More than two-thirds of the country favor legalizing marijuana. With the addition of New York and New Jersey to the list of states allowing adult recreational use, about half the country lives in a state where THC is legal.
Texas is behind the curve and still limits THC to a small segment of the population. Currently, it can only be prescribed by a physician to patients with cancer and PTSD, even though more than half the state thinks it should be entirely legal. Texas’ restrictions make it one of the states with the most restrictive marijuana laws. If further legalization occurs, advocates will have to wait until the next legislative session in 2023.
Matt Hawkins is one of the largest private equity investors in the cannabis business. (Courtesy: Cresco Capital Partners)
I spoke with Matt Hawkins, the Dallas-based managing partner of Entourage Effect Capital. He has more than 20 years of private equity experience, has founded multiple $500 million alternatives firms, and serves on the board of numerous cannabis companies. His private equity firm focuses on investing in the legalized cannabis industry. He spoke to D CEO about the industry’s future, why now is a great time to invest, and what makes it so unique.
D CEO: What is your experience in marijuana investment?
Matt Hawkins: “We’ve made over 70 investments out of three funds. In our third fund, we’ve made our fifth investment. We’ve been investing since 2014 in the legalized space, primarily in the US but also some in Europe and Israel.”
Why is now the right time to get into the space?
Hawkins: “We are at the point where we feel like some federal legislation is inevitable. It’s a matter of when. What’s great about what we’re doing now is making later-stage investments in companies because the industry has matured enough to have later-stage opportunities. So we’re able to build scale with those investments in advance of legalization, which we feel is a huge moment in time.
“When it does become quasi-legal or fully federally legal, you’re going to have a complete rush of capital from institutional capital that’s been sitting on the sidelines to the tune of tens of billions of dollars. In addition to investments from all of the large publicly traded companies, there are industries like pharmaceuticals, nutraceuticals, alcohol, spirits, and tobacco, you name it.”
What makes this timing so unique?
Hawkins: “There’s never been an opportunity like this for private investors in any industry, ever. Typically, institutional capital always gets access to the deals before private capital does, and now it’s the other way around because institutions can’t do it because of federal illegality. It’s an interesting moment in time when you think about it from a capital market standpoint.”
Why is institutional capital still on the sidelines?
Hawkins: “Investors such as endowments and pension funds explicitly say that they cannot make investments in anything that’s federally illegal. For that reason, the institutions that are investing like hedge funds can’t do it on a broad scale. Secondly, you’ve got companies that are traded on the NASDAQ and the New York Stock Exchange that are precluded from doing this for the same reason.”
What types of companies are you considering for investments?
Hawkins: “We find a company that requires growth capital that can take it to the next level. That sets it up for a potential exit upon legalization. That’s what’s attractive to us, and that’s happening across all the sectors of the supply chain in cannabis right now, which is incredibly exciting.”
What makes marijuana different from other commodities?
Hawkins: “THC, the psychoactive ingredient of marijuana, is legalized in certain states and is regulated by each state. You can’t cross state lines, so every state, regardless of its climate, has to grow the product within that state.
“In Massachusetts, for example, there are no outdoor cultivation facilities, so everything’s indoors. The cost structure of an outdoor grow in California might be cheaper than an indoor grow in Massachusetts, but that’s just the way it is. Until it becomes able to cross state lines, that’s the way it’s going to be.”
Will federal legalization upend the existing system?
Hawkins: “In our opinion, it’s not going to be a situation where interstate commerce becomes commonplace overnight. It’s too hard to unravel what’s already in place right now, the state-by-state concept. It’ll be tricky to unwind that initially. It’d be left up to the state to decide how they want to do it, but ultimately it would be regulated at the state level.”
How vertically integrated is the industry?
Hawkins: “In some states, vertical integration is not only allowed but encouraged. Whereas in other states, you can only work in one aspect of the supply chain. In California, where we have a lot of investments, you can be as vertically integrated as you want, which gives you the ability to capture margins at every single level of cultivation. Liquor, spirits, and beer don’t have that luxury, so it’s a wonderful way to build a business.”
What does the future of Texas look like regarding recreational marijuana?
Hawkins: “I think that’ll be next to impossible to do because even in our current state of Texas, the approval rate is way high, but as long as Dan Patrick is lieutenant governor, he’s never going to allow it to get to the Senate floor.”
How far out do you see federal legalization?
Hawkins: “We think it’s probably somewhere between three and seven years. The more public sentiment improves, it’s becoming a bipartisan issue. It’s just a matter of when it gets the attention of the Senate and the House.”
Are you seeing any coalescing around a product that is popular than others?
Hawkins: “What’s amazing about cannabis is all the different forms for delivery or intake. You’ve got the good old-fashioned joint, but then you’ve also got pre-rolls, cartridges for vaping, oils, tinctures, and edibles.
“You also have the beverage category, which is, I think, one of the most interesting sectors out there. THC-infused drinks are a category that’s just getting hot hotter and hotter, so that’s going to be something to keep an eye on.”
A big question surrounding legalization is how to measure the level of impairment for safety purposes. How is that being addressed?
Hawkins: “That has long been an issue in the industry, as there hasn’t been a way to measure the THC level at that very moment. We’ve made an investment out of our third fund in a company called Hound Labs, which does that very thing.
“It’s a game-changer for transportation companies, for example, having their drivers go through states where it is legal, and they can get a medical card. This allows companies and at some point in law enforcement to be able to measure impairment via a breathalyzer because there has to be some accountability with operating a motorized vehicle, so we were in favor of that, and we made the investment.”
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