Pubdate: Sun, 30 Jun 2013
Source: New York Times Magazine (NY)
Copyright: 2013 The New York Times Company
Contact: http://www.nytimes.com/pages/magazine/index.html
Details: http://www.mapinc.org/media/297
Note: The New York Times Magazine is a section of the Sunday edition
of the New York Times
Author: Bruce Barcott
Note: Bruce Barcott is a former Guggenheim Fellow who is currently
writing a book about the battle over salmon and Indian treaties in
the Pacific Northwest.
SELL HIGH
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 and creams 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 resume, 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
cliches," 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."
Editor: Ilena Silverman
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MAP posted-by: Jay Bergstrom