Bearish markets and high interest rates often cause private investors to turn away from anything resembling a risky investment. Yet, now is a very apt time to take another look at the cannabis opportunity in the U.S.
Quite a lot has changed since our previous U.S. cannabis survey from 2020. Recreational cannabis is now legal in a few more states, including New Jersey and New York, the latter of which has even launched a social equity program that aims to help communities affected by the War on Drugs. Despite the market downturn, the sector is growing — legal sales of marijuana and related products are slated to rise about 32% from 2021 to top $33 billion this year and reach $52 billion by 2026, according to MJBiz.
But cannabis startups still have a long way to go before they can begin to truly thrive in the country. The biggest roadblock is cannabis’ illegal status at the federal level, which makes things even more difficult and fragmented than in Europe.
As we learnt in our European cannabis survey, despite cannabis being illegal at a federal level in the EU, companies can produce cannabis in one country and sell to businesses across borders as long as they have the necessary licenses. It’s a stark contrast to the barriers to selling across states in the U.S., and the banking and tax headaches it creates.
The lack of access to traditional financing services — commercial banking, credit card merchant processors, etc. — is holding the industry back. “Banking reform is the key to unlocking access to the capital markets,” said Emily Paxhia, managing director at Poseidon. “Offering mainstream banking services to cannabis operators would break the market open and could change custody rules that prevent institutional capital from participating. It would also create better liquidity and efficiency for market dynamics around publicly traded companies.”
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No one has a clue when banking reforms, let alone federal legalization, could happen, so should investors just wait for more momentum? That’s perhaps what generalist investors are doing but not the specialists. No, indeed, they are looking to preempt institutional capital.
To turn today’s early bets into tomorrow’s lucrative investments, specialized firms like Entourage Effect Capital and Poseidon are deploying capital into so-called “plant-touching” and ancillary businesses. The latter refers to companies that are working on the infrastructure the sector will rely on once in full bloom, and the consensus among specialized investors is that they make for very worthy bets. Funds need funders too, however, and the lack of traditional LPs willing to write checks for this industry can be problematic even though investments are trending upward.
But VCs have found allies in family offices — a category of investors who are less constrained than their institutional peers and have plenty of capital to deploy. “We are seeing more and more first-time family office investors enter the industry at a pace we haven’t seen to date,” said Matt Hawkins, managing partner at Entourage Effect Capital.
We polled four active investors in the space to better understand the cannabis market right now in the U.S. and the regulatory hurdles the sector will have to overcome in the future.
We spoke with:
- Jacqueline Bennett, managing partner and co-founder, Highlands Venture Partners
- Yoni Meyer, partner, Casa Verde Capital
- Matt Hawkins, managing partner and co-founder, Entourage Effect Capital
- Emily Paxhia, managing director, Poseidon Investment Management
Jacqueline Bennett, managing partner and co-founder, Highlands Venture Partners
As cannabis companies struggle to maintain their market cap in public markets and compete with the black market, what is keeping you excited about the space?
The backdrop for public cannabis companies remains bleak with no signs of a near-term recovery. That said, the fundamental business opportunity remains intact.
Weak markets and a challenging macro environment will test operators, expose misplaced strategies and tighten the wedge between cannabis capital (public or private) and liquidity.
While exhaustion is setting in and industry constituents long for a break, now is the best time for investors to discover talent and promising ideas. We saw record levels of M&A activity in cannabis over the past 12-18 months. Most of these acquisitions were paid for with large amounts of stock, and given where stock prices are trading today relative to 52-week-highs, seller’s remorse is the theme.
While economic loss is never fun, what this dynamic does promise is the re-entry of experienced talent in the market.
Have you seen a flight of generalist investors from this sector?
“Given regulatory hurdles surrounding plant-touching companies, investing in ancillary businesses has also provided us an opportunity to bring in more traditional investors into the space.” Yoni Meyer, partner, Casa Verde Capital
Any pullback from investors, I believe, is temporary and driven by current market conditions as opposed to loss of confidence in the sector. It feels impossible to not see opportunity after being submerged in the industry and exposed to the endless potential of both the plant and resulting innovation across verticals.
In the near term, what are you more interested in: Ancillary businesses or plant-touching companies?
I’ve never bifurcated the industry in this way for investing purposes. We have a good balance of ancillary and plant-touching companies in our portfolio, and this is reflective of the diversity in my partnership with Tahira [Rehmatullah] and our category-agnostic investment thesis.
What we won’t compromise on is: strength and experience of management, purpose-driven products or services and a TAM that expands at the intersection of industries.
Do you see any opportunities in this space that are being overlooked by investors and entrepreneurs?
