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Originally published December 1, 2012 at 8:03 PM | Page modified December 1, 2012 at 10:30 PM

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Investors see profit potential in new pot law

Two Seattle-based Yale MBAs emerge as the button-down straight men on the business frontier of marijuana, as legalization in Washington and Colorado turbocharged pot into a mainstream business opportunity.

Seattle Times staff reporter

The law changes Thursday

Initiative 502, approved by voters Nov. 6, legalizes recreational marijuana use for adults 21 and up. Some provisions that take effect Thursday:

Possession: State criminal penalties for possession of 1 ounce of marijuana (or 1 pound in cannabis-infused food, or 72 ounces of cannabis-infused drink) are eliminated. Public consumption of marijuana, like alcohol, can mean a $50 fine.

Retail stores: Marijuana can be legally sold for recreational use only at state-licensed marijuana stores; those stores won't open until at least December 2013. I-502 does not change state medical-marijuana law.

Employment law: Does not change the right of employers to drug-test employees.

DUI: 5 nanograms of THC in a driver's blood becomes equivalent to a .08 blood-alcohol level for driving under the influence.

Federal law: Does not affect the federal ban on marijuana. Federal authorities have not said if they will intervene.

Source: Initiative 502

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A strong dose of professionalism is needed in the cannabis business but, as in any... MORE
DUH... you dont need to have an MBA to see that it would be profitable... MORE
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Brendan Kennedy's work at Silicon Valley Bank required him to put a value on startups and emerging industries. But he quit his job and became an investor himself when he saw limitless potential in one new industry. Marijuana.

The industry was fragmented, rife with unprofessional managers, and the medical-marijuana business couldn't get access to capital.

"And yet, despite all those problems, it had annual revenues" in the billions, Kennedy said. "I became fascinated with it."

Two and a half years later, Kennedy and Michael Blue, two Yale MBAs with backgrounds in banking, are emerging as button-down straight men on the business frontier of marijuana. Their leap into the fledgling industry seems prescient, especially as marijuana is poised to explode from the medical niche to mainstream recreation this week.

"It's the biggest opportunity I'm ever going to see in my lifetime," said Kennedy, 40.

Their Seattle-based private-equity firm, Privateer Holdings, is believed to be the first of its kind in the nation to focus exclusively on marijuana.

But Kennedy and Blue won't be alone for long.

Votes in Washington and Colorado last month to legalize pot for recreational use turbocharged marijuana as a legitimate business opportunity.

Business people packed a marijuana-industry conference in Denver the day after the election, and shares of publicly-traded companies spiked — one that sells marijuana vending machines jumped 3,000 percent — on giddy enthusiasm.

The ripest opportunities are among cannabis-focused businesses ancillary to direct selling or growing of marijuana — from media to insurance, from hydroponic suppliers to specialty software.

Kennedy compares it to the corn industry, which is supported by supply warehouses, makers of high-fructose corn syrup and corn insurers.

"There's whole sub-industries around corn. None of that exists in a mature fashion around marijuana," he said. "It all needs to be built. It all needs to be grown."

The decades-old federal ban on marijuana has constricted such investment, with investors nibbling at the edges.

But the potential size of a recreational marijuana market is now simply too big to ignore. In Washington alone, more than 360,000 people are projected to buy at state-licensed marijuana stores should they open in 2013, creating a billion-dollar industry.

Lawmakers in four Northeastern states are planning to introduce legalization measures.

"The wall of prohibition may crumble sooner than anyone imagined possible," said Troy Dayton, CEO of a marijuana-industry angel investor network, The ArcView Group. "If that happens, this is the next great American industry."

Investors "drool"

Cannabis is already big business. There are at least 20 publicly-traded companies — including indoor farming suppliers, pharmaceutical labs and financial-services firms — that market directly to the marijuana industry. Several of the companies have market capitalizations of $40 million or more.

A 2011 analysis by See Change Strategy estimated the medical-marijuana industry was $1.7 billion in 2011, and could grow to $8.9 billion by 2016 — and that was before legalization measures.

