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High Returns? Private Investors Funding Marijuana Revolution

When Josh Gordon was setting up Rodawg, his company that markets rolling papers and other cannabis “lifestyle” accessories, he ran into a problem: Banks were unwilling to provide funding to marijuana-related businesses, and individual investors still weren’t savvy enough to understand the market.

As a result, there was a shortage of available capital for startups like his.

“People were intrigued by the industry, but at the same time they were a little skeptical,” he says. “Everyone I talked to expressed interest, but they weren’t putting their money where their mouth is because of federal law and just not understanding the industry.”

As a result, he decided to bootstrap the entire operation, first with his own savings and then via a series of investments from friends and family, including his father, who is now one of the company’s managing partners. That was in 2010.

Then something entirely unexpected happened -- Gordon went out and raised an additional half a million dollars from a private angel investor.

“Since legalization, the tide [of investment] has really changed,” Gordon says. “People were all of the sudden looking at this thing as, ‘yes, it’s a reality’ and there’s money to be made here. One thing led to the next, and we raised all $500,000 through one angel. And the rest is history.”

A growing opportunity

Rodawg is only one in a string of new marijuana-related businesses that are finding success on the private markets due to federal regulations that have, to date, kept banks and more established small business funding players out of the industry.

Angel investing in the cannabis space has become so popular that an investment firm called the ArcView Group has sprung up in San Francisco, dedicated to matching informed investors with up-and-coming marijuana entrepreneurs. In May, the group announced plans to invest more than $1 million in several different industry startups, including Rodawg. Others chosen were Uptoke, a digital vaporizer maker; Apeks, an oil extractor manufacturer; and Canna Security America, which specializes in the unique security needs of dispensaries and cannabis cultivation facilities.

[Related: For Cannabis Entrepreneurs, Industry Expansion Brings Growing Pains]

“As is always the case in new markets, the best opportunities are private investments in private companies,” says Troy Dayton, CEO of the ArcView Group.

The group has amassed a roster of nearly 70 qualified investors (ArcView only works with those willing to invest $50,000 or more and who have significant financial means), and it has been holding meet-and-greet sessions across the country over the last several months, at which potential entrepreneurs pitch their ideas.

Among the investors are a number of experienced and longtime industry insiders, such as dispensary operators, pipe manufacturers and cultivators, as well as venture capital representatives, ancillary investment groups and a handful of high net worth individuals. The key, Dayton says, is that everyone in the room is intimately familiar with the challenges and realities of the ever-evolving cannabis market and what an investment in the sector really entails.

“Take the example of point-of-sale software,” Dayton says. “There are plenty of regular point-of-sale companies out there, but why aren’t they getting involved in this industry? One, it’s too small. Two, they don’t understand the market or the customers. And three, they fear reputational and legal risk. But in the next three to five years, the market will grow and those risks will drop, but you’ll still have a very idiosyncratic market.”

At the state legislatures’ level, the reception to legalized marijuana has been warming. The movement got a shot in the arm last fall when recreational cannabis use by adults 21 and over was passed by voters in both Colorado and Washington state. Plus, the 15 other states where the drug is approved for medicinal use ensure a large and growing market for marijuana and related products.

According to the Colorado Center on Law and Policy (CCLP), legalizing marijuana is expected to produce as much as $60 million in combined annual tax revenue and savings for the state budget, and new excise tax receipts alone could total $24 million in the first year. That's on top of the $181 million in revenue that the Colorado medical marijuana industry has generated since 2010, resulting in nearly $10 million in annual tax income statewide.

[Related: For Investors, Marijuana Remains a Cloudy Bet]

But it remains a very risky segment for investors, in large part because cannabis is still illegal under federal law.

"We are certainly going to enforce federal law," Attorney General Eric Holder told a House Appropriations subcommittee in April, adding that he hadn't yet decided what the federal government should do about the legalization votes in Colorado and Washington. "When it comes to these marijuana initiatives, I think among the kinds of things we will have to consider is the impact on children."

In early May, President Obama himself told a group in Mexico City that he does not believe "that legalizing drugs is the answer," stressing that his attention is focused on stemming the tide of illegal drugs entering the United States and addressing the violence that trade has caused in Mexico in recent years.

Smoothing out the playing field

The next stop for Dayton and ArcView Group comes on June 14, when they'll be in New York presenting to a group of potential investors near Wall Street.

“You’re not seeing too many Wall Street firms calling us,” Dayton says. “But it’s individuals who work [in financial services]. They’re checking things out for people who might be a little more careful about getting involved in this industry.”

In his view, the day will come when “there will be entire floors on Wall Street dedicated to research and trading in cannabis.”

There are a handful of publicly traded stocks available for marijuana-related companies now, including Hemp Inc. (HEMP), Cannabis Science (CBIS) and Medical Marijuana Inc. (MJNA), though all remain well entrenched in the small- or micro-cap space and have yet to make waves with serious investors.

For Jason Levin, the founder of Uptoke, a startup that’s creating a new type of marijuana vaporizer, the rise of private investment has not only brought money into the equation, but also new attention to the opportunities that are available.

“Groups like ArcView have been tremendously helpful in bringing legitimacy to the industry and broadening interest in the investment pool by allowing more mainstream investors to get involved. Most people have some personal experience with cannabis but they don’t bring that into their professional life, so for them it’s often ‘how are they being professionally perceived’ and ‘how is their fund being perceived,’ but the two worlds don’t always meet.”

That’s changing, he says, as investors realize the opportunities within the marijuana market, particularly for ancillary businesses like Uptoke and Rodawg that aren’t directly involved in the cultivation or sale of cannabis.

[Related: Why Rising Stocks Are a Buzzkill for Legalized Marijuana]

“The stakes are much higher now,” Levin says. “And it’s becoming more and more, professional, more and more sophisticated. They’re [ArcView] shooting for the same level of respect and quality as any other angel group, from green tech in the 1990s to plastics in the 1960s.”

Small-time investors, too

At the other end of the investment spectrum, crowdfunding is emerging as an alternative for cannabis entrepreneurs by allowing individuals to contribute small amounts to a startup (even in the $50-$100 range) in exchange for a reward or small return on their investment.

It's a model that has proven popular in the tech space with Kickstarter and Indiegogo, and Claire Kaufmann hopes the same will be true of her upstart marijuana crowdfunding network, WeCanna. The site has yet to launch, but Kaufmann is optimistic about its potential.

"I wouldn’t say that crowfunding is particularly profitable, quite frankly," she says. "What is valuable is not necessarily the crowdfunding platform per se, but the community it creates among the entrepreneurs in those networks."

It's also a more familiar and approachable way for people to get involved in an industry that may be new to them, especially if they already have experience with crowdfunding.

"Investing $100 is a very different story than trying to raise $10,000 or $50,000 from an angel investor," says WeCanna spokesperson Roy Kaufmann. "And even if that angel investor doesn’t really feel the $10,000, it is still hard to get those investments right now because the industry is so new and everyone is waiting to see how the state policies will play out. The crowdfunding approach is a way to hedge those risks for investors."