Companies led by women, people of color and minorities. While not unique to cannabis, subconscious bias amongst investors and operators guarantees missed opportunities. Cannabis also happens to be an industry best understood by these overlooked demographics.
Health equity and innovation in women’s wellness is slowly unlocking in parallel with the cannabis industry, and we see significant synergies in R&D and product innovation. The challenge I pose to myself and my peers is to pause, look up and break habits.
There is significant trapped value in cannabis, and until we acknowledge and remove bias from business, we will continue to miss opportunities for justice and innovation.
Cannabis production is still illegal under federal law, which means companies in this industry can’t use traditional financial services. How much of a roadblock is this to the industry’s growth, and how do you advise your portfolio companies to deal with these restrictions?
Restricted [access to] financial services is a massive impediment for the industry and affects every industry participant in a material way. The silver lining is that we get creative, collaborative and deepen a sense of community. These are the same traits we look for in our portfolio teams and so it becomes a self-fulfilling prophecy!
Cannabis is not for someone needing a well-trodden path void of obstacles. People join and stay in cannabis because of a connection that extends beyond business. It’s the mission. At least that’s true of myself and many of the wonderful folks I’ve been fortunate to meet.
With New Jersey legalizing recreational use, several U.S. states could legalize medical or adult use this year. Do you expect these milestones to impact valuations? Are you watching for any changes in regulation that would break this market open even wider?
Following the 2020 U.S. election results, the markets showed us what could happen with regulatory change at the federal level with an immediate uptick in valuations. Since then, Congress has made little to no progress toward federal legalization and cannabis stock prices barely flinch at news of regulatory advances at the state or federal level.
All this is to say that I believe the markets are now waiting for the actual implementation of legislation that has potential for sustained value creation in the industry, like SAFE Banking.
Has the type of LPs willing to invest in cannabis-related funds changed at the pace you hoped?
There has absolutely been an evolution in LP community interest in cannabis. Cannabis remains one of the very few industries with guaranteed growth for many years to come. The challenge is understanding where to find this growth and be comfortable with locking up cash for longer-than-expected periods.
We still meet LPs with strict policies that do not allow investment in the industry, mostly on the plant-touching side. LPs who previously held back because of sentiment or lack of knowledge have been gradually crossing the floor.
My strong advice to new capital in the industry is to partner with experienced cannabis investors. You cannot prepare for the degree of surprise in the space. Never a dull moment!
NY is creating a social and economic equity program as part of its retail license attribution. Are you seeing investors adopting an equity-minded approach to open up the space to communities harmed by legacy drug enforcement policies?
We are gradually seeing more investors and operators acknowledge social equity and the importance of creating and prioritizing opportunities for communities harmed by the War on Drugs and other social injustices.
How do you prefer to be approached, a cold email, or a warm pitch?
I do love a warm pitch.
I respond to an inbound when I feel a connection to a person or a story. My best advice to entrepreneurs at the fundraising stage is to share your vision rather than sell it. Remember why you’re investing your entire life into building whatever it is your building, and let us hear that.
Yoni Meyer, partner, Casa Verde Capital
As cannabis companies struggle to maintain their market cap in public markets and compete with the black market, what is keeping you excited about the space? Have you seen a flight of generalist investors from this sector?
Despite dramatically higher growth prospects than CPG, tobacco, pharma and alcohol (collectively about 5% projected revenue growth year on year), U.S. multistate operators (43% YoY) are still seeing depressed valuation multiples (lagging by about 30%) compared to these traditional industries.
While we’re optimistic about the long-term viability of these businesses, there are a number of structural issues that need to be resolved, including long-term institutional support, access to traditional banking services and rescheduling.
That said, the pullback in public names doesn’t change the Casa Verde strategy; if anything, it makes our entry points into some of the most exciting companies even more attractive. The pullback is a good reminder to continue to be diligent and deliberate in the companies we invest in, but as long-term investors, we don’t get rattled by short-term volatility.
As for the “flight of generalist investors,” there were never many to begin with, so I don’t think the current environment has changed things too dramatically.
In the near term, what are you more interested in: Ancillary businesses or plant-touching companies?
Ancillary companies have always been core to our thesis. In general, these types of businesses are much easier to scale, as they’re unencumbered by state regulations and are considerably less capital intensive. Given regulatory hurdles surrounding plant-touching companies, investing in ancillary businesses has also provided us an opportunity to bring in more traditional investors into the space.
Although we continue to maintain a focus on ancillary companies, we have no restrictions as to where we can deploy capital. Today, we are particularly excited about Europe and believe the region is at a critical tipping point. With the regulatory environment rapidly evolving, we’re very excited about the prospects for certain European operators.
Do you see any opportunities in this space that are being overlooked by investors and entrepreneurs?