"Now, people aren't talking about the medical-marijuana industry, they're talking about the marijuana industry," said Chris Walsh, editor of Medical Marijuana Business Daily, an online publication that sponsored the Denver conference.

Medical-marijuana startups have largely relied on private investment from friends and family. The ability to keep a bank account remains one of the industry's biggest obstacles because federally insured banks view marijuana businesses as illegal.

"Businesses don't like uncertainty in general, and this industry has so much uncertainty," said Walsh, a former business reporter for the Rocky Mountain News. "It could collapse overnight."

The federal government has not indicated how it will respond to Washington's Initiative 502 or Colorado's Amendment 64. Govs. Chris Gregoire and John Hickenlooper of Colorado recently pressed U.S. Attorney Eric Holder to say if he will intervene, and at least 18 members of Congress signed onto a bill to ensure federal authorities wouldn't pre-empt the state marijuana laws.

Silence is interpreted as a good sign by entrepreneurs such as Sean Green, a former real-estate agent who opened a dispensary, Pacific Northwest Medical, in Shoreline, and hopes to expand.

"The longer the feds won't say anything, the more the investors drool," he said. "Before Nov. 6, it wasn't a good risk-reward ratio. Now, people are reconsidering."

The ballot measures in both states allow for-profit growers and retailers, and Washington's law calls for regulating marijuana like alcohol.

Seattle marijuana-industry attorney Hilary Bricken said mainstream business people are quickly emerging, in part because voters approved the initiative by 12 points.

"That margin of victory just wholesaled marijuana to white yuppie America," she said.

Pot for soccer moms

Kennedy and Blue did their risk analysis two years ago. They won a business-planning competition at Yale in 2005 before veering off into business — Kennedy, who'd already started and sold two tech companies, went to SVB Analytics, valuing startups; and Blue into private-equity firms in Connecticut and Arkansas.

Blue, 34, said he had no qualms after talking to conservative friends and family in his native Arkansas. "The feedback was, not only is this a good opportunity, you guys have the chance to do something really good," he said.

They brought on a third partner, Christian Groh, and set up shop two years ago in Seattle, where Kennedy's wife is a Pacific Northwest Ballet dancer.

Privateer Holdings started small and focused. It is closing a first-round investment pool of $7 million, and intends to buy existing marijuana-related businesses with a mainstream profile — "something that appeals to a soccer mom," Kennedy said. They are currently considering buying the manufacturer of a marijuana vaporizer.

They are targeting those kinds of ancillary businesses, not those growing or selling marijuana, because of the federal risk.

Kennedy said their lawyers vetted the strategy, but he said he has not talked with federal authorities.

Privateer Holdings' approach is the most common approach for the two dozen investors involved in The ArcView Group, which provides seed investment for marijuana startups, Dayton said.

"There's the Mark Twain saying, 'When people are looking for gold, it's a good time to be in the pick and shovel network,' " said Dayton. "And gold wasn't federally criminally illegal. There's even more reason to be in picks and shovels."

The first purchase was Leafly.com, a slickly designed website offering more than 40,000 reviews of about 500 marijuana strains. The website sorts them for medical use — from anxiety to seizures, and for effect — from lazy to tingly.

Medical-marijuana dispensaries in eight states upload their menus to Leafly so the site can send customers to a nearby retailer.

Kennedy emphasizes the need for professional management in an industry that is, at times, its own worst enemy.

"I'm waiting for the day when we can go to a conference, and you don't have to listen to Bob Marley," he said.

He's run six Ironman triathlons, and says he didn't use marijuana for about 20 years before trying it this year, on the theory that "I have to practice what I preach."

It has been hard to get this far: They were rejected by nine banks before finding one willing to do business.

But he and Blue are bullish, especially after the Nov. 6 votes.

"I've seen a lot of small companies that grew to be big companies," said Kennedy. "This is unlike anything I have ever seen."

Jonathan Martin: 206-464-2605 or jmartin@seattletimes.com.

On Twitter @jmartin206.

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