Pubdate: Sun, 30 Jun 2013
Source: New York Times Magazine (NY)
Copyright: 2013 The New York Times Company
Note: The New York Times Magazine is a section of the Sunday edition 
of the New York Times
Author: Bruce Barcott
Note: Bruce Barcott is a former Guggenheim Fellow who is currently 
writing a book about the battle over salmon and Indian treaties in 
the Pacific Northwest.


Brendan Kennedy and Michael Blue, private-equity financiers, settled 
into a downtown Seattle conference room in March to meet with a 
start-up. Both wore charcoal blazers and polished loafers. Kennedy, 
41, is the former chief operating officer of SVB Analytics, an 
offshoot of Silicon Valley Bank. Blue, 35, learned his trade at the 
investment-banking firm de Visscher & Co. in Greenwich, Conn. Two 
years ago they quit comfortable posts to form Privateer Holdings, a 
firm that operates on the Kohlberg Kravis Roberts model: they buy 
companies using other people's money and try to increase their value. 
What sets them apart is the industry in which they invest. Privateer 
Holdings is the first private-equity firm to openly risk capital in 
the world of weed. Or as the Privateer partners prefer to call it, 
"the cannabis space."

Megan and Ben Schwarting, a casually dressed couple in their early 
30s, made a presentation. Their company, Kush Creams, produces 
"cannabis topicals," which are lotions and creams infused with 
marijuana's active ingredients. Kennedy and Blue had invited them in 
to learn more about the pot-cream market.

"We know nothing about topicals," Blue said as he reached for a 
little jar of something called Purple Haze. "Walk us through this 
like we're third graders," Kennedy added.

Megan offered a nervous smile. Their products, she said, contain 
cannabinoids like THC and CBD. They're medically active but won't get you high.

"What do people use it for?" Kennedy asked.

"Pain relief, initially," Megan said. But customers have found them 
useful for "everything from fibromyalgia to psoriasis."

She told the financiers about their product line, which included eye 
creams, toothache drops and a first-aid spray called Owie Wowie.

"How do you extract it?" Kennedy said, referring to the cannabinoid 
oil that's mixed into the lotion.

"That's kind of our company secret," Ben said. "We work mostly with 
one strain. Others don't produce quite the same effect."

"What led you to start the company?" Kennedy asked.

The couple acknowledged that they started years ago as pot growers. 
"Then we had daughters and wanted to move into something with less 
risk," Megan said.

The Privateer partners are always hunting for a good investment, but 
it was apparent that they wouldn't be taking a stake in topicals any 
time soon. Though state law allows the manufacture and sale of 
cannabis topicals, Kennedy and Blue worried about whether you could 
make the stuff without violating federal drug laws. This put topicals 
off-limits as an investment, at least for now. If there's one rule 
that Privateer lives by, it's "don't touch the leaf."

Kennedy and Blue's venture into the cannabis space began three years 
ago. At the time, Kennedy was directing the operations of SVB 
Analytics, which specializes in entrepreneurial fields like high 
tech, genomics, medical devices and green energy. He spent part of 
his time in San Francisco and Santa Clara, Calif., for work and part 
in Seattle, where his wife has a high-profile career with the Pacific 
Northwest Ballet.

One day a call came in to the SVB office from an entrepreneur who 
sold inventory software to medical-marijuana dispensaries. He wanted 
to know how to attract venture capital. Christian Groh, who was head 
of sales at SVB Analytics, took the call and told Kennedy about it. 
They were intrigued and amused. Pot software? They knew their own 
firm wouldn't touch it. "Nobody wants to be known as the first banker 
or venture capitalist to make an investment in the cannabis 
industry," Kennedy later told me. "The risk to the firm's reputation 
is too great."

Later that week, as he drove on I-280 through Silicon Valley's green 
hills, Kennedy happened to tune in a radio show on marijuana 
legalization. He hadn't touched pot since he was 19, he says, but the 
notion proposed by one guest seemed to make sense: Marijuana should 
be regulated like whiskey or wine. Kennedy thought about the software 
developer. Maybe there was a way to get into the business without 
being directly involved with pot. The growing and selling of 
marijuana, as it becomes increasingly legal, will require many 
ancillary products. "When everyone is looking for gold," the saying 
goes, "it's a good time to be in the pick-and-shovel business."

When Kennedy pulled off the highway, he called Blue, his old Yale 
School of Management classmate. "You know how we've always talked 
about starting something together?" he said. "I think I've found it. 
We need to start a venture-capital firm in the cannabis space."

At the time, Blue, who is from Arkansas, was happily ensconced at a 
sleepy financial firm in Little Rock, where he and his wife had 
settled to raise their children near her parents. If you were casting 
a comedy, Blue would be the bow-tied square who thinks things are 
getting out of hand when somebody orders a second pitcher of beer. To 
him, Kennedy's idea was outrageous. It was insane. And it was interesting.

That night, lying in bed, Blue turned to his wife, Christina. "I'm 
going to tell you something about a conversation I just had with 
Brendan," he said. "No one knows about it yet. But here's what he's 
thinking." Neither Kennedy nor Blue could shake the notion. Working 
during their off-hours in Santa Clara and Little Rock, they dug into 
the existing marijuana research. They read the 1970 Controlled 
Substances Act, National Institute on Drug Abuse reports, medical 
studies from all over the world. They made reconnaissance visits to 
dozens of marijuana dispensaries. They decided that the only way 
they'd be comfortable even seriously thinking about the idea was if 
they could determine that marijuana was truly helpful for medical patients.

It was clear that not everyone with a medical-marijuana card was 
consuming pot for medical reasons. But they also came to the 
conclusion that many sick people were being helped. "One study after 
another pointed to its effectiveness for treating symptoms of 
multiple sclerosis, epilepsy and chemotherapy," Blue recalled. The 
research wasn't completely exculpatory, of course. Some studies 
suggested that chronic pot use could lead to long-term cognitive 
deficits, especially among people who start in their teens. Still, 
they found enough evidence to persuade themselves and, they hoped, 
potential investors.

But Kennedy and Blue were not just interested in cannabis for 
humanitarian reasons - they knew the payoff could be enormous. 
Medical marijuana is now a $1.5 billion industry, it's estimated, 
operating in 18 states and Washington, D.C. Within the next year New 
York and three other states may join them. A recent Fox News poll 
found that 85 percent of Americans - and 80 percent of 
self-identified Republicans - approved of the medical use of 
marijuana if a physician prescribed it. Last November voters in 
Colorado and Washington State went one step further - legalizing 
marijuana for adults 21 and older. And recently, the Pew Research 
Center reported that for the first time in more than 40 years of 
polling, a majority of the nation's adults now favor full 
legalization. (In 1991, only 17 percent of adults supported it.)

Still there was a criminal risk, though how great was unclear. Much 
depends on the federal response to medical-marijuana laws and the new 
statutes in Washington State and Colorado. The Justice Department's 
current policy on medical marijuana has turned district U.S. 
attorneys into de facto drug czars, with some (New Mexico) allowing 
the handful of dispensaries to operate and others (California) 
raiding and closing hundreds of retail operations.

In thinking about whether to go into the pot business, Kennedy and 
Blue struck upon the historical example of Joseph Kennedy (no 
relation to Brendan) and the repeal of Prohibition. In the fall of 
1933, as repeal of the 18th Amendment appeared all but inevitable, 
the father of the future president traveled to England, where he met 
with the managing director of the Distillers Company. By the time he 
returned home, Kennedy had locked up the American import rights to 
Dewar's whisky and Gordon's gin. According to Daniel Okrent's 
Prohibition history, "Last Call," Kennedy had previously obtained 
medicinal liquor permits and warehouse space. ("Medical liquor" could 
be legally purchased with a doctor's prescription.) On Dec. 6, 1933, 
the day after Prohibition ceased, Kennedy's Somerset Importers was up 
and running.

The way Brendan Kennedy saw it, he and Blue had the chance to do what 
Joe Kennedy did 80 years earlier. Setting themselves up in the 
medical-marijuana field made good short-term sense, and their early 
entry would position Privateer Holdings as a major player if 
marijuana turned fully legal.

Still, they worried. "We realized early on that the biggest risk 
wasn't legal," Kennedy told me one day between investor pitches. "It 
was the risk to our professional and personal reputations." Investing 
in the cannabis space would most likely burn their bridges to the 
traditional banking world. They floated trial balloons to see how the 
idea played among friends and family. One of Kennedy's older 
brothers, a firefighter, was open to it. He told Kennedy about an old 
family friend, a rock-ribbed Republican fire captain, who used 
cannabis to fight the nausea from chemotherapy treatments when he 
battled cancer in the 1990s. Kennedy had no idea.

"We heard stories like that almost every time we brought up the 
subject," Blue said.

Blue's elders at his Little Rock firm - old Southern country-club 
gents - reacted with interest, not disgust. Blue recalled James 
Atkins, the firm's 78-year-old managing director who was known as 
Bum, telling him: "You're talking about more risk than I've ever 
taken on. If you do it, do it the right way. Make sure everything's 
aboveboard and legal."

At the end of six months, Kennedy's idea had evolved from crazy to 
risky. "Where are you at with this?" he asked Blue. Blue thought 
about it. "I'm about 70 percent in," he said.