Sourcing equity and/or debt capital can be very challenging given the limited number of cannabis investors. There is simply not enough capital to support the industry, so there are certainly opportunities being overlooked. On the debt side, while many large public cannabis companies can secure somewhat reasonable interest rates, smaller operators struggle to find affordable capital. One of our portfolio companies, Bespoke Financial, provides short-term debt financing solutions for middle-market cannabis businesses.
Cannabis production is still illegal under federal law, which means companies in this industry can’t use traditional financial services. How much of a roadblock is this to the industry’s growth, and how do you advise your portfolio companies to deal with these restrictions?
Although traditional financial services are not accessible, there are around 700 credit unions and state-chartered banks that service the cannabis industry. While SAFE banking would alleviate many challenges, we don’t foresee this legislative change in the near future.
With that said, we advise our companies/founders to create redundancies across their businesses, especially as it relates to bank accounts.
With New Jersey legalizing recreational use, several U.S. states could legalize medical or adult use this year. Do you expect these milestones to impact valuations? Are you watching for any changes in regulation that would break this market open even wider?
While the wave of cannabis legislation across the U.S. is certainly exciting, there is no clear correlation between one state’s legislation and cannabis valuations. What drives valuations in the U.S. is more closely related to speculation surrounding federal legislation.
For example, New Jersey saw over $2 million in adult-use cannabis sales on the first day of its program, yet we did not see an uptick in valuations for companies with operations in the state. Conversely, when President Biden was elected in November 2020, we saw a massive spike in valuations, as investors believed the new administration would bring sweeping cannabis reform at the federal level.
As a result, we maintain limited excitement around state legislation and remain much more focused on changes at the federal level.
Has the type of LPs willing to invest in cannabis-related funds changed at the pace you hoped?
Over the last five years, we have gradually seen more institutional interest from venture and private equity funds, especially as co-investors in our portfolio companies. We are frequently talking with more traditional players, like endowments and pension funds, but many of these investors are not yet ready to jump into the space.
NY is creating a social and economic equity program as part of its retail license attribution. Are you seeing investors adopting an equity-minded approach to open up the space to communities harmed by legacy drug enforcement policies?
Programs like the social and economic equity program in NY, along with social equity investing as a whole, are garnering significant mainstream attention. We believe it is extremely important to support communities impacted by legacy drug enforcement policies. We make it a point to prioritize calls and expedite the feedback loop for minority-founded companies to ensure we are providing valuable guidance.
How do you prefer to be approached: a cold email or a warm pitch?
We prefer to be approached through a warm introduction but constantly review all inbound communication, especially from our website.
Matt Hawkins, managing partner and co-founder, Entourage Effect Capital
As cannabis companies struggle to maintain their market cap in public markets and compete with the black market, what is keeping you excited about the space?
I’ve remained optimistic about the industry’s growth potential considering the rising rates of consumer adoption and successful state-level legalization efforts. This is still an attractive sector for investors who want to engage with public and private markets before quasi-legalization occurs.
While the timeline for federal legalization is unknown, we are seeing leading operators build scale as the market ebbs and flows. We just have to stay focused and patient.
Have you seen a flight of generalist investors from this sector?
Certainly, many investors have left the space (especially in the public sector), but we have multiple new investors in our third fund that see the opportunity since valuations are at rock-bottom levels.
In the near term, what are you more interested in: Ancillary businesses or plant-touching companies?
Both are compelling opportunities considering how we invest across the supply chain. We aim to keep a diversified portfolio.
Both ancillary and plant-touching companies provide unique investment opportunities that we leverage by deploying capital in strategic geographies and sectors throughout the industry with the goal of building scale in advance of institutional capital entering the space.
Do you see any opportunities in this space that are being overlooked by investors and entrepreneurs?
As I mentioned, our firm invests in all levels of the supply chain within the cannabis industry. However, I believe we secured a first-mover advantage by investing in cannabis safety and monitoring technology.
Last year, we invested $10 million in Hound Labs, the company behind the only breathalyzer that measures THC content at the exact moment of the test, unlike conventional drug tests. This product has the potential to change/enhance drug-testing protocols in corporate America and beyond.
Cannabis production is still illegal under federal law, which means companies in this industry can’t use traditional financial services. How much of a roadblock is this to the industry’s growth, and how do you advise your portfolio companies to deal with these restrictions?
While banking business services are widespread in the industry, from local banks, state-chartered banks and credit unions, lack of access to traditional lending services and equity-related institutional capital continue to be the greatest pain points for legal cannabis companies.
The industry is unable to write checks that allow it to compete with adjacent industries like alcohol and pharmaceuticals. Established larger cannabis companies are focusing more on consolidation in an effort to build scale before legalization happens.
