Marijuana prohibition is a big opportunity for a few funds

A few dedicated funds are
capitalizing on marijuana prohibition in a big
way.
Anthony
Bolante/Reuters

• Marijuana
  is one of the fastest-growing industries in the US. It’s also
  illegal.
• Federal prohibition has given rise to a number of
  dedicated funds that
   are looking to
  capitalize on the “short window” of opportunity before
  institutional investors start writing checks.
• Investors who are patient and willing to take on the
  risk stand to make huge gains. 

 

Legal marijuana is one of the fastest-growing industries
in the US. It generates hundreds of millions in tax revenue in
states where selling
the drug is legal, and it’s expected to become a
$32 billion global market in the next four years. It’s also
considered illegal by the federal government.

But for a few cannabis-specific
funds, federal marijuana
prohibition is the opportunity of a lifetime. 

While many of the biggest Wall Street banks and
institutional investors may want to do business in the cannabis
industry, their limited partners — typically large pension funds
or insurance companies — are spooked by federal
prohibition. 

Jon Trauben, a partner at the New York City-based Altitude
Investment Management, which manages around $25 million,
told Business Insider in a recent interview that the firm is
taking advantage of that short “window of opportunity” to invest
in marijuana before prohibition recedes and the big institutional
players jump into the sector.

“It’s unique, timely, and you can’t ignore it,” Trauben
said.

Here’s how it works: canny investors like Trauben hit up
high-net-worth individuals or family offices for capital. These
entities are willing to take on tons of risk putting their money
to work in what amounts to a legal grey area. 

Through dedicated funds — structured as
venture capital,
private equity, or hedge
funds — that capital can be quickly deployed to finance
growth in the
booming cannabis sector, especially for US-based companies
that are working under severe capital constraints.

Most of these funds invest in
ancillary companies, like tech startups that provide software
and payroll services to the booming marijuana industry but don’t
actually grow or sell the plant itself. That shields them from
most of the risks involved with doing business in an industry the
federal government considers illegal, but still allows them to
reap profits. 

Jenny Cheng/ Business Insider

The chaos theory of investing in cannabis 

Many investors in the marijuana industry are taking a page
straight out of the “Game of Thrones” playbook: Chaos,  in
this case, is a ladder to strong returns.  

“When there’s complexity, when there’s chaos, when there’s
uncertainty, that’s when the people who are really good at doing
what they are doing stand to make really strong gains,” Micah
Tapman, a managing director at
Colorado-based Canopy, which focuses on
early-stage investments in the cannabis industry, previously told
Business Insider.

“The lack of banking and lack of access to capital is
creating a huge opportunity,” Danny Moses, a hedge funder
behind the famous “Big Short” trade chronicled by Michael
Lewis said
at the Cannabis World Congress and Business Expo in New
York. “It’s a gold mine, but it’s also a minefield.”

Moses, who has called investing in marijuana the “big
long,” has put some of his personal money into Merida
Capital, a New York-city based private equity fund led by a
former corporate attorney, Mitch Baruchowitz.

To Baruchowitz, who told Business Insider in June that his
firm manages around $50 million, the best investments are those
that build the “scaffolds” for the marijuana industry.

“So our investment thesis is one that is much more geared
towards that scaffolding,” Baruchowitz said. He pointed to Merida
portfolio companies like Simplifya, a software service that
helps cannabis dispensaries comply with byzantine operating
regulations, which tend to differ state-by-state. 

As with any cutting-edge industry, there’s a learning curve
for investors. But it’s easier when they’re not competing with
multibillion-dollar funds. 

“There’s no truer way to learn something unless you spend
your own money,” Trauben, of Altitude, said. “And right now, we
don’t have to compete with the Goliaths.”

Wall Street is banging at the door 

The legal grey area the cannabis industry finds itself in
is slowly shrinking, and the window of opportunity for investors
will eventually close. 

Big institutional firms are already pushing into marijuana
as attitudes around the drug change, and a number of bills
legitimizing the industry at the federal level
work their way through Congress.

Karan Wadhera, the managing partner of Casa Verde, a Los
Angeles-based venture capital fund focused on ancillary cannabis
companies,
told Business Insider in April that his fund is receiving a
lot of inbound interest from large institutional
investors. 

“I think this is a testament to both the size and pace of
growth in the cannabis industry,” Wadhera said, adding that last
year, “many top VCs would not be ready to entertain a
conversation on cannabis.”

Just last week, Constellation Brands — the beermaker behind
Corona —
sunk $4 billion in a stock deal into Canopy Growth, a
publicly traded marijuana company. It’s the largest corporate
investment into a marijuana cultivator to date.

And guess who advised Constellation on the transaction?
None other than the most institutional of institutional firms:
Goldman Sachs. Bank of America, one of the largest banks in the
world, provided the financing.

Read more of our cannabis industry coverage: