​Private Equity, Legitimacy and the Cannabis Industry

Steve Gormley |

Written by Steve Gormley

As it stands, the legal cannabis industry is currently estimated as an annual $2.7 billion market. The value of the legal cannabis industry after federal prohibition is repealed is estimated at $38.6 billion, roughly 12% larger than the entire ‘Organic Foods’ industry. Given these measures, it’s not surprising that the space is filled with entrepreneurs and investors hoping to capitalize on what’s colloquially referred to as the ‘Green Rush.’

With this in mind, it’s important that enthusiasts in the space do their research on different business models designed for a strong ROI. While some ventures might have low success rates, others (such as private equity) are looked at as future investment vehicles with boundless potential for revenue. From my perspective, there’s no better opportunity for profit and prosperity in the space than private equity, driven by legitimate business practices, in the California cannabis industry.

Current Industry Status

While the industry as a whole is booming, the cannabis space itself has a good deal of progress to make before businesses across the US will be able to function without fear of lost tax breaks, federal intervention, and unpredictable lunges from ‘traditional’ companies. Cannabis remains on the federal drug schedule in the same category as heroin, contrary to all legitimate studies pointing to its usefulness through medical treatments, and advocates are hard at work to ensure that medical patients and business owners are able to operate in line with reasonable, state-specific policies. There have been countless examples of companies failing to receive access to banking due to federal illegality, as well as medical patients failing to receive their much-needed medication due to unfounded state regulatory hurdles.

This being said, it’s important to note that well-organized lobbying efforts exist in every state, the success of which can be validated by the fact that 28 states and the District of Columbia have legalized medical marijuana over the past 17 years, over 50% of which passed legislation in the past five. Over the last three years, eight of these states and the District of Columbia have passed legislation permitting the recreational adult use of cannabis products, and tax revenues from these states have been used for purposes ranging from increasing municipal education budgets to aiding the homeless. We can and should look at ways in which the industry/space should be improved, but we need to keep a firm grasp on what is working so that we can model new states’ legislation after successful bills in legal regions.

Why Private Equity?

As time has passed and the space has become more legitimate, more and more companies in the cannabis industry have become publicly traded for the purpose of expanding their base of potential investors to greater levels. This is a tactic that has a great deal of rationale behind it, to be sure, but the main issue with investing in public companies is that the opportunity to see high valuation is limited; generally speaking, such extreme valuations will already be factored into the stock price. Whether this reduces systemic risk or not remains to be seen, but there’s no doubt that purchasing private equity allows for the ability to look for (and find) largely undiscovered gems, especially in the cannabis space, which can allow for exceedingly high revenues.

In addition to concerns that investors might have about investing in publicly traded companies as a general tactic, the cannabis space has none of the protections that any other industry enjoys. Given the status of cannabis as a Schedule 1 substance, public companies have difficulty moving to larger exchanges, such as the Nasdaq, especially when touching the plant (where most of the money lies). Private equity, on the other hand, allows for a broader variety of deal structures for investors, and companies choosing to take this route often have an easier time accomplishing their objectives as they don’t have to fly in the face of federal illegality.

As for other methods of investing in cannabis companies, it’s important to consider the length and validity of one’s options. If I were to mention the term ‘crowdfunding’ to the average investor five years ago, for example, they wouldn’t know what I was talking about. While the concept itself is interesting, crowdfunding creates an accounting nightmare, especially in a space with as much regulatory oversight as the cannabis industry. In the absence of a body of legal precedents in the industry that support one’s ability to safely take in investments through crowdfunding, the practice seems to be a risky one at best.

Legitimate Practices

Ethicality is a vitally important business practice across sectors, as most entrepreneurs will tell you, but it’s especially crucial to the success of a business in the cannabis industry. Given a rapidly shifting regulatory framework, an increasingly high number of unlicensed participants in the space, and a high number of disincentives for businesses to follow legal guidelines (such as the inability of business-owners in the space to write off tax deductions due to federal illegality), it’s easy for industry occupants to veer off from the straight and narrow. As a result, business owners in the industry that operate with a high degree of ethicality and honesty are looked at with a degree of validity that is unattainable to those that engage in dishonest business practices. It’s also worth considering that given the highly social nature of the space, business relationships (while often high-tech) are often of the old-fashioned nature, with social interactions being prioritized to a high degree. With all this in mind, the importance of being honest in the space can’t be overemphasized.

Why California?

The advantages to investing in California’s cannabis industry, as opposed to those in other states, are numerous and well-established. In September of last year, the new MMRSA (Medical Marijuana Regulation and Safety Act) laws were signed into effect, marking the most significant change in California’s cannabis laws since the passage of Prop 215 in 1996, which legalized medical marijuana in the state. This milestone was surpassed last month when California residents voted in support of allowing the adult recreational use of cannabis via the passage of Proposition 64, which will take effect in January of 2018.

In terms of total revenue and business opportunities in the space, there are currently an estimated 80 fully compliant medical marijuana licenses in the city of Los Angeles. Of the $6.7 billion of revenue generated from legal cannabis in 2015, 25% was captured in LA County. This particular region of the country is well-known for its capacity to generate high revenue through cannabis cultivation and dispensation, and the high number of licensed dispensaries in Los Angeles alone (not to mention the even higher number of unlicensed dispensaries in the area) is indicative of this widely-held position.

In Conclusion…

The cannabis industry as a whole presents almost innumerable opportunities for revenue growth and entrepreneurial ventures, and anyone with a vague sense of its potential would be mistaken to pass off the growing trend towards legal cannabis as a vehicle for profit as anything other than a solid, worthwhile investment. With this in mind, interested parties need to do their research and ensure that the paths they take into the industry are chosen with a degree of foresight and thoughtfulness, and it’s my opinion that there’s no better opportunity for high ROI in the industry than via investing in California-based private equity firms operating with a high degree of ethicality. With luck, the percentage of people jumping into the space that have done their research will increase, and those that have missed particular opportunities will have the means of getting re-engaged with the right tools.

Steve Gormley is a Founding and Managing Partner of Seventh Point, LLC: a private equity pledge fund focused on the acquisition of legal and compliant cannabis industry assets through new deployments, straight acquisitions, joint ventures and strategic financing. Steve is a renowned expert in the legal marijuana sector and whose analysis is featured prominently in outlets like Forbes, Wall Street Journal, CBS News, US News and World Report, Chicago Tribune, and Marketwatch. Steve is a partner in a retail hydroponic supply distributor outfitting commercial-grade cultivators in the Los Angeles area.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer



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