My advice has been to be patient. Some form of federal cannabis legalization is a matter of “when,” not “if.” The real benefit will be the potential to build scale and profit once traditional lending and institutional capital floods the market.
With New Jersey legalizing recreational use, several U.S. states could legalize medical or adult use this year. Do you expect these milestones to impact valuations? Are you watching for any changes in regulation that would break this market open even wider?
New Jersey’s adult-use launch was a significant milestone for the East Coast cannabis market and will likely bolster industry growth. However, the industry can only reach a certain level of maturity without meaningful federal banking reforms.
Implementing policies like the SAFE Banking Act would reduce the cost of capital, allow mainstream banks to serve plant-touching companies and streamline business transactions across the industry.
Has the type of LPs willing to invest in cannabis-related funds changed at the pace you hoped?
We are seeing more and more first-time family office investors enter the industry at a pace we haven’t seen to date.
NY is creating a social and economic equity program as part of its retail license attribution. Are you seeing investors adopting an equity-minded approach to open up the space to communities harmed by legacy drug enforcement policies?
Absolutely. The cannabis industry, as a whole, is enacting policies and creating professional opportunities for individuals affected by the War on Drugs. We will continue seeking ways to invest in social and economic programs that will meaningfully support communities harmed by cannabis prohibition.
How do you prefer to be approached: a cold email or a warm pitch?
Our team is always open to new conversations and opportunities. Feel free to reach out to us.
Emily Paxhia, managing director, Poseidon Investment Management
As cannabis companies struggle to maintain their market cap in public markets and compete with the black market, what is keeping you excited about the space?
Despite recent market volatility, we still consider cannabis one of the most attractive consumer product segments in the United States. The prospect of free cash flow bolsters the future of the cannabis industry once we see changes in regulations and taxation. New laws for cannabis banking will make the market much more efficient.
Have you seen a flight of generalist investors from this sector?
Yes, but this largely stems from common misunderstandings and a lack of due diligence. There is the assumption that the cannabis industry is small, but there are still numerous untapped opportunities. New states and countries lifting cannabis restrictions will create broader consumer market growth. Capital has been a commodity for generalist investors — they’ve had to refocus on their existing portfolios after seeing a 70% drawdown in the public markets.
In the near term, what are you more interested in: Ancillary businesses or plant-touching companies?
We consider investment opportunities in both sectors and have always believed there is a benefit to investing in ancillary and plant-touching companies. We have an open perspective on how the market works, and we feel our approach unlocks more opportunities to generate returns. An investment in a plant-touching or operational business can inform future investing around ancillary companies or vice versa.
Do you see any opportunities in this space that are being overlooked by investors and entrepreneurs?
Our most recent fund is investing in critical industry infrastructure that supports the operational efficiency and effectiveness of cannabis operators. Poseidon recently invested in Komplyd and C15 Solutions — compliance software solutions and EQMS designed to help new cannabis companies.
Cannabis production is illegal under federal law, which means companies in this industry can’t use traditional financial services. How much of a roadblock is this to the industry’s growth, and how do you advise your portfolio companies to deal with these restrictions?
Federal legality isn’t a concern outside of banking and tax issues from a business standpoint. We’re focused on looking at legalization initiatives at the state level, which will inevitably create additional expansion opportunities.
Morally and ethically, I take tremendous issue with cannabis’ current status as a Schedule I substance and its effect on communities from a criminal justice perspective.
With New Jersey legalizing recreational use, several U.S. states could legalize medical or adult use this year. Do you expect these milestones to impact valuations? Are you watching for any changes in regulation that would break this market open even wider?
I don’t expect these recent milestones to impact valuations. Each state’s cannabis market is unique and should be evaluated differently. New Jersey will be different from how New York or any other state opens.
Banking reform is the key to unlocking access to the capital markets. Offering mainstream banking services to cannabis operators would break the market open and could change custody rules that prevent institutional capital from participating. It would also create better liquidity and efficiency for market dynamics around publicly traded companies.
Has the type of LPs willing to invest in cannabis-related funds changed at the pace you hoped?
Unfortunately not. We had hoped to see it open up beyond high-net-worth individuals and family offices to include a more institutional level of interest, as you would see in other sectors.
NY is creating a social and economic equity program as part of its retail license attribution. Are you seeing investors adopting an equity-minded approach to open up the space to communities harmed by legacy drug enforcement policies?
Yes. Poseidon is investing in groups that work with equity partners, and we’re hopeful New York and other markets will establish comprehensive programs that benefit people impacted by cannabis prohibition.
How do you prefer to be approached: a cold email or a warm pitch?
A warm introduction from a respected colleague is preferred. That way, I’m always able to give a response. Or you can reach out on our website.