Profiting as The Black Market Dies with Cannabis Investor Douglas Leighton

Douglas Leighton

Douglas Leighton of Dutchess Capital details why most people don’t understand how the cannabis market is different. Most new businesses have to convince prospective customers to try their product or service. This is not the case with cannabis. There are millions of people that use cannabis illegally right now they just need to be brought over to the new, legal market.

Also learn about Doug’s savvy investment style that includes investments in: MassRoots and Dixie Elixirs.  See Dutchess Capital’s report, The Macro View of the Cannabis Market.

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Matthew: Hi, I’m Matthew Kind. Each week I’ll take you behind the scenes to interview the insiders that are shaping the rapidly evolving legal marijuana industry. Learn more at www.cannainsider.com. That’s www.cannainsider.com. What are the five disruptive trends that will shape the cannabis industry in the next five years? Find out with your free report at www.cannainsider.com/trends. That’s www.cannainsider.com/trends. Now here’s your program. Douglas Leighton is a partner at Duchess Capital, and a well-known cannabis investor. Today we’re going to learn why Douglas is excited about the cannabis industry and what he sees is the best investments. Welcome to CannaInsider Douglas.

Douglas: Thanks very much for having me Matt.

Matthew: To give us a sense of geography, can you tell us where you are in the world today?

Douglas: Sure, I’m in rainy and cold Boston today.

Matthew: Okay. Can you tell us a little bit about Duchess Capital and its focus?

Douglas: Sure Duchess has been around for about 15 years, almost 20 years. I’m sorry. And we are a hedge fund. We have several offices around the globe, and we are industry agnostic, and we invest in primarily publically traded entities. And about a few years ago we started looking into the legal marijuana market, and we sort of progressed into, you know, still doing our traditional business, but we’ve put about 25 percent of our resources into the legal marijuana space.

Matthew: So you produced a report recently that gives a lot of detail about the cannabis industry and your thoughts about it. Excellent, very well done. Can you give us some high level overview of what’s in that report and what’s important about it?

Douglas: Sure. The first thing I think to mention, which is very important, is that this is a industry that is being served illegally and has been served illegally for thousands of years which today stands at about a $50 billion illegal black market. The current legal market for cannabis is approximately $2 billion. As more states come online, that black market will diminish and it will become a legal market. That gap has to be narrowed. That $48 billion has to be narrowed. That in itself is probably the highlight of the entire report.

The second is the fact that the demand is constant. The demand has been there for years and there’s no real marketing that has to be done on the side of these dispensaries and retailers because the demand is there, and marketing is a very large portion of a business’s budget, and that makes it very easy to sell a product that there’s already a current demand. The other thing that’s very important about that is that there’s only 24 jurisdictions in the United States have allowed either medical or adult use marijuana. There’s still 26 left to go. So that just in itself is a doubling or almost a tripling in the market due to the state sizes, populations in each state. And of those ones that actually have gone full, either recreational or medicinal, they’re still not fully built out. So we estimate about $1.7 billion will be spent in infrastructure, sort of the picks and shovels to miners over the course of the next 18 months. And that’s what gets us excited about the business.

Matthew: That’s an excellent point. So this industry exists. It’s just moving from black to white market, let’s say, and all these customers are lined up. It’s so much different than investments where you’re speculating if a market will… if we can create a market. The market is already there, it’s just transferring it to a, in many cases, less desirable, or most cases less desirable black market to a legal market. So excellent point. It’s enormous. It’s an absolutely enormous market. Can you tell us a little bit about your cannabis related investments so far, who you invested in and why?

Douglas: Sure. We looked at the cannabis space for quite a long time before we actually made an investment. And we started with the widest funnel possible. And our first investment was a company called Mass Roots, which is the only and specifically social media network for the cannabis space. I believe you had Mass Roots on a couple of weeks ago I think.

Matthew: Yeah, Isaac. Isaac, he’s a very smart young man.

