Over the last fifteen months nearly every fifth call fielded by the Hoban Law Group involves questions about private equity: What is a private equity fund? How do I set up a private equity fund? Should I invest in a private equity fund? Is it legal to invest in a cannabis private equity fund?
Private equity and related fund structures are the topic of discussion in nearly every corner of the cannabis industry. This topic gets nearly as much industry attention as the topic of public markets in Canada. Setting up such funds and responding to such inquiries is our business. But what do you need to know about private equity? This article attempts to shed light on the challenges investors face and serve as a guided exposé on current affairs in private equity.
Legal cannabis sales are expected to reach $25 billion by 2025, and private equity is slowly finding confidence in the industry. With the rapid advancement of marijuana policy in recent years, investors have grappled with how to manage the opportunity with the associated risk.
Last year, Marijuana Business Daily reported that 18% of funds from financing rounds conducted by Marijuana Related Businesses (MRBs) came from private equity or venture capital firms in 2015, up from 4% in 2014. This growth is like that which MRBs are experiencing with banks, as both private equity funds and banks struggle to weigh the risks involved with servicing the marijuana industry.
The continued threat of industry “crack-down” and existing federal laws have kept most established funds from investing in MRBs. This is particularly true for MRBs that “touch the plant.” Harrison Phillips, Advisor at Viridian Capital, says “[m]ost investors are more comfortable investing in companies not directly engaging the cannabis plant due to perceived reputation risk and federal regulations.”
One problem for MRBs that touch the plant is they typically don’t have access to banking services or common tax deductions that most businesses have, which is a red flag for investors. Also, most entering contracts for private equity and venture capital groups prohibit fund managers from investing in illegal products and services. With such restrictions, “this is a no-go area for traditional venture funds, at least for now,” said Venky Ganesan, chairman of the board of the National Venture Capital Association. For investors like Phillips and Ganesan, waiting until cannabis is reclassified under federal law is the safest play.
Not surprisingly, much of the available private equity is going to ancillary products and services that don’t touch the plant. Investors have generally targeted companies that don’t grow or handle the plant; instead, companies that provide soil, gardening equipment, lighting, software, and packaging have seen the most financial support. The financials, however, show that attitudes may be changing.
So far in 2017, privately held MRBs have raised $476 million, compared to $190 million in 2016. Recent surveys also show investments are now being made across numerous verticals within the industry, including recreational cannabis, medical cannabis, technology platforms and software, and cannabis information resources.
Phillips mentioned “as the industry has begun to mature and investors have watched state-legal businesses generate profits and tax revenue without harming their communities, more groups have begun investigating and making investments into companies touching the plant,” and that “some cultivators, retailers (medical and adult-use), and infused product manufacturers have steadily attracted more investment from investors with greater risk tolerance.”
Perhaps the best example of this is private equity group Privateer, led by CEO Brendan Kennedy, whose funds now exceed $140 million. The fund is currently one of the largest private equity investors in MRBs that touch the plant. The Seattle-based private equity firm’s portfolio includes Tilray and Marley Natural, both producers of marijuana. Kennedy said “investors see . . . the end of [marijuana] prohibition as inevitable, so they wanted exposure now, they wanted exposure across multiple geographies, multiple industry verticals, and multiple consumer segments.”
However, equity firms, like Privateer, remain skeptical of how safe their investments in cannabis are in the United States. With cannabis still illegal, investors in the U.S. have traditionally considered biotechnology and pharmaceutical companies to be the safest and most valuable investments regarding companies that touch the plant. But ROI in this arena comes with set-backs, as clinical research and cannabis drug development can take years to complete, especially when cannabis is still illegal.
In response, Privateer has focused its attention on international companies. Take Tilray for example, a federally licensed Canadian medical cannabis producer. With Tilray, Privateer’s investors don’t need to take on risk like they would with a Cannabis investment in the United States. While recreational cannabis is still illegal in Canada, medical cannabis is not, and Tilray’s medical grow operation is fully legal.
“Canada has the most sophisticated medical cannabis program in the world,” Kennedy said, adding that he expects “Canada’s medical market to be a $1 billion opportunity.” While this is good news for savvy investors, U.S. businesses are being left behind. Money and products that could benefit American companies are instead being sent to other countries to capitalize on the emerging cannabis market. Just recently, Tilray became the first company to export medical cannabis products from North America to the European Union.  This is a sign the global market for cannabis is taking shape.
Kennedy goes on to say that “Privateer plans to invest more than half of the [recently raised] $40 million in foreign markets where further marijuana legalization is either in effect or very close to happening, including Australia and Germany. To support his strategy, Kennedy cited that Germany is the globe’s second largest healthcare system with a medical cannabis program nearing implementation, which he thinks will be part of a $100 billion global market in the next few decades.
Overall, the legality of the U.S. cannabis industry has pushed private equity to seek new ways to capitalize in foreign markets. Investors in the states have grown impatient as an unprecedented amount of money is being generated by legal cannabis around the world. As it relates to cannabis, it is incumbent of legislators to get on board with legalization soon, otherwise American businesses will continue to miss out.
 Marisa Kendall, Venture Capital Investors Betting Big on Cannabis, The Cannifornian (April 25, 2017), http://www.thecannifornian.com/cannabis-business/venture-capital-investors-betting-big-cannabis/ (last visited Oct. 2, 2017).
 Meghan Daniels, 5 Predictions for Cannabis Investing in 2017, Axial (February 7, 2017), https://www.axial.net/forum/5-predictions-cannabis-investing-2017/ (last visited Oct. 3, 2017).
 Michael F.E. Akkwai, et. al., Raising Capital and Investing in the Cannabis Industry, Torys Quarterly: Sharpen Your Focus (July 19, 2017), https://www.torys.com/insights/publications/2017/07/raising-capital-and-investing-in-the-cannabis-industry (last visited Oct. 3, 2017).
 Jeff Beverly, Opinion: How to Make Money From Marijuana Without Ever Touching a Plant, MarketWatch (November 26, 2016), http://www.marketwatch.com/story/how-to-make-money-from-marijuana-without-ever-touching-a-plant-2016-11-22 (last visited 10/5/2017).
 Kendall, supra.
 Daniels, supra.
 Viridian Capital Advisors, Cannabis Deal Tracker, Investment and M&A Activity in the Cannabis Industry, http://mailchi.mp/viridianca/deal-tracker-2930241 (last visited 10/5/2017).
 Akkawi, supra.
 Daniels, supra.
 Taylor Soper, Fast-Growing Marijuana Investment Firm Privateer Holdings Raises Another $58M to Fuel Expansion, GeekWire (August 21, 2017), https://www.geekwire.com/2017/fast-growing-marijuana-investment-firm-privateer-holdings-raises-another-58m-part-larger-round/ (last visited 10/5/2017).
 Bart Schaneman, Insights Froma Cannabis Investment Heavyweight, Five Questions With Privateer Holdings CEO Brendan Kennedy, Marijuana Business Magazine (March 2017), https://mjbizmagazine.com/insights-from-a-cannabis-investment-heavyweight/ (last visited 10/5/2017).
 Tom Huddleston, Jr., Private Equity Fund Raises $100 Million for Cannabis Startups, Fortune (November 4, 2016), http://fortune.com/2016/11/04/privateer-cannabis-marijuana/ (last visited 10/5/2017).
 Daniels, supra.
 Schaneman, supra.