American culture has a long and storied history with marijuana. Pot usage was prevalent in the counterculture of the 1960s but the Controlled Substances Act of 1970 classified marijuana as a Schedule 1 drug and its used was forced to go underground. But it should be remembered that marijuana had actually been legal in this country for many years. It was a staple crop of the colonists and even George Washington himself grew hemp on his Mount Vernon farm.1

The trend of decriminalizing marijuana has been speeding along for years now. While the possession and sale of marijuana is still illegal on the federal level, decriminalization and in some cases, legalization (either for medical or recreational use) is spreading on the state level.

Today, marijuana use is making a comeback. Just as the Gold Rush of the 1800s challenged adventurers to ‘Go West’ seeking fortunes, today the marijuana ‘Green Rush’ is on. 2012 was a landmark year for marijuana advocates as Colorado and Washington State legalized recreational marijuana use for those 21 or older. Oregon and Alaska have since joined.

Medical Marijuana

Long regarded as hazardous to your health, marijuana’s benefits are becoming increasingly apparent today. Marijuana use, either through smoking or ingestion of extracted chemical compounds like Cannabidiol (CBD), can address a variety of medical problems. They can help children suffering from epileptic seizures, people with migraines and anxiety disorders, glaucoma patients , sooth cancer sufferers and even prevent the spread of some cancers.2 The research has become so compelling that even CNN’s Dr. Sanjay Gupta reversed his negative opinion on medical marijuana.

California was the first state to legalize medical marijuana back in 1996, paving the way for the first medical marijuana dispensary in Fairfax, California that same year.3 Today, almost half the United States allows some form of legalized medical marijuana use (23 states, plus the District of Columbia) with another thirteen states planning on votes in 2016.4

Tax revenues

A case for legalization can be made because increasing tax revenues would help fund struggling local budgets. Municipalities that currently oppose legalization may change their tune if their fiscal situations worsen, causing essential services to be impacted, which would sway voters. Further, the retirement of many municipal workers (including police and fire) could be shored up with additional tax revenues in the face of underfunded public pensions. It could be a very large boost to budgets indeed. ArcView Market Research estimates we could see $22 billion in legal sales from our national cannabis market by 2020.5

One financial success story is Colorado, whose marijuana taxes include the standard 2.9% sales tax, plus a 10% special marijuana sales tax and a voter-approved 15% excise tax on wholesale marijuana transfers.6 For 2015, Colorado marijuana sales just missed the one billion dollar mark ($996 million) allowing the state to reap a windfall $135 million in tax revenues.7 $35 million of that total will go to fund school construction projects and funding college scholarships.8 The potential to close infrastructure funding gaps nationwide is compelling.

Investing in Marijuana

Marijuana growers have popped up all over the legalized states, seemingly overnight. The problem for growers is the price of marijuana has dropped as a flood of supply has hit the market, especially in Washington State. CNBC reports “growers who jumped into the new legal market hoping to make a killing in cannabis are now getting killed by a glut of product.” 9

Some marijuana-related businesses are large real estate owners in states where recreational marijuana use is legal. This includes not only farmland but water acreage. Water rights, especially in arid areas like Colorado are extremely important, and valuable. These owners rent land and other facilities to tenant growers. Some provide state of the art technology (hydroponic lighting and temperature control systems) as well as expertise (experienced, often multi-generational growers) to tenants.

Marijuana businesses not only include growers, but also related stocks including ‘consulting’ companies, paraphernalia manufacturers, marijuana-infused edibles bakers and a variety of balms and solutions made from extracts. Security services have also become profitable since many marijuana businesses deal in large amounts of cash because they’re shunned by banks.

Marijuana Stocks

With the future so seemingly bright for marijuana, individual investors naturally couldn’t wait to invest in marijuana stocks. The first wave of so-called ‘pot stocks’ hit the market earlier this decade. Not unlike the dotcom craze of the late 1990s, many skyrocketed but eventually fizzled out. Advocates will suggest there is now a second wave of more mature marijuana companies. But you need to be careful.

Many marijuana-related stocks are small, thinly traded ‘penny stocks’ providing limited and questionable public information for investors. The SEC has also issued several warnings that marijuana stocks can be fraught with misinformation and overhyped growth prospects.10 And you’ll be hard-pressed to find a financial advisor that will solicit a marijuana-related investment for clients. More risk-averse investors are waiting for a marijuana exchange traded fund to be created because the stock-specific risk is spread throughout a group of stocks. As of now, none exist.

