How to Invest in Dope
Cut paper by Bovey Lee/Tom Schierlitz for The New York Times
By BRUCE BARCOTT
Published: June 25, 2013
Brendan Kennedy and Michael Blue, private-equity financiers, settled
into a downtown Seattle conference room in March to meet with a
start-up. Both wore charcoal blazers and polished loafers. Kennedy, 41,
is the former chief operating officer of SVB Analytics, an offshoot of
Silicon Valley Bank. Blue, 35, learned his trade at the
investment-banking firm de Visscher & Co. in Greenwich, Conn. Two
years ago they quit comfortable posts to form Privateer Holdings, a firm
that operates on the Kohlberg Kravis Roberts model: they buy companies
using other people’s money and try to increase their value. What sets
them apart is the industry in which they invest. Privateer Holdings is
the first private-equity firm to openly risk capital in the world of
weed. Or as the Privateer partners prefer to call it, “the cannabis
space.”
Megan and Ben Schwarting, a casually dressed couple in their early 30s,
made a presentation. Their company, Kush Creams, produces “cannabis
topicals,” which are lotions andcreams infused with marijuana’s active
ingredients. Kennedy and Blue had invited them in to learn more about
the pot-cream market.
“We know nothing about topicals,” Blue said as he reached for a little
jar of something called Purple Haze. “Walk us through this like we’re
third graders,” Kennedy added.
Megan offered a nervous smile. Their products, she said, contain
cannabinoids like THC and CBD. They’re medically active but won’t get
you high.
“What do people use it for?” Kennedy asked.
“Pain relief, initially,” Megan said. But customers have found them
useful for “everything from fibromyalgia to psoriasis.”
She told the financiers about their product line, which included eye
creams, toothache drops and a first-aid spray called Owie Wowie.
“How do you extract it?” Kennedy said, referring to the cannabinoid oil that’s mixed into the lotion.
“That’s kind of our company secret,” Ben said. “We work mostly with one
strain. Others don’t produce quite the same effect.”
“What led you to start the company?” Kennedy asked.
The couple acknowledged that they started years ago as pot growers.
“Then we had daughters and wanted to move into something with less
risk,” Megan said.
The Privateer partners are always hunting for a good investment, but it
was apparent that they wouldn’t be taking a stake in topicals any time
soon. Though state law allows the manufacture and sale of cannabis
topicals, Kennedy and Blue worried about whether you could make the
stuff without violating federal drug laws. This put topicals off-limits
as an investment, at least for now. If there’s one rule that Privateer
lives by, it’s “don’t touch the leaf.”
Kennedy and Blue’s venture into the cannabis space
began three years ago. At the time, Kennedy was directing the operations
of SVB Analytics, which specializes in entrepreneurial fields like high
tech, genomics, medical devices and green energy. He spent part of his
time in San Francisco and Santa Clara, Calif., for work and part in
Seattle, where his wife has a high-profile career with the Pacific
Northwest Ballet.
One day a call came in to the SVB office from an entrepreneur who sold
inventory software to medical-marijuana dispensaries. He wanted to know
how to attract venture capital. Christian Groh, who was head of sales at
SVB Analytics, took the call and told Kennedy about it. They were
intrigued and amused. Pot software? They knew their own firm wouldn’t
touch it. “Nobody wants to be known as the first banker or venture
capitalist to make an investment in the cannabis industry,” Kennedy
later told me. “The risk to the firm’s reputation is too great.”
Later that week, as he drove on I-280 through Silicon Valley’s green
hills, Kennedy happened to tune in a radio show on marijuana
legalization. He hadn’t touched pot since he was 19, he says, but the
notion proposed by one guest seemed to make sense: Marijuana should be
regulated like whiskey or wine. Kennedy thought about the software
developer. Maybe there was a way to get into the business without being
directly involved with pot. The growing and selling of marijuana, as it
becomes increasingly legal, will require many ancillary products. “When
everyone is looking for gold,” the saying goes, “it’s a good time to be
in the pick-and-shovel business.”
