Before Ajay Narayan ’14 went to business school, he was a lawyer in California, the first state to legalize medical marijuana. Friends who wanted to get into the business—anything from growing plants to opening a medical dispensary—would ask for legal advice. Narayan became well versed in the laws surrounding marijuana. Coming east, he realized he had an expertise that few of his classmates possessed. “The people operating cannabis businesses in California were primarily not from the traditional corporate business world,” he says. Narayan returned home and now runs a Costa Mesa, California, firm, MJ Legal, which advises retailers and other cannabis businesses on how to operate legally in the state. “Something happened between the time I graduated and now,” Narayan says, “and now this is looked at as a legitimate industry.”
That something is money. As more and more states legalize marijuana not just for medical use but for recreation as well, investors are seizing on opportunities to invest in nearly every aspect of it—from the operations that grow the plants to the companies that produce the packaging, and, of course, the retailers who sell the products.
There’s opportunity to be had: According to Marijuana Business Daily, the industry publication for all things cannabis, the legal market in the US will hit somewhere between $11.2 and $13.7 billion in retail sales this year and could be as big as $30 billion by 2025. Roughly two-thirds of current sales are for recreational cannabis products, which include the traditional dried plant, or flower, for smoking as well as increasingly popular categories such as edibles in the form of gums and candies. The remaining third comes from people who use cannabis primarily for medical purposes.
According to Chris Leavy ’06, a leading investor in cannabis businesses, the industry has grown more complex and specialized as both consumers and producers become more experienced and incumbents develop increasing scale. He says that has made it much tougher to enter the business and compete successfully than it used to be. “It’s a little bit like vineyards now,” he says. “There is a real difference in the genetics and quality of the cannabis based upon who the cultivator is. And it takes capital and it takes operational know-how to be really good at this.”
Meanwhile, the murky legal status of cannabis on both the federal and state levels poses significant challenges for operators and investors. The laws and regulations governing cannabis haven’t caught up with greater social acceptance or a rapidly maturing industry, and that creates obstacles for would-be and actual cannabis entrepreneurs.
“There are some states where it's much easier to open up a dispensary. But guess what? That means it's easier for everybody. So those are the areas that we would tend to avoid. The economics are a lot more attractive if you can identify people who can operate in the states where it's really difficult to operate. — Chris Leavy '06
At the federal level, cannabis, which cannot legally be transported over state lines, is still a Schedule I drug, meaning the federal government believes cannabis has no currently accepted medical use and has a high likelihood of being abused; other Schedule I drugs include heroin and LSD. Meanwhile, businesses that directly handle cannabis are subject to IRS rule 280E, which was designed to prevent illegal drug dealers from laundering profits through front companies. The rule prevents even state-licensed cannabis businesses from taking the normal federal tax deductions and credits that other businesses can. Together, the Schedule I and rule 280E restrictions make traditional banks and other financial institutions resistant to taking on cannabis companies as customers, in turn making it difficult for those companies to get things most businesses need, such as loans, checking accounts, and other financial services.
And as if that were not discouraging enough for the budding entrepreneur, all the states that permit cannabis have their own laws, zoning regulations, or other rules governing who can be a grower, processor, or retailer and where and how they can operate. Even in states such as Colorado or Massachusetts, where marijuana is fully legal for both recreational and medical use, obtaining real estate and licensing for a cannabis business can be an expensive and time-consuming proposition.
Still, there is success to be had for the right investor. As Leavy puts it, “The regulatory mess also creates opportunities.” Formerly a managing director at BlackRock, Leavy is a partner with Philadelphia-based Shire Capital Advisors, where he leads an investment group that has deployed over $100 million into private transactions in the cannabis industry. Last year, Shire Capital led a group making a $40 million investment in Ascend Wellness Holdings, a company that operates in four states and landed the first license to sell cannabis for recreational use in Boston. Leavy is on the board of directors of Ascend Wellness and the advisory board of Norcal Cannabis Company.
In terms of investment dollars coming into the industry, Leavy divides the cannabis business into three basic categories. He explains: “One is in what I’ll call the limited license operators. These are companies that operate in states or localities where there are restrictions in terms of how many players there can be. The second category is emerging CPG [consumer packaged goods] brands. Most of those tend to be in California, and they’re heading east. The third category is what we’ll call the ancillary business, the proverbial picks and shovels.” By that, Leavy means products and services for the industry, including bottles for CBD oil [see sidebar], to consultants like Narayan, and accounting software for retailers.
The biggest opportunities for firms like his, Leavy says, are in the areas that present the greatest obstacles. The logic is that the more difficult a business problem is, the more money there is to be made by someone who can solve it. For example, he says, private equity and other investors are happy to make the loans to cannabis companies that most banks won’t. “The absence of federal banking reform creates an industry where gaining access to debt financing for cannabis businesses is hard,” he says. “Because it’s hard, that means if you provide it, you get paid extremely well for doing that.”
As for the complexities of local regulation, he says, “There are some states where it’s much easier to open up a dispensary. But guess what? That means it’s easier for everybody. So those are areas that we would tend to avoid. The economics are a lot more attractive if you can identify people who can operate in the states where it’s really difficult to operate.” Leavy says firms like his profit by using their expertise to find operators who know their specific markets extremely well and can best navigate local real estate markets and politics.
Even in states like California, a very big market in which recreational marijuana is legal, opening a cannabis operation can be tricky and expensive. For a retail store, for instance, usually the first hurdle is finding a city that will even allow a retailer to open, then securing one of a limited number of approved locations. According to Narayan, “that’s going to be usually in a commercial or industrial zone that is not touching any sensitive-use areas like schools and parks. There’s a limited amount of that, and everybody wants it at the same time.”
