Investing in the Cannabis Industry

EA: Justin, how did Measure 8 first get into the cannabis space?
JO: Well, so Measure 8 was launched by Boris Jordan, who is the executive chairman of Curaleaf Holdings in January of 18, as a vehicle for private market investments that didn't fit Curaleaf. I later joined as CEO in 2019 to launch our hedge fund and to try to turn us into basically the biggest cannabis asset manager out there. We're unique that we have a private and a public market effort that are both separate. We've deployed over 200 million out of our VC fund and we're running currently 50 million in the hedge fund strategy. We had a big 2020, up 74% on the hedge fund side and we allocated 97 million out of the VC fund, which was the industry leading total for 2020.
EA: What do you look for in management when you are considering an investment?
JO:Management is critical in this space. It's evolving so rapidly and there's just so much to deal with in terms of the tax regime, regulatory restraints. It's very difficult. What we really look for, we're blessed because we genuinely know these management companies from very early on in their life cycle. We come across them early on, we watch them evolve. Even if we have an allocated investment dollars, we're sort of noting how they perform, have they continuously met their benchmarks that they said they would meet? And basically the management teams that consistently execute are the ones that we allocate to. We look for people that have done it in other industries. That's usually very helpful. We just like guys that have a very cogent vision of what they're planning to do. Those are kind of the consistent themes that we're looking for.
EA: How involved is Measure 8 in the management of their portfolio companies?
JO:We aren't very involved in the actual management. I would say we're more involved in the strategic direction. We really don't want to micromanagement. We basically have made investments because we believe in the management team, unless there's some in distress, might be a unique situation. What does that really mean? We try to provide a thoughtful M and A program, give them a lot of assistance securing the lowest cost capital possible ideally with a strategic bent. More than a few cannabis companies have signed term sheets that they really didn't understand. The capital markets aspect is vital. And we're basically there for them as a strategic advisor along the way. We take board seats, we try to be intimately involved on an ongoing basis, not just allocate and leave it alone.
EA: As far as Measure 8 goes now, what geographies and verticals are you focused on right now?
JO:We're really very agnostic, generally speaking, but there's so much opportunity in the US that we've made all of our investment except for one in the US. I'll get to that in a little bit. We've made a couple of investments in California. We're focused on brands in California, the distribution opportunity in California, both D to C and B to B. We're also very focused on sort of the limited license states east of the Mississippi. We think a lot of the growth is going to come from there. We have, it's kind of in the hedge fund side, we're very focused on the biggest USMSOs with outside exposure to the states that we think will drive the lion's share of growth in 21 and then beyond. On the private side, we do everything from investments into tech, we have an investment in Europe that we're very excited about and we're looking to do more into Europe. And like I said, distribution.

COVID-19 really impacted the industry. But one thing it certainly did was accelerate new technologies as relates to omni-channel retailing. Brick and mortars are still critical, but now people are doing curbside. People are doing delivery and we want to be out in front of that trend. And that trend has been significantly accelerated over the last nine months.
EA: And how do you look at the relative valuations between a public and a private company?
JO:We'll always obviously demand a lower valuation for a private company simply because you have less liquidity. But what's interesting in cannabis is just as observing them over time, the public versus private market valuations have really compressed and expanded at various times. That's one of the reasons why in Measure 8, we like to have a private market vehicle and a public market vehicle. In the middle of 2019, for instance, private and public market multiples converged and in some cases, the public markets were actually at a discount to the private markets.