When Kennedy pulled off the highway, he called Blue, his old Yale School
of Management classmate. “You know how we’ve always talked about
starting something together?” he said. “I think I’ve found it. We need
to start a venture-capital firm in the cannabis space.”
At the time, Blue, who is from Arkansas, was happily ensconced at a
sleepy financial firm in Little Rock, where he and his wife had settled
to raise their children near her parents. If you were casting a comedy,
Blue would be the bow-tied square who thinks things are getting out of
hand when somebody orders a second pitcher of beer. To him, Kennedy’s
idea was outrageous. It was insane. And it was interesting.
That night, lying in bed, Blue turned to his wife, Christina. “I’m going
to tell you something about a conversation I just had with Brendan,” he
said. “No one knows about it yet. But here’s what he’s thinking.”
Neither Kennedy nor Blue could shake the notion. Working during their
off-hours in Santa Clara and Little Rock, they dug into the existing
marijuana research. They read the 1970 Controlled Substances Act,
National Institute on Drug Abuse reports, medical studies from all over
the world. They made reconnaissance visits to dozens of marijuana
dispensaries. They decided that the only way they’d be comfortable even
seriously thinking about the idea was if they could determine that
marijuana was truly helpful for medical patients.
It was clear that not everyone with a medical-marijuana card was
consuming pot for medical reasons. But they also came to the conclusion
that many sick people were being helped. “One study after another
pointed to its effectiveness for treating symptoms of multiple
sclerosis, epilepsy and chemotherapy,” Blue recalled. The research
wasn’t completely exculpatory, of course. Some studies suggested that
chronic pot use could lead to long-term cognitive deficits, especially
among people who start in their teens. Still, they found enough evidence
to persuade themselves and, they hoped, potential investors.
But Kennedy and Blue were not just interested in cannabis for
humanitarian reasons — they knew the payoff could be enormous. Medical
marijuana is now a $1.5 billion industry, it’s estimated, operating in
18 states and Washington, D.C. Within the next year New York and three
other states may join them. A recent Fox News poll found that 85 percent
of Americans — and 80 percent of self-identified Republicans — approved
of the medical use of marijuana if a physician prescribed it. Last
November voters in Colorado and Washington State went one step further —
legalizing marijuana for adults 21 and older. And recently, the Pew
Research Center reported that for the first time in more than 40 years
of polling, a majority of the nation’s adults now favor full
legalization. (In 1991, only 17 percent of adults supported it.)
Still there was a criminal risk, though how great was unclear. Much
depends on the federal response to medical-marijuana laws and the new
statutes in Washington State and Colorado. The Justice Department’s
current policy on medical marijuana has turned district U.S. attorneys
into de facto drug czars, with some (New Mexico) allowing the handful of
dispensaries to operate and others (California) raiding and closing
hundreds of retail operations.
In thinking about whether to go into the pot business, Kennedy and Blue
struck upon the historical example of Joseph Kennedy (no relation to
Brendan) and the repeal of Prohibition. In the fall of 1933, as repeal
of the 18th Amendment appeared all but inevitable, the father of the
future president traveled to England, where he met with the managing
director of the Distillers Company. By the time he returned home,
Kennedy had locked up the American import rights to Dewar’s whisky and
Gordon’s gin. According to Daniel Okrent’s Prohibition history, “Last
Call,” Kennedy had previously obtained medicinal liquor permits and
warehouse space. (“Medical liquor” could be legally purchased with a
doctor’s prescription.) On Dec. 6, 1933, the day after Prohibition
ceased, Kennedy’s Somerset Importers was up and running.
The way Brendan Kennedy saw it, he and Blue had the chance to do what
Joe Kennedy did 80 years earlier. Setting themselves up in the
medical-marijuana field made good short-term sense, and their early
entry would position Privateer Holdings as a major player if marijuana
turned fully legal.