Douglas: Yes, yeah. The team, Isaac and the team over there have done a fantastic job at building out this network with very little capital, and there’s a need to have this sharing service where on the terms of service of Twitter, Facebook, Instagram, you’re not allowed to post pictures of cannabis. This allows in states where it’s legal, you can talk and post pictures about cannabis and that is your marijuana profile where you don’t want your coworkers, parents, friends to see that maybe you use cannabis for medicinal purposes or you’re in an adult state that allows it, and you don’t want anyone else to know. This is where that’s your profile semi-anonymous network, and that has been… that’s been a fantastic and fun investment. We invested in that about a year and a half ago. You know, they’re now up to about 215,000 users from 6,500 when we made the investment which is pretty amazing.

Another company that we did sort of fall in that funnel concept was American Cannabis Company, and they are a end-to-end business service company that helps you if you’re looking to get a marijuana dispensary or cultivation license. They’ll help you from the beginning, planning stages of business and perform all the way through the application through standard operating procedures for running a dispensary and for running a commercial cultivation. And that company has been fantastic as well, and they’re growing very rapidly. Those are just two. We’ve made about 14 investments in this space so far to date.

Matthew: Do you see a spark in the eye of some of these entrepreneurs? Is there something at a gut level where you say, you know, I’ve looked at the math, but there’s something I just really like about these entrepreneurs?

Douglas: Absolutely. Without the spark there’s no investment. These are all young, younger-ish people and they are all immature, not as immature as they were two years ago when we first started looking, but they’re immature from a business prospective side, but they all are very hardworking, very energetic. They have the vision. They understand the industry. And they know where the industry is going to be. You know, the standard sort of stereotype of a stoner is, you know, sitting on the couch, you know, eating Doritos, watching TV. From the entrepreneurs we’ve seen, we do not get that image whatsoever. These are all very hard working, smart, young kids that are working 17-18 hour days, 7 days a week, and they’re really the pioneers of a new industry.

Matthew: Do you focus exclusively on equity investments or do you do some loans at all?

Douglas: We’re primarily equity, however we have done some short term debt loans to companies who are already equity invested in, just to sort of help them out over a hump either for factoring reasons or for some different short term financing issues, but generally we’re equity investors not debt investors.

Matthew: Do you have any opinion on whether or not you want to invest in companies that touch the plant or don’t touch the plant, or is that a non-issue for you?

Douglas: It’s a non-issue for us. We will invest either in the plant or not. We don’t invest in either Colorado or Washington State because of the residency requirements which forces you to invest in debt. We’re not debt investors so we’re staying away from those markets that touch the plant.

Matthew: Help us understand the supply and demand dynamics here. Infrastructure nationwide is still being built out. A lot of grow operations are still small, but we’re seeing some larger ones come online. At what point does the price per gram start to really plummet, or do you think that will happen?

Douglas: So that’s one of the interesting things that we wrote about in our report which is this is a very different situation than most other investments that we’ve looked at over our 25 plus year history. In that in some states, for instance Colorado, it was not… it was vertically integrated. You had to grow and sell your own marijuana for many years. As of July 1st, there was a decoupling of that where now you can actually grow your own marijuana and sell it to dispensaries. That is going to lead to a commoditization of the product which in turn will turn, put price pressure, and that is another reason why we’re not investing in Colorado, very similar to Canada and similar to Washington State.

Other states such as Massachusetts for instance, they do not allow that. You have to be vertically integrated. That will keep the price very high and the product will not be commoditized because you have to grow it and sell it in your own retail shop. And as far as interstate commerce, I don’t think I will see interstate commerce at least for ten years. And the reason why, many other people disagree with me, but the reason I believe that is for the simple fact that in the state of Massachusetts, you can’t even ship wine into the state of Massachusetts which has been legal for 80 years. They’re very protective of that, and I don’t see them changing that rule to allow anyone else to ship marijuana across state lines, especially in the state of Massachusetts.

Matthew: That’s a great point there. So the dispensaries in Massachusetts in essence by default have regional monopolies because there’s not enough supply and it’s so strictly regulated. Does that leave room for the black market to still exist then?

Douglas: Well it won’t because there is… as long as the price is similar to the price in the black market, which it should be able to be because it’s easier to grow and less expensive to grow on a commercial scale than it is to grow ten plants in your basement. That will in effect keep the price very similar to the black market.

Matthew: Okay. And how about let’s look at 2015, and are you looking at making any more cannabis related investments in 2015, or are you just keeping an open mind to see what comes to you, or what do you have on the horizon?

