High finance: Tech firms, investors budding up to cannabis | Crain's Silicon Valley

High finance: Tech firms, investors budding up to cannabis

At first glance, the recent New West Summit in San Francisco looked like any modest-sized tech event in the Bay Area. Corporate-style booths housed demonstrations of circuit boards, sensor systems and industrial equipment, while panelists talked venture funding, ecommerce, artificial intelligence and big-data analytics.

But a closer look revealed an exhibitor displaying bongs, water pipes and vaping systems. In a nearby booth, a participant invited guests to handle giant buds of fragrant marijuana to demonstrate how the company’s lighting system yields superior pot growth.

Yes, the New West Summit was no ordinary tech event—the focus was on the emerging market for legal cannabis. And that market is blazing right now, attracting major interest and capital from technology-oriented firms and their partners in the financial world.

Legalize it

Recent moves by Alaska, Colorado, Oregon and Washington to legalize recreational cannabis set the stage for the expansion of the marijuana growing business. However, the impending vote on California’s Proposition 64—which is predicted to pass with nearly two-thirds of state voters in favor of the measure—will shift the market growth into high gear.

Retail sales of marijuana in the United States are expected to rise to $25 billion in 2020, nearly quadrupling the total of $6.5 billion this year, according to a forecast from cannabis research firm GreenWave Advisors LLC. GreenWave’s forecast hinges on the expected success of legalized recreational cannabis initiatives in five states this November—most notably California.

“California is clearly the largest market in the United States,” said Matt Karnes, founder and managing partner at GreenWave. “California represents about 55 percent of the U.S. market.”

High technology

The legalization of recreational marijuana is spurring rapid growth in the cultivation business. Cultivators that can produce top-quality product with high yields stand to command enormous profits. On the other hand, these enterprises face huge risks that are inherent in an intensely regulated market—including potential prosecution for failing to conform to state regulations.

It is both the opportunities and potential downside that make growers willing to invest in technology solutions that will minimize risk and maximize yield. In this regard, cannabis stands apart from other segments of the agricultural business.

At a panel session at the New West Summit, Eli Duffy, co-founder and CEO of Colorado-based Grownetics Inc., explained why his company uses artificial intelligence in its marijuana growing operations.

“If I’m a tomato grower, and I grow 5 percent more tomatoes, the amount of money I’m making per pound of tomatoes, the margins are so low, that I if I increase my yield by 5 percent, it’s not worth it to invest $100,000 in a Grownetics system,” Duffy said. “But when cannabis is commanding a price of over $1,000 a pound, and the margins are so much higher than any commodity agricultural crop, growers are incentivized to pay that extra money to invest in technology to increase their yields.”

What a rush

Technology’s appeal to growers has spurred a rush of technology firms entering the market with products serving all aspects of the business, from agricultural innovations to online services to sophisticated lighting systems.

Grownetics, for example, offers advanced crop analytics and efficient indoor cultivation systems, consulting, design and even installation for growing facilities. In a promotional video, the company said it is “…building a self-driving car for cultivation. A smart thinking garden that thinks for itself, and learns for itself.”

Meanwhile, Palo Alto-based PotBiotics is using neural-net technology to recommend the cannabinoid levels and the particular strains that can best treat the specific conditions of medical marijuana patients.

It's not just the science of growing that presents an opportunity for new businesses. Kind Financial of Los Angeles, for example, is offering software that helps growers remain within the regulatory and financial constraints of the business.

“Every heavily regulated industry in the world, from pharmaceuticals to gambling to alcohol—the backbone of those industries is compliance,” said David Dinenberg, Kind’s founder and CEO. “It all comes down to compliance. As state governments brought forward laws for legalized and medicinal marijuana, we saw the need for robust compliance systems.”

Adherence to laws and regulations is particularly critical in the cannabis business.

“If you are in violation of state law, you are subject to federal prosecution and losing your license,” Dinenberg noted. “If you are in that position, the federal government views you the same as someone selling drugs on a street corner.”

Hands off

The massive growth potential of the marijuana business is attracting considerable amounts of investment money. In 2016 so far, the cannabis market has seen 184 capital raises totaling $666.3 million, according to Viridian Capital Advisors, a cannabis industry strategic and financial advisory firm. The biotech and pharmaceutical segments lead all other segments of the market in terms of capital raised.

The technology segment of the cannabis business may be more attractive to investors who want to cash in on the burgeoning marijuana industry than enterprises directly involved in growing or selling the crop. One of the reasons is the Internal Revenue Service’s Section 280E rule, which prevents marijuana businesses from deducting their ordinary and necessary business expenses.

“I think there’s still very much of a feeling amongst a lot of capital folks that businesses that don’t touch the plant or that aren’t directly involved in having to be licensed are much more apt to receive equity and debt financing,” said Jonathan Teeters, director of government affairs at cannabis commerce firm Tradiv. “This is because we’re still in an environment where it’s federally illegal and we still have an issue with the banking. With 280E issues, companies can’t really capture all the potential savings and efficiencies that are on the table for smartly run companies. Until we fix those things, investors are going to look for companies in the conventional space, those that are making products that are qualified as not being cannabis that can capture all the financial incentives that can make a really profitable company and a good investment.”

A blooming opportunity

As the size of marijuana business explodes and the competition intensifies, so too will demand for technology and the funding to pay for it.

“Three years ago, when I started in the industry, a large grow was 20,000 square feet. Today a large grow is 400,000 square feet,” said Scott Greiper, president of Viridian. “You need capital for scale. You need to bring in lighting and HVAC and filtration systems. All these requirements for technology need capital.”

Agricultural technology companies represent one of major areas of capital investments in the marijuana business, Greiper observed. 

“The third biggest area of investment is the ag tech companies that provide the lighting systems, the nutrient systems, the cooling systems and the water systems. This is because as the cultivation side grows, and requires more capital and bigger dollars, smarter money is coming in to fund that and is demanding that they employ advanced technologies."

As the revenue and the scale of the cannabis business expand, more technology and capital investment firms are expected to enter the market. As they do, it’s a good bet that events like the New West Summit will start to look more and more like other events in the Bay Area, with an increasingly corporate flavor and a focus on the bottom line.

October 20, 2016 - 6:32pm