Still, they worried. “We realized early on that the biggest risk wasn’t
legal,” Kennedy told me one day between investor pitches. “It was the
risk to our professional and personal reputations.” Investing in the
cannabis space would most likely burn their bridges to the traditional
banking world. They floated trial balloons to see how the idea played
among friends and family. One of Kennedy’s older brothers, a
firefighter, was open to it. He told Kennedy about an old family friend,
a rock-ribbed Republican fire captain, who used cannabis to fight the
nausea from chemotherapy treatments when he battled cancer in the 1990s.
Kennedy had no idea.
“We heard stories like that almost every time we brought up the subject,” Blue said.
Blue’s elders at his Little Rock firm — old Southern country-club gents —
reacted with interest, not disgust. Blue recalled James Atkins, the
firm’s 78-year-old managing director who was known as Bum, telling him:
“You’re talking about more risk than I’ve ever taken on. If you do it,
do it the right way. Make sure everything’s aboveboard and legal.”
At the end of six months, Kennedy’s idea had evolved from crazy to
risky. “Where are you at with this?” he asked Blue. Blue thought about
it. “I’m about 70 percent in,” he said.
In January 2011, Kennedy felt that they needed to make a decision. The
opening was clear. By some estimates, the size of the state-legal market
could reach nearly $9 billion by 2016. That would make it equivalent to
the worldwide market for mobile gaming. “This is an existing
billion-dollar industry with immature companies run by unprofessional
managers,” he told me. “There are no market leaders, no standards and
poor branding. There’s a taboo around the product that’s rapidly
changing. There’s no involvement by Wall Street, venture capital or
banks — yet. I’ve never seen an opportunity like it.”
Blue needed to think it over. He and his wife dropped the kids with her
parents and took a day to map out the potential risks and benefits. He
would be putting marijuana on his résumé, and start-ups often fail. But
Blue was excited about creating a new market with Kennedy and the
rewards could be substantial. After growing up in a small town in
Arkansas, he said, meeting people like Kennedy and having opportunities
like this “were exactly why I’d gone to business school.” At the end of
the day, Christina turned to her husband and said, “You have to do
this.” Blue called Kennedy the next day. “One hundred percent,” he said.
“I’m in.”
That summer, Kennedy and Blue attended a conference of
cannabis-industry leaders at the Hotel Nikko in San Francisco. The two
wore suits and ties. “Most people thought we were D.E.A. agents,”
Kennedy recalled. They scouted for investment-worthy start-ups but found
none. “It was a cavalcade of crazy,” Kennedy recalled. One panel
featured industry leaders discussing the benefits of taking a cannabis
company public. To Kennedy and Blue, who had actually worked on
I.P.O.’s, the notion was delusional. They eventually adopted a new
tactic. Every time a panelist offered a crackpot assertion, the
financiers scanned the audience to see who seemed to be rolling their
eyes. “Those were the people we wanted to talk to.”
The conference forced them to reconsider their business model. “We’re
way too early,” Kennedy said to Blue. Entrusting great sums of cash to
the equivalent of Harold and Kumar seemed foolhardy. Kennedy and Blue
decided they had to switch from a venture enterprise to a private-equity
model, in which they could purchase companies and install their own
management if necessary.
A handful of accredited investors openly backed marijuana-related
companies. But most of them, including members of the ArcView Group, the
most visible cannabis-financing network, had longstanding ties to
medical dispensaries and marijuana activism. They were successful
cannabis entrepreneurs looking to help out the industry’s next
generation. Privateer wanted to be different. It would remain far from
the leaf, considering investments in only those businesses that were
“legal at the local, state and federal level,” as Blue put it:
inventory-tracking software, lighting for indoor grow sites, security
services for sites and dispensaries, business liability insurance.
