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How to invest in marijuana: advice from cannabis venture capitalists

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Ever since Colorado legalized cannabis for all adults in 2014, the cannabis industry has blossomed, with a multitude of companies competing to scale up as more states legalize the drug. On October 17, Canada became the first G7 country to legalize the plant for all adults.

The industry is growing rapidly — some analysts estimate it will be a $75 billion industry in the US alone — but few institutional funds are willing to invest since marijuana is still considered an illegal, Schedule I drug by the US federal government.

That’s where some dedicated funds see a window of opportunity.

Business Insider surveyed the top venture capitalists writing checks in the booming marijuana industry to understand where the best opportunities lie for new investors.

Read more: The top 12 venture-capital firms making deals in the booming cannabis industry that’s set to skyrocket to $75 billion

The cannabis industry’s ‘peculiar characteristics’ are an opportunity for some investors

“If you strip away the hype around the cannabis industry, it’s really no different from other, more established sectors or business models,” said Brett Finkelstein, a managing director at Florida-based cannabis fund Phyto Partners. “Great venture-capital investing requires the ability to see opportunity where others see a challenge.”

There are challenges aplenty in the industry, with its collection of state and local regulations guiding how companies can operate. And cannabis is a brand new industry, with a paucity of data and rapidly changing regulations, making it unlike any other emerging sector.

“As with any new market, investors should get to know the community and understand the market’s peculiar characteristics,” said Eric Hippeau, a partner at New York City-based Lerer Hippeau.

Hippeau’s firm is one of the few established institutional funds investing in the cannabis industry — albeit in software and media companies that support the industry, not in the plant itself. Most firms avoid the legal risk associated with investing in companies that touch the plant directly, like dispensaries or cultivators.

The fund, famous for its early positions in digital-media companies like BuzzFeed and Axios, has made investments in LeafLink, a software platform for dispensaries; and Vangst, a recruitment platform for cannabis companies.

Hippeau said the “patchwork” nature of the cannabis industry poses special challenges for firms putting money in the space, though it’s also a big opportunity.

“Investors need to understand these nuances,” Hippeau said.

David Abernathy, a vice president at The Arcview Group, a network of high-net-worth cannabis investors, echoed Hippeau’s sentiment and cautioned investors to keep abreast of the swiftly changing rules and regulations around cannabis.

“The landscape evolves on an almost daily basis,” Abernathy said. “Cannabis markets are very nuanced and complicated from a regulatory perspective.”

Abernathy added that the opportunities for investors vary greatly “state to state” and country to country, depending on how the regulations are written.

The ability to understand the unique risks involved with the cannabis industry allows focused investors to seize opportunities that more risk-averse funds may miss.

Small marijuana plants grow in a lab at the new Commercial Cannabis Production Program at Niagara College in Niagara-on-the-Lake, Ontario.
REUTERS/Carlos Osorio

Ancillary businesses like software and technology are poised for rapid growth

“There are some great potential investments in plant-touching businesses — especially emerging brands,” Abernathy said. But in his view, the businesses with the most growth potential are “ancillary” companies that provide products and services supporting the cannabis industry.

Karan Wadhera, the managing partner at Los Angeles-based Casa Verde Capital — which has rapper-turned-Renaissance-man Snoop Dogg on its management team — agreed that ancillary businesses provided the most compelling growth opportunities in the cannabis industry.

“These businesses are especially exciting, as they can scale the quickest with the smallest amount of capital,” Wadhera said, adding that his fund is focused on backing “seasoned entrepreneurs” who can manage risk and approach the cannabis industry with maturity.

Read more: The CEO of the largest cannabis company in the US reveals who his biggest competition is — and pinpoints how he’s fending off multibillion-dollar private-equity funds

“When you invest in a company, you are placing your confidence and trust in the team,” Wadhera said.

Michael Gruber and Jeff Howard, the managing partners of Illinois-based cannabis fund Salveo Capital, said the complex nature of the cannabis industry demands full-time focus.

“Cannabis can be a great investment if managed by a fulltime team of finance professionals who truly understand the nuances of this burgeoning, but still nascent industry,” Gruber and Howard wrote in an email. Diversifying where you invest is critical to shedding some of the serious risks involved in the industry, they added.

A growth opportunity.
Jaime Saldarriaga/Reuters

Tapping into a ‘strong network’ is key

Jon Trauben, a Wall Street veteran who’s now a partner at Altitude Investment Management, a New York-based cannabis fund, said building a “strong network” in the cannabis industry is crucial to making smart investment decisions.

“Build a strong network to test their investment thesis,” Trauben said. “Data and clarity in the cannabis market is lacking, so having a strong network to tap into is essential.”

Some investors cautioned against investing in some of the larger, publicly traded cannabis companies, as the hype surrounding the industry has caused valuations to skyrocket.

“There are definitely some that will be far more valuable in the future, but I also think there are many that won’t execute well and will be worth significantly less in the future,” Matt Shalhoub, a managing director at Toronto-based Green Acre Capital, said. “There has been a lot of volatility in the space, and people definitely need to have the stomach for large swings in either direction.”

Overall, investing in the cannabis industry is “very challenging,” Morgan Paxhia, a managing partner at San Francisco-based Poseidon Asset Management, said.

“Take your time to establish a good foundation instead of rushing into the market,” Paxhia said. “Define your investment process.”

Like other fund managers in the cannabis industry, Paxhia said he’s “very bullish” on ancillary technology companies, from consumer devices to software as a service.

“Yes, this industry is moving very quickly, but managing outside capital carries a lot of responsibility for the betterment of your investors and the legitimacy of the industry,” Paxhia said.

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