical cannabis or cannabis products to the end user.

You also have a whole slew of ancillary businesses that have sprung up. And some of the more successful companies in the space today are on the ancillary side, because it’s easier to grow your business on the ancillary side. In general, it’s not as challenging to get and maintain licensing.

To hark back to the very famous Mark Twain quote, “When there’s a gold rush on, it’s a good time to get in the picks and shovels business.” Today, some of the more successful companies really have come from the picksandshovels side of the industry. Although in the long term, clearly the businesses that wind up becoming the market leaders—and the most successful in terms of producing products and creating great retail environments—are going to be the biggest winners in the space.

Snow: Is it permissible to mail marijuana products to end users?

Krane: No. It is permissible to mail some of the ancillary products, [like] delivery devices. Those types of things you can often send. But no, you cannot send any—

Snow: So, for now, it is a brickand-mortar retail experience.

Krane: It is entirely a brickandmortar retail experience, other than some states allowing for the dispensary license holders to also deliver directly to the patients. I don’t think any of the adult-use states have delivery yet, although that probably will come in the future. But a lot of states do allow for dispensaries to deliver. This is particularly important in medical states where you’re dealing with, in some cases, very seriously ill patients. It can be difficult for them to get to a brickandmortar store at times. Some of these patients are not ambulatory. Others are just ill and it’s a real endeavor for them to get out to a store. So, they can deliver, but no—this is still 100% illegal under federal law, so nothing can be sent through the U.S. Postal Service. And certainly none of the third-party carrier systems—your FedEx or UPS—are going to touch this.

Snow: Where do you see the opportunity to build scalable businesses right now?

Krane: I think a company like ours that is fairly diversified in our offerings in terms of being involved both in the investment side. I think looking at some of these emerging funds and investment vehicles is a good way to get involved at a higher level and diversify your investment.

Also, companies that do consulting. You have to really do your research. But the best of the best consulting companies tend to be some of the more successful businesses in the space, because they can work with operators in multiple spaces and multiple states—[they] get small pieces of lots of different businesses. Essentially, just through consulting, you’re diversifying your risk by not putting all of your money into opening one dispensary or one grow, which may or may not fail.

There are a number of point-of-sale companies, a couple of which have been very successful, that need to service this market. And as the market grows and you have more cultivation facilities and more dispensaries, they’re all going to need inventory control, inventory tracking, and point-of-sale. So, things like those are also very attractive vehicles.

Snow: Does the statebystate compartmentalization of this industry mean that it’s hard to build a brand that translates across states?

Krane: Yes, it does. It is very difficult to build a brand. In fact, there are very few companies in the space that have been successful at taking their brand national. There are a few that are starting to do it. As we see more and more states come online, some of the more successful businesses from the earlier states are now starting to apply for licenses in new states.

I think where you do have the opportunity today to build more of a national brand is probably on the product side of things; [for example], if you can build a really good infused-products line, for example, or a good line of vaporizer-pen…or e-cigarette cartridges. Or you build a really good edible line with great branding and great product. I would look at companies like Dixie Elixirs, for example, or O-Pen. O-Pen came out of California; Dixie came out of Colorado. [They] have had some success in translating that brand nationally.

Snow: Private investors are used to evaluating and embracing risk as part of their investment programs. Among those risks is not typically running afoul of federal drug laws.

Krane: That’s correct.

Snow: So, what do investors need to understand about backing a portfolio company in this space?

Krane: You have to be extremely diligent in your due diligence and in your background checks of the folks you’re going to work with. I mean, this is not something where you want to look at a healthy balance sheet and go, “Great. I want to put all (or a bunch of) my money into this company.” You want to really evaluate who the operators are. You want to look at what the regulatory environment is in that state. What does it take to be in compliance or to be out of compliance? Then, [you] have the target for investment really open up their operations to you.

You want to be able to see all their books. You want to see all their policies and procedures. You want to see what kind of audit protocols they have in place. You want to make sure that they’re running a compliant operation, not just one that is doing well.

Snow: To what extent are there models of businesses that could be pursued in the cannabis world, taken from (call it) the alcohol world?

Krane: I think most of this industry is going to develop similarly to the way the alcohol business has developed. We’re starting to see that now in a lot of the adult-use states, which have multiple-tiered licensing. You’ll have producers that have one class of license. In some states, you’re looking at multiple classes of licenses within a specific class. So, you may have small-scale producer licenses and large-scale producer licenses, which we see in alcohol. You [may] have a license to have a small boutique winery, or you may have a massive vineyard. You may have a craft brewery, or you may be a large-scale—a macrobrew.

You’re starting to see similar things develop along the products side of this industry where you’ve got real boutique cultivators that focus on super high-end strains that require a lot of care and a lot of time, that’ll sell for a lot higher. Then, you’ve got folks that are opening 250,000squarefoot greenhouses that’ll produce good-quality product, but not the absolute best. But they’re going to do it at economies of scale that really bring the wholesale price down and allow you to dominate a market.

Snow: Correct me if I’m wrong, but I’m going to guess that the available capital for investment in this space is coming primarily from wealthy individuals and family offices, not from institutional investors, which are probably restricted by the sense that this is a vice space. Or they just can’t get their arms around the risks of investing in this new frontier.

Krane: You’re absolutely right about that. The overwhelming majority of investment in this space comes from friends and family investors, angel investors and individual investors. There is essentially no institutional capital to speak of in the space. And it…mostly has to do with the fact that this is still federally illegal. So, banks won’t touch it—they’re not going to risk their FDIC status or federal charter to go make a loan to a business in this industry.

We’re just starting to get to the point where banks are willing to open checking accounts, and there are still very few banks that are willing to do that much, even though the federal government has now said it’s OK for banks to do business in the space. None of them are going to make loans. None of the big institutional firms, or really any institutional firms, are going to touch this.

Snow: Final question for you, Kris. What are some of the biggest misconceptions that you’ve come up against, whether you’re talking to potential investors or just someone you’ve met at a cocktail party or other social venue about your business?

Krane: A lot of people still feel that this is sort of the wild, wild West. And while, in some ways, there is a kernel of truth to that, this is such a brand new industry and some states are far less regulated than others and more difficult to do business in. This is really becoming an industry that is legitimate. It’s run by some real professionals—some folks with some great experience in business. And I think…people have a misconception about what a dispensary is going to look like. They think about a head shop, or a run-down store with some Bob Marley posters misaligned on the walls.

When you take them through a great dispensary—[such as] a Harborside Health Center in Oakland; a Harvest in Tempe, Arizona; Berkeley Patient’s Group; or the clinic in Colorado and the types of dispensaries that we’re going to roll out here in states like Nevada, Illinois, and Massachusetts over the course of the next six months to a year—when you take folks through those operations, or similarly, through a well-run, well-regulated cultivation facility, it becomes apparent very quickly that, “Oh, this is just another business.”

And, in many ways, this is a really well-run business. The difference today from where we were four years ago is that it’s just a massive change.

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