Blue began to commute between Arkansas and Seattle, eventually
relocating his family. Christian Groh, the SVB colleague who took that
initial phone call from the pot programmer, was the firm’s third
founding partner. The private-equity model proved popular with
investors, who began wiring money to Privateer Holdings in November
2011. None of their investors were comfortable being named, but Kennedy
said a handful of old-money families in New York and Boston have
accounts with the firm. Though there aren’t any pension funds or
institutional investors, the firm has attracted wealthy individuals on
the political left (who often see cannabis as a humanitarian cause) and
on the right (who view it as a libertarian cause). “If you put our
investors in a room, they wouldn’t agree on anything other than this one
issue,” Kennedy told me.
By the end of 2011, the firm had enough cash on hand to make its first
purchase. They chose Leafly, a Yelp-like Web site that offers
crowdsourced reviews of medical-marijuana dispensaries and cannabis
strains. A big part of the site’s appeal was that it wasn’t already
branded with symbols of pot culture. “It didn’t have any of the old
clichés,” Kennedy said. “The site wasn’t plastered with pot leaves or
pictures of Bob Marley.”
Shortly after the cannabis-topicals presentation, I
went with Kennedy, Blue and Tonia Winchester, who helps direct
Privateer’s corporate strategy, to Heckler Associates, a Seattle ad
agency, to discuss a campaign for Leafly. “We had to pitch the Heckler
partners for six hours to get them to take us on,” Kennedy told me on
the way over.
Heckler is known for taking small companies and breaking them
nationwide, and the firm’s lobby is decorated with logos designed for
Starbucks, K2 and New Balance. Scott Lowry, the accounts director, led
the Privateer team into a back office, where he laid out the contents of
a Leafly marketing kit being readied for shipment to 500
medical-marijuana dispensaries. A few weeks before, Lowry and the
Privateer team looked at light green Leafly promotional stickers. The
logo was good. Everything about it from the rounded typeface to the red,
green and purple rectangles, had been designed to be as mainstream and
friendly as Amazon or Target. But the stickers’ background color sent
the wrong message: hippie, head shop. Now Lowry showed the team new
white stickers, which looked bright and pristine. Blue nodded, pleased.
Lowry ticked through the marketing box. “We’ve got T-shirts, hats,
stickers, magnets, window clings, dispensary bags, posters and a
brochure display,” he said. To reinforce the medicinal aspect of
dispensaries and Leafly, the Heckler team had printed thousands of
Leafly-branded bags, just like the ones handed out at the pharmacy
counter at Walgreens or Rite Aid.
One item on the contents sheet caught Kennedy’s eye. “Where we list the
hat, it says, ‘Skull cap,’ ” he said. “ ‘Skull cap’ is skater. It’s
aggressive. What about ‘beanie’? ‘Beanie’ is happy.”
Toward the end of the meeting, Lowry revealed a Leafly ad aimed at a
mainstream print publication. The ad featured two residents of an
upscale New York City neighborhood. A dapper businessman exits his
brownstone. “While beating cancer, Ian used Blue Dream,” the copy said,
referring to a specific type of cannabis. A woman on her morning run
passes nearby. “Molly prefers Kali Mist to relieve pain.” The tagline:
“What’s your strain?”
It looked like a pharmaceutical ad: urban professionals each using a
specific strain of cannabis to address a specific need — and using it
like an antidepressant or a statin. Lowry later explained the thinking.
“In the early ’60s, Honda wanted to sell motorcycles to Middle America,”
he said. The problem was the motorcycle’s reputation. Hoodlums and
outlaws rode motorcycles. Think of Brando in “The Wild One.” “So Honda
came out with a campaign: ‘You meet the nicest people on a Honda.’ ” The
ads featured mothers and daughters, wealthy dowagers, even Santa Claus,
all riding Hondas. Cannabis, Lowry said, is the new motorcycle.
The Privateer team loved it. “This ad could run in The Wall Street
Journal or an AARP publication,” Kennedy said as we walked out into the
street. “Ultimately we’re trying to create reliable, trusted products
that are attractively packaged. What this industry needs is a clean
American brand.”
