Leighton on Dutchess Capital and Cannabis

Dutchess Capital

As founder and managing partner of Dutchess Capital, a Boston-based venture capital firm, Douglas Leighton is no stranger to burgeoning industries. He has spent the last 25 years funding companies across an array of industries, and he is quite comfortable swimming in the swift waters of venture capital, where the potential for great success and great failure are constants.

Leighton and his team took a strong spotlight to the cannabis sector a few years ago, and recent investments by Dutchess Capital are proof enough that the firm plans to stick around.

Leighton recently spoke with MJINews to give us insight into his views on the progress being made by the industry, progress (or lack thereof) on the socio-political front and his thoughts on the potential size of the industry going forward.

Inevitably these questions and answers fed into the current investments he’s making, and his views on the best way to capitalize on all of the crosscurrents taking place in the industry.

 

Market Growth and Statistics

Leighton talked at length about the current estimates for the total size of the industry—how accurate they are, and just how fast they may be growing. Leighton’s firm recently released a research report that MJINews has made available in its library.

ArcView Market Research provides an industry baseline figure of roughly $2.5 billion in revenue from legal cannabis sales in the U.S. last year, up from $1.3 billion in 2013. ArcView predicts the revenue figure could hit $10 billion by 2018 as more states “come online.” Dutchess Capital has supplemented these estimates with its own internal research to form the canvass it uses to assess opportunities in the cannabis space.

While these stats should interest any investor (or current sideline-watcher), just imagine how important they are to a venture capitalist dealing in illiquid markets. Pragmatically, there is a long list of risks and impediments out there to be rightly assessed and accounted for before investing in the space, but time and effort must also be taken to understand just how big these markets are and how fast they are transitioning.

By Leighton’s estimates, there are 2.8 million square feet of new cannabis plants being grown this year and that’s just in the state of Nevada. While currently only a medical use state, Nevada has instituted what will be the nation’s first “reciprocity” medical usage system, meaning anybody with a medical marijuana card can purchase cannabis while visiting the state.

By his estimates, nearly $2 billion in capital is being put to work to allow for this square footage growth. And he and his research team arrived at those estimates before the November elections, where Oregon, Alaska, and Washington, D.C., passed legislation for recreational cannabis.

Leighton noted:

“Some people think they have missed the Green Rush; however, due to the delays with individual states, there are still billions of dollars to be deployed over the next two years within the current legal states, and there are still 23 states to go.

 

“Ask anybody intimate with the industry, and they’ll tell you it’s just the tip of a much larger iceberg. Depending on which survey or study you trust the most, there are between 15 and 24 million people in the U.S. that use cannabis ‘frequently,’ and they may spend as much as $4,000 per year on their usage.”

 

Key Opportunities in the Space

Leighton sees huge investment opportunities coinciding with this growth, which has already shown up in a near doubling of nationwide revenues from legal sources in 2014. And while Dutchess Capital does have investments in companies that “touch the plant” in states where it’s legal, Leighton is most focused on the opportunities in ancillary businesses such as consulting, lighting, enriched soils, and end-consumer products.

Investments in these areas can succeed without having to depend on who is winning the ground war in cannabis growth and distribution, an arena that’s likely to see immense volatility in the next decade and a good deal of shaking out amongst its participants.

A key addressable market in Leighton’s eyes is the consulting market. Because of the federal ban, each state that has medicinal or recreational laws has to in many ways reinvent the wheel to get operations going. As yet, nobody can come in and stamp down a national footprint to scale production and distribution. The steps to get up and running are wildly different from state to state, as is the upkeep.

That is why Dutchess Capital recently invested in American Cannabis Company (OTCQB: AMMJ), a Denver-based firm that provides “birthing” services like site selection, application submissions and supply chain management. As a new client’s facility progresses past this stage, American Cannabis Company also offers physical cultivation materials like soil, lighting and harvesting equipment, as well as many proprietary products it hopes to see gain traction in coming years, like Cultivation Cube.

The costs to start a new grow facility can cost upwards of $5 million per installation, Leighton said. And while a pound of cannabis can cost nearly $1,000 to produce, the wholesale margins are still large enough to entice entrepreneurs to enter the space. This creates a fertile opportunity for consulting firms that have proven expertise in setting up turnkey operations and navigating a dynamic regulatory environment.

