Investing in a Cannabis Business

I am not a marijuana prude. I was in college in the 1960s.  I enjoyed it at the time but that is not a reason to invest in cannabis… or not to.

When I was in my 20’s and 30’s my closest friend was a major player in the drug paraphernalia business.  He sold high-end pipes, lighters, incense and stash boxes, wholesale, to boutiques and head shops around the US. I did a little bit of legal work for him and he, in turn, introduced me to many of the people who were active in the paraphernalia industry.

Today I can get all the marijuana that I might want. I am a cancer patient living in California where medicinal pot is readily available. I can get a card and order from a dispensary. They will deliver it to my home if I wish.

I asked my doctors about marijuana after my last round of chemo thinking that it might help me to regain some of the weight I had lost.  They offered to give me Marinol, a pharmaceutical that is a synthetic form of THC, the active ingredient in cannabis. It improves the appetite but provides no euphoria.  They offered me three  reasons:

First, they told me that the pot that I might get from a dispensary would vary greatly in terms of its THC content.  If doctors prescribe a drug, they want to be able to regulate the dosage. They told me that I could not trust the THC content on the label, as their experience showed it was not often accurate.

They also told me that much of the pot I might acquire at any licensed dispensary was likely to have been treated with pesticides.  A local TV station in San Francisco did a report where they picked up a few samples from several dispensaries and found pesticides in almost all of them.

Finally, there was the unassailable logic: “You just had cancer, why would you want to put smoke in your lungs?”  Yes, I could have ordered pot-infused brownies, but brownies are what I used to eat to come down from the high, so what was the point?

Investing in cannabis and cannabis-related businesses is a very hot item right now. There are dozens of small micro-cap companies that grow marijuana or sell it in states where pot is legal.  There are real estate funds renting agricultural land, warehouses and retail space to growers and dispensaries.  There is also a plethora of hemp and cannabis related oils, creams, dietary supplements and other products available. A hemp based toilet paper is a personal favorite of mine.

Because of my interest in investments and crowdfunding, in particular, I get a lot of questions about investing in cannabis-related businesses.  I generally tell people to invest in something else. I believe that the risks associated with a cannabis company are just too high.

Forgive me for stating the obvious but cannabis is illegal in the US both to possess and to sell.  Just because 28 states have allowed the use of marijuana for medicinal purposes, it is still illegal in those states.  State and federal penitentiaries are full of people who were convicted of selling marijuana.  Arrests are made every day.

The federal government is not currently enforcing existing federal law against small growers and dispensaries opting instead to focus US Justice Department resources on large dealers and drug cartels.  But that policy only started during the last 30 months of the Obama administration.

It is illegal for banks and federally chartered financial institutions to handle the proceeds of marijuana sales. In 2011, the federal government raided two credit unions in Sacramento, California clamping down on financial institutions that ignored that fact.

Several states in which cannabis is legal have attempted to remedy this in a number of ways.  In Colorado, state regulators permitted the creation of a state chartered credit union specifically to handle cannabis related businesses. A federal judge refused to allow the credit union to join the Federal Reserve System so transactions could not be processed.

As a practical matter, dispensaries cannot take checks or credit cards meaning that they accumulate a large amount of cash. They pay their rent in cash and their suppliers, employees, insurance and even their taxes.

Dispensaries and dispensary owners are obvious targets for thieves.  Some dispensary owners apply for concealed carry permits. Many use armored cars, private security and private depositories for the cash that they cannot store elsewhere. Customers, who must carry cash when they visit a dispensary, are also potential targets.

Some growers and dispensary owners establish holding companies or companion businesses to disguise where the cash comes from. You can imagine a dispensary supplying cash to a check-cashing business. But hiding the cash can lead to other problems.

In any business handling a lot of cash, there is always the presumption that some will get skimmed off along the way.  Most states that permit retail cannabis sales are careful to have stringent controls to make certain that they collect their sales taxes. Given that the federal government would still want all dispensaries closed, all that cash opens the door for more scrutiny by the IRS. The IRS is, after all, the way the government closed down Al Capone.

I remember the first Reagan administration when the Attorney General, Ed Meese, wanted to drug test every employee in the country. Test positive for pot and you would be out of a job and likely unemployable.

You cannot listen to the current Attorney General, Jeff Sessions, and honestly believe that he is going to look the other way while America gets high. He has been consistently on the record as being anti-marijuana.  People who believe otherwise have no basis for that belief. Anyone who thinks that the US Justice Department will continue to look the other way has not been listening.

Enforcing marijuana laws also furthers the Attorney General’s policy of rounding up undocumented immigrants. If the police kick down your door without a warrant because they “smelled marijuana as they approached” found no drugs but a cache of stolen property, there is a fair chance that the search might be quashed because you would get your day in court.  If they do the same and find an undocumented immigrant in the home, that immigrant will likely be deported without a day in court or any due process.

There is also the fact that the cannabis business has some nasty competition. Just north of where I live in California, in Humboldt and Mendocino counties there are a large number of pot farms. Some are run by Californians; some are run by drug cartels.  At some point the cartels are going to burn out their more legitimate competitors, or worse.

Finally, there is that fact that many of the cannabis products, oils, creams, etc. are making claims that would make the patent medicine salesmen of the 1880s blush. Cannabis does not cure cancers, autism or hemorrhoids. Call me when a peer reviewed study by a major medical school says otherwise.

One thing that might change the federal government’s thinking about legalization is the amount of tax revenue it might generate.  In states like Colorado, if the sales tax is only 7%, the state gets $70,000 on every $1 million of pot that is sold.  That is roughly the equivalent of the salary of one grade school teacher or one highway patrol officer for a year. Most states that have legalized cannabis charge a higher than 7% sales tax on purchases.

If and when Congress gets around to “fixing” the cannabis market, it is reasonable to assume that high priced lobbyists from the alcohol, tobacco and pharmaceutical industries will cut up the market between themselves.  If Congress approves marijuana sales and production it is likely to do so in a way that large companies will produce packs of 10 or 20 uniform marijuana cigarettes with a US excise tax stamp affixed to every pack in the same way alcohol and tobacco products are sold and taxed.

None of this, not the continued illegality of marijuana, the continued competition from the cartels or the legalization to the large corporations bodes well for the small micro-cap companies that are in the industry now or that are likely to get into the industry in the foreseeable future.  That is why I don’t think investing in one of these small companies is a good idea.

If you really believe that marijuana use will grow substantially in the next few years with 10 or 20 million new users entering the market, I suggest that you consider investing in Pizza Hut, Nabisco or Frito-Lay or perhaps Weight Watchers.  That way no matter which way the cannabis industry grows, your investment portfolio is likely to grow with it.