Family offices ‘dipping their toes’ into cannabis market

Any one of three developments possible over the next six to 18 months could help boost demand for cannabis exposure among family offices, according to executives at Salveo Capital.

Jeffrey Howard, managing director at the cannabis-focused investment firm, told Agri Investor that the fundraising environment during the first quarter of 2018 was more favorable than the entire second half of 2017.

That change, according to Howard, has been helped along by a series of strategic cannabis-related investments by pharmaceutical, consumer goods and other companies, as well as political developments assuaging early fears that Attorney General Jeff Sessions would make cracking down on state-led legalization a key focus of the Trump Administration’s Justice Department.

While full-scale federal legalization remains unlikely in the near term, Howard says, distinct bills decriminalizing marijuana at the federal level and providing additional protections for the states that have legalized recreational use are working their way through Congress. If passed, either bill could help entice larger investors further into the sector.

“If the DEA is forced to reschedule cannabis to something less that a schedule one, institutional money will take notice, because that’s a game-changer. That allows for medical research.”
Jeffrey Howard

In addition, he said, the Federal Drug Administration could soon approve a drug for childhood epilepsy derived from cannabis that could provide another signal of progress  some investors have been waiting for.

“The DEA could be forced, politically, to reschedule cannabis to something less than a ‘Schedule I’,” Howard said, explaining that the designation is used for substances determined to have no medicinal value.

“If that happens, institutional money will take notice, because that’s a game-changer. That allows for medical research. That opens up banking as well. It makes it a lot smoother entry for institutions to justify investments in the space.”

While high-net-worth individuals have been the most active investors into cannabis to date, Thomas Mazarakis, a former Goldman Sachs executive who joined Salveo as managing partner earlier this month, told Agri Investor that could change as the regulatory environment surrounding the crop continues to loosen.

“Family offices are just starting to dip their toes in the space,” Mazarakis said. “Reputational and legal risks and stigma are decreasing now to a point where I would expect, over the next six-to-12 months, to see a significant increase in interest and participation from family offices.”

Still on the sidelines

While some family offices have made direct investments in cannabis, Howard said, most are entering the market for the first time, helping make a diversified fund such as Salveo’s an attractive way to gain wide exposure quickly.

Notwithstanding developments helping stoke demand among smaller investor groups, Mazarakis said the lack of a clear path to full federal legalization means that larger institutions, such as pension funds, are likely to stay on the sidelines in the near term.

“They will be the last ones to jump in, and when you do get to that point, that will be providing exit opportunities for our portfolio companies,” Mazarakis predicted. “We look forward to that, but we don’t necessarily want or need for it to happen today.”

Can’t touch this

Salveo is currently targeting a mid-year $25 million close on a debut fund it hopes will lay the groundwork for what Howard described as a “much larger” second vehicle. So far, the firm has confined its investments to ancillary companies that do not “touch the plant.”

Its current seven-company investment portfolio includes tailored workforce management software provider Wurk, a company offering high-end coffee and smoking accessories called Tokyo Smoke and Front Range Biosciences, a Colorado-headquartered company focused on genomics and breeding for high-value crops, including cannabis.

Aside from a desire to avoid the complicated regulatory environment that accompanies marijuana cultivation, the fact that states that have legalized for both medicinal and recreational purposes have continued to increase the number of cultivation licenses granted annually has helped bring the wholesale price of cannabis down significantly, according to Howard.

“What initially was a premium to be an investor in an oligopoly is now going away,” Howard explained. “What used to sell in pockets of the Northwest at $4,000 a pound wholesale is now selling at $1,000 a pound. We have it going down to $500 a pound. We think that’s where the floor is.”

Given that a state-of-the-art indoor grow costs around $50 million to build, Howard said, falling prices make the sub-sector less attractive, forcing the industry towards a more efficient greenhouse model.

“You could grow outdoor – certainly – for less than $500 [per pound]; greenhouse: less than $500,” said Howard. “Indoor grows: it remains to be seen, if the prices continue to go down, if it is going to continue to be as profitable as it once was.”