U.S. Federal Legislation: Is the Illegality Dam Crumbling?

Updated: Mar 13, 2019

As you may remember, Merida Capital Partners had just started the close of Fund I when Attorney General Jeff Sessions created a stir by removing the Cole Memorandum’s protections from state legal operators. Three weeks later, we launched Fund II, nearly matching Fund I within 25 days which showed that many investors saw opportunity among the uncertainty. As we near $50 million AUM and prepare to open the second tranche of Fund II on Monday, we have begun to think that our timing and the timing of huge political announcements is somehow intertwined based on today's incredible development which we can actually say we predicted.

Today started as your typical sleepy Friday after an event-filled week that saw John Boehner join the Advisory Board of one cultivation-focused investor, Acreage Capital, which seems to be more about optics than substance, and MedMen file their LOI to go public at valuations that seem to be quite expensive, but we congratulate both on their milestones and wish them luck and success. And then…kapow!

The headline (“Trump, Gardner strike deal on legalized marijuana, ending standoff over Justice nominees”) hit the wires and all heck broke loose. The next three hours marked a wild ride for the stock market, with cannabis related stocks moving up 20-25% after a Wednesday that already saw them rise 5-15% on average. This, after weeks of low-news drifting downward brought stocks up almost 50% from recent lows in just two days and exemplified the volatility and sudden changes that even one piece of news can bring when federal illegality and state legality are at play.

It also highlights one of the fundamental virtues of a professional investor like Merida with a vehicle for long-term investing: We can have a long view of the market and the capital to position our portfolio for the eventual unwinding of cannabis scheduling well before it occurs, which is truly a matter of when and not if. Whether you are a cannabis investor, a Merida investor or just an interested observer, we work hard to provide you insights on important movements in cannabis, because a well-informed investor ecosystem benefits the entire cannabis industry and as a result, benefits our portfolio.

When AG Sessions announced his intention to unwind the Cole Memorandum in January, it largely chilled the stock market and significantly depressed interest in the cannabis sector from institutional investors. In our commentary on January 4th, we reassured you all, saying:

“At Merida we feel confident that pushback from people like Cory Gardner (a Senior Republican in the Senate) and others will be swift and that this speedbump will in some way help Merida in the long run. It will likely give institutions pause, which creates more room for us to continue executing our strategy without larger competitors. It gives our companies more time to grab market share or grow their businesses with less mature competition…

We'll leave you with a prediction: As State AGs largely defy Sessions (just as they do on immigration), we believe President Trump or another senior official will come out and clarify what the administration's thoughts on this are, or they will gracefully deflect and say they have worked with congresspeople like Sen. Gardner (who is threatening political Armageddon for President Trump today on nominees at Judiciary) to find a modest solution that leaves the status unchanged regardless of today's Sessions statements.”

We aren’t going to pretend we are not proud in using our considerable information and data about the political ecosystem to have nailed that prediction cold. What is fascinating is that it looks like the announcement today might go much further than the federal/state détente on cannabis laws, as Senator Gardner referenced a “permanent solution” at the federal level in one of the articles today.

We won’t make a firm prediction on what that solution might be but it's fair to say that we have done an incredible amount of work with both state- and federal-level political players to have some ideas on where this might go, and it probably involves an excise tax first, then a later descheduling.

Regardless of the how, what does this mean for the broader investment universe? Several important things come to mind that are of importance to you and potential investments you may be making, or in how you view Merida and the opportunity we present:

Number One: Less Illegality Means More Regulation Is Coming

In any loosening of federal regulation, states are going to clamp down in a manner similar to California’s head-spinning addition of rules and regulations this year, while other states with relaxed laws are going to make sure that operators comply with a host of rules and regulations. With regulations come tools that help prove compliance. While most people think that means seed-to-sale tracking, we think of compliance in a much broader sense and the QC/QA/validation/safety rules that are likely to come should benefit our portfolio in an impactful way.

Here's a brief summary of Merida’s exposure to regulation:

New Frontier Data

As a leading information source for investors, state and international governments and industry participants, any shifts in regulation and broader behavior will be sought after, and NFD does a great job of collecting raw data and creating actionable information from it. Its partnership with Cohn Reznick on tax compliance might prove to be the most powerful informational service on the digital side of cannabis if the federal government or the IRS decide that before operators can move forward under a loosened state/federal system, they must prove their compliance in the past with tax laws.


As a leading compliance provider, Simplifya helps operators stay on top of critical compliance tasks and the ever-changing landscape of rules. With California's client list exploding, operators will turn to trusted and optimized tools like Simplifya to ensure that they don’t run afoul of rules on the state level that could jeopardize an operation which now no longer has federal illegality hanging over its head. Like New Frontier (with whom Simplifiya is partnered), the company also works with insurance companies and banks who are sure to see a huge spike in compliance-related needs as competition will be fierce in those verticals if federal rules loosen and they can now engage freely in the space.

Steep Hill Labs

As rules tighten in California, lab testing has been a touchpoint for operators and regulators alike. Over the past three years, lab testing requirements have consistently become much tougher as the East Coast pharmaceutical markets brought a disconnect in the industry to light. We cannot imagine that states will not require stringent requirements at least as rigorous as the standards in Pennsylvania, New York, California and Florida, which virtually guarantees that Steep Hill and its leading lab testing platform -- already in many states -- are going to be challenged by the volume of cannabis being tested. That challenge has led to innovation and investment from Steep Hill that further distinguishes its efforts and is an area of cannabis that should explode in total addressable market over the next three years.

Kush Bottles

Two words: Childproof. Packaging. You can be sure that the federal government, or states, will require safety measures that keeps cannabis out of the hands of minors. Kush already helped California determine packaging standards and is sure to be in the room if the federal government dictates similar standards. As a note, Kush recently announced revenue of $10 million in their most recent quarter, which ended before California’s operators returned to pre-January levels of licensed production and Kush is poised to become much more than packaging as it acquires complimentary businesses like Summit Innovations.


Regulation means cost. Cost means operators must get efficient to survive. GrowGen has already shifted much of its business to commercial operators, all of whom will rely on GrowGen to efficiently and cost-effectively fulfill their needs. The recent partnership with Alliance Biologics will allow GrowGen to offer industrial-quality organic nutrients that will help producers efficiently feed their plants without using contaminants, which could lead to failed lab tests or endanger consumers. GrowGen recently projected full year 2018 revenue of $37 million and should be an important provider of equipment and supplies to the competing operators of the future.

Manna Molecular

Operators looking for solutions that allow them to produce pharmaceutical-quality medicine for patients will look to automation as a necessary tool. Manna’s Mannabot and transdermal patch system are already exploding in Nevada and California and are sure to find bigger audiences as validation and quality control become paramount concerns in a highly regulated ecosystem.


Like Kush and GrowGen, our most recent investment, Mainstem, a procurement and business to business purchasing tool, is likely to benefit from any loosening of federal rules as competition spikes and operators look for efficiency in their procurement process. Mainstem is in the process of integrating with many of the leading seed-to-sale providers to allow operators to order equipment and search for new equipment or supplies as needed right from their existing systems. The natural overlap with Kush (already a supplier on the platform) and GrowGen is exciting for us, and we are proud to have added them to the Merida family in April.


We could see a scenario where energy usage and carbon footprint become an issue due to the high demands of cannabis cultivation. Lumigrow is a leader in reducing both and could be a force if the federal government or states impose mandates on growers. We believe California, for one, could impose restrictions that mandate some level of low energy lighting or HVAC requirements that could benefit scientifically inclined companies like Lumigrow.

Number Two: The Window for High Impact Investment at Lower Acquisition Costs is Closing

While many people think they'll be able to find and invest in companies for years to come or sit on the sidelines until certainty in the industry is established, we think that this belief is in direct contravention of the evolution we have been observing.

I've heard Danny Moses, as sharp an investor as you will ever meet and one of Michael Lewis’s sources for Flash Boys (after playing a big role in the Big Short), tell people that it “might be the second inning but it will skip innings four, five and six before you know it.” We agree. Even in the face of AG Sessions, rules were already changing, and states like Massachusetts were moving ahead with adult-use programs, as Pennsylvania, New York and New Jersey themselves grapple with the question of adult use legalization.

The entire thesis at the core of Merida Capital Partners is to be positioned for those eventual changes so that we capture the tailwind of the cannabis opportunity in our sails before needing to compete with the Apollos or Blackrocks of the world. We believe cannabis has to be considered the single best opportunity on the long side in at least the last 25 years. Federal illegality drives this opportunity because it keeps institutions out for the most part. If today’s news drives confidence that the federal dam is breaking, expect institutions to begin competing for deals, which means the countdown to traditional financing has started. We are confident we can compete on that stage but the return expectations we have are unlikely to sustain after an initial rush of valuation increases for current holdings in an environment where competition for deal flow becomes intense with a tsunami of institutional dollars looking at the same deals.

Number Three: Diversification into Strategically Aligned Companies Should Outperform

A shakeup in federal regulation will create a tremendous amount of uncertainty and volatility, which we at Merida believe can be mitigated by investing in companies that bring value to one another and insulate each other from outside competition. Our companies work together in many ways: They share information, strategically cross-sell, and look for ways to enhance their respective businesses by introducing potential customers to each other. In many ways, Merida has created a support net for our portfolio that both reduces risk, and in an upside scenario, should enhance returns as rules loosen and the cannabis industry grows to compete with the $200+ billion alcohol industry.

Constellation Brands bought into Canopy for that reason. MedMen partnered with Cronos for that reason. Merida in many places has served as the glue for both acquisition and partnership in the case, of just to name a few examples, New Frontier/Simplifiya, GrowGen/New Frontier, Mainstem/Kush, Steep Hill/New Frontier, Kush/Summit Innovations and more, and we believe our portfolio will align due to the status of many of our companies as leaders in their respective verticals.

We hope today's news excites you as much as it does us and we wish you all success in turning information into action in your cannabis investments. We hope this helps you put today’s news in context and we appreciate your continued interest in Merida.


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