Leighton added:

“When assessing investments within the space, we came to the conclusion that consulting was one of the sectors with the most potential, due to its ‘top down’ approach. I will equate this to the concept of selling picks and shovels to miners.

 

“In the case of cannabis, it is the consultants providing guidance and selling the related products to the growers on a B-to-B platform. There is an exorbitant amount of money being spent on new grows, and as more states come online, the demand for consulting services and products will intensify. The fact that AMMJ has already established a proven track record of winning highly coveted state licenses, as well as having a direct sales channel through which they can sell their ‘picks and shovels,’ bodes well for their continued growth and success.”

 

The Industry’s Path to Legalization

Leighton’s views were more cautious regarding the industry’s current trajectory, and the timeline he sees on major breakpoints like extra states approving cannabis for recreational use or a change in the schedule listing by the federal government.

As a veteran investor in startup industries, Leighton takes a prudent stance. When asked if mid-2016 would mark the time an inflection point in sentiment might be reached, he expressed his hope that we find ourselves there, but he isn’t staking his investments on it.

Regardless of the time frame, Leighton is confident that we will cross that inflection point, and when we do, the path to full legalization will be within sight and grasp.

There are three key areas of reform that he noted as essential to the next phase:

  • Banking reform – right now the situation is simply ridiculous, and creates an unsafe environment for not just business owners but all participants in the system.
  • Image reform – changing the “stoner” stereotype.
  • FDA Schedule – until cannabis is removed from the Schedule I list, the whole industry will be stuck in first gear.

And until we make meaningful progress on all three fronts, the cannabis industry will, to a large extent, be on the outside looking in on the mainstream investing psyche.

Leighton suggested, “If you can stomach the risk, now is the time to be dipping your toe in the water. Once these three items abate, the valuations will skyrocket as money will flow into the sector from more traditional sources.”

 

Recent Dutchess Moves in Cannabis

Dutchess has put a high value on technology and informational business in the cannabis space. As such, they are an early investor in startup MassRoots, a social media company which has created a unique user community that could someday be the go-to source for ad dollars by cannabis product retailers.

Leighton has also overseen the formation of an incubator in Boston, which currently houses two startups focused on consumer products. Because of the facility’s geographic location, neither startup is touching the plant—one is producing a foldable, transportable water pipe made of silicone, and the other is working on R&D within ceramics for consumer products.

Leighton described the advantages of a young company spending its early days in an incubator. Calling it “boot camp,” companies within the incubator get several benefits:

  • Reduced overhead expenses – utilities, office supplies, technology, etc.
  • Mentoring from proven leaders in setting up C-level personnel for the next phase of growth.
  • Access to the deep bench provided by a firm like Dutchess that has cultivated contacts and long-term relationships within the cannabis industry and outside of it. This allows for the cross-pollination of key ideas and information, as well as strategic partnership opportunities.

 

Stewardship in an Evolving Industry

An important need for investors is to feel confident that the representations made by companies in the cannabis space are true to the products and services they are actually developing and marketing—that they are not abusing investor interest in the space in order to artificially prop up stock prices.

Leighton hopes to help this effort along through his seat on the board of the newly-created Association of Responsible Cannabis Public Companies (ARCPC), along with other board members like Emily Paxhia of Poseidon Asset Management and Alan Brochstein of 420 Investor.

“I like being part of the ARCPC; there were too many public companies that popped up overnight and claimed to be in the cannabis space just to promote their stock. The formation of the ARCPC will hopefully weed out the bad actors, as well as shed light on the legitimate companies in the space,” Leighton said.

2015 will be a year of further illumination on cannabis-based companies and with Douglas Leighton’s role in ARCPC, increased self-regulation within the industry should increase investor confidence.

Ryan has spent nearly 20 years analyzing financial markets and investment opportunities for institutional and high-net worth investors. He specializes in determining the size and scope of new markets, changing industry trends and the market potential of new companies, products and services. Ryan has also published hundreds of articles on investment topics, market commentary and macroeconomic analysis.

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