Now, since the elections and with the big year end run and early rally in 2021, there's again, a big divergence between public and private. That provide for different opportunities sets depending on what the specific environment is. Right now, this is providing an easy opportunity for some of our private companies to get public. Right now, the capital markets are open. That's very exciting background. We're much more focused on valuation on the VC side, obviously. On the hedge fund side, we are very aware of valuation, but we're also making trades at a more opportunistic and based on other criteria.
EA: You mentioned in your response to the election that took place in November, the results, what other impact did that election results have on this industry?
JO:I think it's going to be pretty massive. I think the horse was out of the barn regardless and we were going to get massive regulatory reform over the next 10 years, no matter what. But like COVID did for omni-channel retailing, these election results are going to accelerate the regulatory environment. I personally think that all we expect in 2021 for sure or that we're really optimistic about is the SAFE Banking Act and some resolution of the onerous 280e tax regime. And then we expect many state level initiatives. Up to 10 states could either adopt a medical or adopt an adult use program in 21. And that's really the short term and medium term growth drivers. A lot of people focus a lot of head share and mind space on the federal legality, but really the state level initiatives are what's going to drive the growth for the medium term. And that's a significant tailwind just getting the illicit market onto the regulated market is really a huge opportunity.
EA: You talked about the states versus the federal legality. Do you see the federal government making any change with respect to a Schedule I type drug for cannabis?
Justin Ort: That's a great question. Kind of the million dollar question. I would've said that that was my base case because the MORE Acts would have leaned you towards a de-scheduling or rescheduling that might not have been the best case if they go to a Schedule II, for instance, because that has a lot of issues unto itself. With the Democrats in charge, was unclear what they were going to focus on. After COVID, there's so many things that this country needs, but it was really encouraging to see that multiple times Senator Schumer has focused on cannabis.

I think that that's going to be prominent in the planning. I think the federal government, I don't know if they're ready to go for a rescheduling. Schumer's initial outline and it's very broad obviously and these are early days, but in the initial cut was that he wanted more of a state's act framework, which is basically let the states decide. We're not going to have interstate commerce yet. It's not going to be fully federally legal, which is really a very good hybrid for the industry. That's a really good result if that is the case. But like I said, it's very early days. De-scheduling, rescheduling, I'm less optimistic that that will occur, simply because the early indications are more for States act versus a rescheduling.
EA: Right. And I think the federal government has got its hands filled with enough other things to worry about de-scheduling cannabis, right now.
JO: I think that's very fair. They want buy in from other things.
EA: You mentioned the SAFE Banking Act, which is obviously a high priority for everyone these days. What other regulatory advances are you expecting in 2021?
JO:Just as a side, we'll never make an investment predicated on a particular regulatory advance or any legislation occurring. Anything that does happen is sort of gravy. It's an upside scenario. Just wanted to put that in the background. But what we're hoping for slash expecting are SAFE Act, removal of 280e or some adjustment of 280e. For any listeners that don't know, 280e is a very difficult tax rule. You cannot deduct the cost of goods sold as opposed to a regular business because it's federally illegal, you basically are paying 80%, 70 to 80% taxes on your top line. And the amazing thing is these business models are so sound that the companies are still profitable despite that. But there's 30% type of variability that they can get back in taxes, even more, depending on what kind of operator they are.

And so right now the federal government is not focused on that. It's bringing in a lot of revenue, but it is stifling the industry. It is creating a lot of unintended consequences. And it's one of these situations where if they just got rid of 280e or changed it, they would actually bring in more net revenue. And so they would have to maybe take one step back, but in the long run, they would actually be able to reap more revenue. I'm optimistic that with the Democrats in charge, they kind of get the risk reward better and they understand how important it is to balance some budgets, the time is certainly right from the states' level. People, they really need the money.
EA: Yeah. Just to clarify what 280e does for our listeners. It doesn't allow companies that are Schedule I companies and Schedule I drugs to deduct ordinary operating expenses that are available to most other commercial companies. That creates a much larger or a higher tax burden for these companies.
Justin, thank you for joining us today. I appreciate your insights and thank you for listening to CannaCast, which is part of EisnerAmper’s podcast series. Please visit eisneramper.com/cannabis for information and podcasts and join us for our next CannaCast podcast where we'll discuss other budding issues. Thank you everyone.