There are other ways risk-averse investors can gain indirect marijuana growth exposure. New York stock exchange-listed Scotts Miracle Grow (symbol: SMG) bought a hydroponics supplier and has stated its plans to expand resources into the legalized pot area. There is also Nasdaq-listed GW Pharmaceuticals (symbol: GWPH),a British biotech company that develops cannabinoid-based medical treatments.11 Many predict Big Tobacco will enter into the area eventually, with existing infrastructure and similar existing products (cigarettes) that could boom with increased decriminalization. Keep in mind, these securities are listed for informational purposes only and investments of any kind, especially anything marijuana related, should always be discussed with a financial planner who can determine your particular situation and risk tolerances.

Another approach to investing the marijuana industry may be through municipal bonds. Increasing revenue from pot sales could improve the credit rating of existing municipal bonds in legalized states. In 2014, credit rating agency Moody’s issued a positive announcement affirming that Colorado tax revenues from marijuana exceeded expectations.12 If nothing else, it could reduce future borrowing costs, making the bonds more secure. Some have speculated that states with serious fiscal problems, like California, could benefit directly from municipal bonds backed directly from marijuana sales. For now, the growth of the industry is hampered due to a lack of financial infrastructure-in other words, many banks are wary of dealing with marijuana businesses due to their federal prohibition.

Financing for Marijuana Businesses

The real moment for the industry will come when institutional money embraces marijuana investments. For now, the stigma and legal ramifications keep most major institutional investors away. But not all.  Last year, San Francisco venture capital firm Founders Fund made a multi-million dollar investment in Privateer Holdings, a private equity firm that invests in a variety of marijuana related businesses.13 This was big news as the Founders Fund boasts Peter Thiel as co-founder. The VC fund has invested in successful companies ranging from SpaceX to Airbnb.

Since most commercial banks won’t touch marijuana businesses, a profitable opportunity has arisen for venture capital firms, business development companies and private equity firms to get involved with financing. But the term sheets for this financing often include substantial amounts of convertible securities, both equity and debt, which aren’t always the most attractive terms for the businesses. Since many of the convertible securities convert into more classes of equity (warrants, common and preferred stock) any public shareholders, should refer to a dilution table to fully understand the extent of new supplies of shares if the price rises. This could place a significant cap on the stock’s price and may not be fully communicated to investors.

Businesses with substantial assets sometimes use venture debt, where the loan is backed by real assets of the company.14 More aggressive banks might offer this type of debt which is superior to convertible issuances in a couple ways. One, it should result in a lower borrowing cost to the business since the loan is fully secured loan (by the assets) and two, it results in no dilution to equity holders of the company. Many startups have management with large equity stakes in the company so a viable investment that doesn’t dilute their ownership is viewed positively. Venture debt lenders typically lend between 25%-75% of the fair market value of the assets, depending on the liquidity of the assets and stability of the business.15 For marijuana land renters, the assets (land, water rights, grow houses) are illiquid in nature so think towards the lower end of the 25-75% range.

The trend towards marijuana decriminalization has clearly left the station with many ‘ganga-preneurs’ trying to stake their claim to fortune. There are sure to be plenty of winners and losers as the green rush is still in its infancy. The financial and banking regulatory environment may ultimately determine how well the marijuana industry grows.

 

1http://usnews.nbcnews.com/_news/2012/12/06/15726635-a-history-of-pot-from-george-washington-to-legalizing-ganja
2http://www.huffingtonpost.com/2012/09/19/marijuana-and-cancer_n_1898208.html
3,4https://en.wikipedia.org/wiki/Timeline_of_cannabis_laws_in_the_United_States
5http://www.arcviewmarketresearch.com/media-coverage/
6,7,8http://www.thecannabist.co/2016/02/09/colorado-marijuana-sales-2015-reach-996-million/47886/
9http://www.cnbc.com/2015/02/11/legal-marijuana-sales-so-much-pot-in-washington-growers-giving-it-away.html
10http://www.sec.gov/oiea/investor-alerts-bulletins/ia_marijuana.html
11http://www.thestreet.com/story/13494984/1/why-pot-stock-gw-pharmaceuticals-could-go-even-higher-in-2016.html
12https://www.moodys.com/research/Moodys-Colorados-tax-revenues-from-legalized-marijuana-exceeding-expectations–PR_297013
13http://www.latimes.com/business/la-fi-20150108-founders-fund-marijuana-story.html
14,15http://www.forbes.com/sites/georgedeeb/2014/03/19/comparing-equity-vs-debt-vs-convertibles-for-startup-financings/#64022f56aa3d