PlayBook 2Q 2019

The Wild West of the budding cannabis industry

June 21, 2019
This story is featured in the 2Q issue of the PitchBook Private Market PlayBook.

SAN FRANCISCO—Under one interpretation of US law, Bharat Vasan is a drug-dealing kingpin. But to the hundreds of investors, entrepreneurs, opportunists, experts and executives hanging on his every word inside an airy event space one Tuesday last month, the CEO of Pax Labs was something else entirely.

A business mogul. A role model. A man who saw the future.

Never before had I seen so many people dressed so nicely, gathered in such a swanky spot, to talk about marijuana.

It was an overcast afternoon in the Dogpatch neighborhood, a strip on the city's east side in the late stages of gentrification. The new home of the Golden State Warriors is under construction nearby. Vasan was on stage to open CannTech 2019, a summit hosted by early-stage venture firm DCM in the hopes of bringing together "cannabis, tech and capital." It was early May, barely two weeks after Pax closed a $420 million VC round to help finance its popular cannabis vaporizers—a stunning (and apt) amount for a company reliant on a product still illegal under federal law.

But that might not be the case for long. The times they are a-changing, and they're a-changing rapidly. Medical marijuana is now legal in a majority of US states. A majority of US citizens now support full legalization. It seems less a question of "if" than "when."

"It's hard to put the genie back in the bottle," Vasan said.

The prospect of a massive new legal marketplace worth tens of billions of dollars is enough to make investors up and down Sand Hill Road swoon. But it also raises questions. About regulation and product quality, yes—but also moral questions about VCs swooping in to capitalize on a substance that for decades has been demonized and criminalized. The idea of selling marijuana to the masses isn't new; it's just that for most of the past century, doing so was often punished by a lengthy stint in jail. In 2019, though, the dealers have moved from the street corner to the C-suite.

The cannabis revolution is here, and VCs are taking notice. In 2013, startups in the sector drew just 11 venture investments worth a combined $16 million; by last year, those figures had exploded to 146 deals worth $982 million, per PitchBook data. In just the first four months of 2019, the value of VC deals in the space ballooned to $1.2 billion.

What exactly the high-flying future will look like, though, is still a hazy question.

"It's kind of like the Wild West," said Twitch co-founder and investor Justin Kan during one panel discussion at the summit.

If that's the case, then CEOs like Pax's Vasan are settlers staking their claims. To many, Pax might best be known as the former parent company of Juul, a spinoff focused on nicotine vaporizers that was recently valued at a jaw-dropping $38 billion. But Pax had already banked more than $100 million in VC backing of its own before this year, and the business announced its presence in a major way with that $420 million funding in April at a $1.7 billion valuation, far and away the highest for any company in the cannabis industry.

Vasan was at the summit to talk about growth—in business terms, not botany. The legal cannabis space is, of course, still in its infancy, with countless problems to be solved. Some of the major ones Vasan identified are related to quality, control and predictability. In other words, consumers should be able to go to a dispensary, describe the effect they're looking for, and get it. But such consistency has been difficult to establish.

Along with problems, the youth of the cannabis space also presents opportunities. The industry is a blank slate, which means companies can be whatever they want to be. It's a rare chance for marketers to establish brand identities from scratch amid a landscape where the competition is still relatively scarce, and where many potential customers still don't quite know what to make of it all.

"We want to establish cannabis as a force for good," Vasan said. "Figure out what the story is. Any time you're building a brand, there needs to be a story around it."

It's a message that's certainly been taken to heart by another panelist at the summit, Gunner Winston, the CEO of Dosist. His company is also concerned with issues of quality, control and predictability: Dosist makes disposable vaporizers that provide precise quantities of THC and CBD—the two main compounds derived from cannabis—aiming to bring small doses to a higher-end, distinctly non-stoner clientele.

A former hedge fund pro, Winston took the helm of Dosist in 2017 and immediately, as he described it, "put brand ahead of business." Winston pruned the list of stores that sold the company's products, focusing on finding the right partners to sell Dosist products rather than the most partners. Sales took a temporary dip, but he says it's been well worth it in the long term.

"If you think this space isn't going to get more competitive, you're tricking yourself," Winston said. "And so you have to prioritize brand."

The latest example of that prioritization is Dosist's first storefront—a fashionable open-concept space in Venice, CA, decorated entirely in white. It's reminiscent of an Apple Store, which Winston cited as evidence for the importance of linking a product to the location where it's sold. The future of buying marijuana isn't knocking twice at a locked door in a back alley.

"We're an aspirational brand," Winston said. "We're looking to inspire people."

The summit also included a pitch competition featuring six different founders. One of them—Dorian Morris of Undefined Beauty—presented a similar idea of inspiration, but from a slightly different angle. Morris is a black woman, which is relevant for a couple of reasons. One, it makes her stand out in a cannabis space where only 5% of executive roles are held by women of color, according to Marijuana Business Daily. And two, it ties in with her company's goal of using CBD-infused skincare products as a vehicle for "empowering women and minorities."

For decades, a disproportionate number of men and women arrested and jailed for marijuana-related offenses have been people of color. Now, a disproportionate number of those banking huge profits from the plant are white. It's a dichotomy Morris can't ignore.

"The cannabis industry was built on the backs of black and brown folks. A lot of people aren't taking that into account, and I am," she said. "I want to take something that was negative and bring a lot of positivity to it."

It was a message echoed in part by Jim Patterson, the chief executive of Eaze, which operates an on-demand cannabis delivery service in California and Oregon; the company was valued at $315 million with a $65 million round of VC funding in December. In an effort to build what Patterson described as "a sustainable and just industry," the company recently partnered with Code for America to build software that identifies people with cannabis-related offenses that could be expunged.

"These are just low-level possession offenses," he said. "But the problem is, when people have that on their record, they're unable to get jobs—it really affects them moving forward."

Patterson also talked about the illegal marijuana that still very much exists, and the need for both regulators and companies in the space to do a better job of stamping it out. It was a bit of a surreal experience to listen to a CEO cheerfully discussing the price of an eighth of weed on the streets of Los Angeles and the vagaries of different varieties of Blue Dream. But in Silicon Valley, that's the new reality. You got the sense that some of the attendees at the summit couldn't quite believe it.

"Even in the most recent history, there was obviously the war on drugs and the federal government really leaned into trying to suppress this plant," Patterson said. "There were those activists that risked their freedom."

The era of marijuana users in the US risking their freedom might soon be over. Which means the era of venture capitalists risking their cash in pursuit of massive returns in the cannabis space has only just begun.

Correction: This article was updated on June 26 to reflect that Pax Labs products are not illegal under federal law. The company manufactures vaporizers but does not directly sell or distribute cannabis.

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