Douglas: So we will close two deals probably the end of this year bringing the total to sixteen. And next year, you know, we look to do 12 to 15 investments. If we, you know, we’re shown 30 we would do that, that set the criteria. If you know valuations are still in check, you know, we’ll certainly look at more, but we would… we also would do none if we couldn’t find the right spot for it.

Matthew: Yeah let’s talk about valuations for a little bit. Where do you see them? They’re still reasonable, do you see more becoming unreasonable? What can you tell us?

Douglas: They had a spike along with the public equity markets in January through March. They have become a little bit more reasonable. They need to be considerably more reasonable. They’re not yet, and a lot of these entrepreneurs simply just don’t understand how to value a company, and they believe because they’re in the cannabis space that it’s worth a considerable more. And the issue with that that was just recently in the last week, a company that raised capital at a very high valuation. They launched their product and within a week, they were sued by a major city, the second largest city in the country and they were sued to be shut down. And now they’re fighting. They’re using all the invest money for lawsuits. So as much as I love this space and I think it’s the next great frontier, there’s a tremendous amount of risk in this space, and that’s why valuations need to be adjusted to that.

Matthew: If I’m a entrepreneur listening or an investor listening, what are the big problems that need to be solved in the cannabis industry that someone’s going to be, do really really well if they can solve these big problems?

Douglas: I’m going to… three off the top of my head. One, banking, and that’s merely a safety issue. There’s too much money being carried around by people that should not be carrying around that much money. Number two, they need to reschedule the drug. This is not as risky as heroin or cocaine. And number three, they need to change 50 years of brainwashing and stigmatism that is put on this plant on how evil it is and that needs to be changed. Those three things are the most important things. You’re never going to change number three or make any money from it anyway, but the first two are very very important to change.

Matthew: Now a lot of the entrepreneurs out there that understand the investor's point of view really well seem to do well. And I think there’s a perception that that’s not the case. But can you tell us a little bit about how entrepreneurs can be more investor friendly?

Douglas: Sure. The first is to not… to put a pitch deck and PowerPoint together that you understand and that is your gut feel that’s your vision, not that someone wrote for you and you’re reading it to me. I want to hear it from your heart of exactly what your vision is and how you’re going to get there, and what you believe is your, you know, differentiating fact in your value proposition and what this money that we’re going to invest is going to turn into. And the second thing is to have open communication. While the process of the investment is being made, once it’s made, constant reports, monthly reports on financials whether it be contracts, user growth, anything positive and most importantly anything negative. We have 25 years experience in investing. We have a very deep bench of people that can help us out, and we need to know all the good news as well as all the bad news, and if a pivot has to happen, let us know about it. Let’s discuss it and let’s try and fix it together, not just tell me everything’s great every day, because I know that’s not the case.

Matthew: Right, and you don’t want to be the last one to know. Okay. So you mentioned you’re in Boston, and the stigma still exists to some extent, in some places much more than others. How is it changing there? Are attitudes changing a little bit?

Douglas: A little bit. You know, Boston’s always a little slower to change than other places, but it’s slowly changing. And you know the issue is people again have been so, you know, brainwashed by “Reefer Madness” throughout the years and how dangerous the drug is that people really need to be educated to understand that it’s not as dangerous as heroin and cocaine. It’s not addicting. No one ever died from it, and there just needs to be an education process which is taking place, but it just takes a long time.

Matthew: And Doug how can people learn more about Duchess Capital?

Douglas: They can go to www.duchesscapital.com or they can call us on any of the social media outlets. We’re on all of them. And you know, contact us if you have any questions.

Matthew: Thanks so much to Douglas Leighton for being on CannaInsider today. Thanks Doug.

Douglas: Thanks very much. Have a good day.

Matthew: If you enjoyed the show today, please consider leaving us a review on iTunes. Every five star review helps us to bring the best guests to you. Learn more at www.cannainsider.com/itunes. What are the five disruptive trends that will shape the cannabis industry in the next five years? Find out with your free report at www.cannainsider.com/trends. That's www.cannainsider.com/trends. Have a suggestion for an awesome guest on www.cannainsider.com, email us feedback@cannainsider.com. We would love to hear from you.

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  • http://www.cannainsider.com/ Matthew Kind

    Don’t forget to read Dutchess Capital’s special report on the macro view of the cannabis market (see above) it is very insightful.