Obtaining the real estate is only the beginning; next is the matter of getting licensed. “You have to put together a proposal, which is a matter of financials,” Narayan explains. “Then there’s usually an interview process where local government officials meet the team. For dispensaries, there’s usually a competitive element, meaning there are more applicants than there are permits available. I’ve seen situations where there are 200 applicants and only 17 spots. Also, once you get through local permitting, then you have to apply statewide as well.”
Narayan says the whole process can take about six months and could cost as much as $50,000. In fact, all the of the costs involved with being legal, he says, take a big bite out of an operator’s profits and fuel a thriving black market, where illegal dealers can profit from selling high-quality product at prices legitimate shops can’t match. Narayan says that back when he got started, before coming to Columbia, California law on cannabis was vague and difficult to follow. It’s a lot clearer now, he says, but many issues around legal cannabis remain unsettled. One problem in California and elsewhere is the question of whether and how priority for licenses should be granted to social-justice applicants—individuals from communities hit especially hard by stringent war-on-drugs legislation that, among other things, made cannabis illegal.
Among those advocating for granting priority to social justice applicants is Regina Smith ’79, executive director of the Harlem Business Alliance. According to Smith: “A 1979 study revealed that the bulk of the men who populated upstate prisons were black men from seven neighborhoods in New York City. Central Harlem was one of them. The study was later revised to include Westchester, Long Island, and upstate communities. We’re talking about over 40 years of harm not just to those men but also to their family members and to their community. We strongly believe that in these affected communities, these individuals should be the only ones to receive priority for licenses at no cost, as well as services and grants to start businesses, particularly in these seven neighborhoods.” She adds that entrepreneurs of color are typically more likely to hire employees of color, yet African American entrepreneurs have a much more difficult time getting capital to start a business than their white counterparts. To ensure local control of legal cannabis businesses, she says that she would support restrictions on investment from hedge funds and other big investors from outside the community.
Leavy sees it differently, saying that to restrict investment opportunities for entrepreneurs of color will only limit opportunity. “The people who were most hurt by the war on drugs should be able to benefit,” he says. “But when somebody wants to sell cars, they don’t have to figure out how to engineer an automobile and build the automobile; they open up a dealership and they partner with Toyota or Chevy.”
For Smith, however, the main issue is local control. Taking money from outside investors means they’ll have the majority control. She adds, “Dispensary and ancillary businesses should be owned by longtime members of the affected communities, by the equity applicant. They should have majority ownership.” As for bigger players, “there are plenty of other locations throughout the city and state where they can do very well,” Smith says. “But we really need to make certain that Harlem residents are deeply invested and poised for success once this becomes legalized.”
It is impossible to say when exactly that might be, but Smith says she hopes New York gets around to it in the coming year or so. As for changes to federal law, Leavy says he’s heartened by support in the US House of Representatives for a banking overhaul bill that would provide safe harbor for banks serving the cannabis industry and that could come to the Senate in 2020, as well as for a proposed measure that would defund the Justice Department’s efforts to prosecute cannabis businesses that have state medical or recreational licenses.
The marijuana business in the US seems likely to stay complicated from a legal and regulatory standpoint for the foreseeable future. What also seems likely, however, is that investment dollars will continue to pour into the space. The days of the cannabis Wild West may be over, but the age of marijuana as big business looks to be just beginning.
CBD: Stirring Up a New Industry
The hottest thing in the cannabis business right now doesn’t make you high. Cannabidiol, or CBD, is a chemical found in both marijuana and hemp, a relative of the marijuana plant. Once extracted, it can be smoked, vaped, applied to the skin, and added to food, beverages, and pretty much anything else you can think of.
What does it do? For some people, nothing, but others say it provides all the benefits of marijuana without the high. CBD doesn’t contain THC, the psychoactive intoxicant in marijuana; proponents tout it passionately as a remedy for ailments including sleeplessness, muscle pain, depression, cancer, and Parkinson’s disease. Although CBD is widely considered to be safe, there is no hard data yet that proves it has medical usefulness, except for the treatment of some unusual forms of epilepsy.
If you’re suddenly seeing CBD products everywhere right now, there’s a very specific reason. The Farm Bill passed at the end of 2018 legalized widespread hemp farming for the first time; until then, federal law didn’t distinguish between hemp and other cannabis plants, which had been illegal to grow since 1937. As soon as farming hemp became legal, entrepreneurs quickly began filling shelves with all kinds of CBD products.
Among them is Eric Schwesinger ’02, a commodities trader who has turned most of his attention to raising money (his target is $5 million) to start a business growing hemp and extracting its CBD in New York State. He says that while the CBD business is “orders of magnitude” less complicated than cannabis in terms of regulation, it still isn’t easy, with various states having their own layers of often conflicting laws and the FDA providing little guidance on what claims it will allow CBD producers to make. The attraction, of course, is the potential profit. Schwesinger says that at the moment, good-quality hemp—plants containing about 10 percent CBD by weight—is going for about $30 a pound.
Barbara Goodstein ’83 is also launching a new CBD company, B Great, which will sell a line of CBD-infused supplements, lotions, and cosmetics. Goodstein, an experienced marketing executive and a board member of Kushco Holdings, a large producer of cannabis packaging and accessories, is looking to raise $8 million from investors.
She says the CBD business still has something of an outlaw image about it and that a big opportunity lies in overcoming that. “There are no real brands in this space, and there aren’t that many sophisticated marketers,” she says. “The biggest issue that people have is that they don’t know what brands to trust.” Goodstein thinks the potential market is enormous. “I think it’s going to get bigger,” she says, “but there’s going to be a shakeout of a lot of the small companies.”