In January 2011, Kennedy felt that they needed to make a decision. 
The opening was clear. By some estimates, the size of the state-legal 
market could reach nearly $9 billion by 2016. That would make it 
equivalent to the worldwide market for mobile gaming. "This is an 
existing billion-dollar industry with immature companies run by 
unprofessional managers," he told me. "There are no market leaders, 
no standards and poor branding. There's a taboo around the product 
that's rapidly changing. There's no involvement by Wall Street, 
venture capital or banks - yet. I've never seen an opportunity like it."

Blue needed to think it over. He and his wife dropped the kids with 
her parents and took a day to map out the potential risks and 
benefits. He would be putting marijuana on his resume, and start-ups 
often fail. But Blue was excited about creating a new market with 
Kennedy and the rewards could be substantial. After growing up in a 
small town in Arkansas, he said, meeting people like Kennedy and 
having opportunities like this "were exactly why I'd gone to business 
school." At the end of the day, Christina turned to her husband and 
said, "You have to do this." Blue called Kennedy the next day. "One 
hundred percent," he said. "I'm in."

That summer, Kennedy and Blue attended a conference of 
cannabis-industry leaders at the Hotel Nikko in San Francisco. The 
two wore suits and ties. "Most people thought we were D.E.A. agents," 
Kennedy recalled. They scouted for investment-worthy start-ups but 
found none. "It was a cavalcade of crazy," Kennedy recalled. One 
panel featured industry leaders discussing the benefits of taking a 
cannabis company public. To Kennedy and Blue, who had actually worked 
on I.P.O.'s, the notion was delusional. They eventually adopted a new 
tactic. Every time a panelist offered a crackpot assertion, the 
financiers scanned the audience to see who seemed to be rolling their 
eyes. "Those were the people we wanted to talk to."

The conference forced them to reconsider their business model. "We're 
way too early," Kennedy said to Blue. Entrusting great sums of cash 
to the equivalent of Harold and Kumar seemed foolhardy. Kennedy and 
Blue decided they had to switch from a venture enterprise to a 
private-equity model, in which they could purchase companies and 
install their own management if necessary.

A handful of accredited investors openly backed marijuana-related 
companies. But most of them, including members of the ArcView Group, 
the most visible cannabis-financing network, had longstanding ties to 
medical dispensaries and marijuana activism. They were successful 
cannabis entrepreneurs looking to help out the industry's next 
generation. Privateer wanted to be different. It would remain far 
from the leaf, considering investments in only those businesses that 
were "legal at the local, state and federal level," as Blue put it: 
inventory-tracking software, lighting for indoor grow sites, security 
services for sites and dispensaries, business liability insurance.

Blue began to commute between Arkansas and Seattle, eventually 
relocating his family. Christian Groh, the SVB colleague who took 
that initial phone call from the pot programmer, was the firm's third 
founding partner. The private-equity model proved popular with 
investors, who began wiring money to Privateer Holdings in November 
2011. None of their investors were comfortable being named, but 
Kennedy said a handful of old-money families in New York and Boston 
have accounts with the firm. Though there aren't any pension funds or 
institutional investors, the firm has attracted wealthy individuals 
on the political left (who often see cannabis as a humanitarian 
cause) and on the right (who view it as a libertarian cause). "If you 
put our investors in a room, they wouldn't agree on anything other 
than this one issue," Kennedy told me.

By the end of 2011, the firm had enough cash on hand to make its 
first purchase. They chose Leafly, a Yelp-like Web site that offers 
crowdsourced reviews of medical-marijuana dispensaries and cannabis 
strains. A big part of the site's appeal was that it wasn't already 
branded with symbols of pot culture. "It didn't have any of the old 
cliches," Kennedy said. "The site wasn't plastered with pot leaves or 
pictures of Bob Marley."

Shortly after the cannabis-topicals presentation, I went with 
Kennedy, Blue and Tonia Winchester, who helps direct Privateer's 
corporate strategy, to Heckler Associates, a Seattle ad agency, to 
discuss a campaign for Leafly. "We had to pitch the Heckler partners 
for six hours to get them to take us on," Kennedy told me on the way over.

Heckler is known for taking small companies and breaking them 
nationwide, and the firm's lobby is decorated with logos designed for 
Starbucks, K2 and New Balance. Scott Lowry, the accounts director, 
led the Privateer team into a back office, where he laid out the 
contents of a Leafly marketing kit being readied for shipment to 500 
medical-marijuana dispensaries. A few weeks before, Lowry and the 
Privateer team looked at light green Leafly promotional stickers. The 
logo was good. Everything about it from the rounded typeface to the 
red, green and purple rectangles, had been designed to be as 
mainstream and friendly as Amazon or Target. But the stickers' 
background color sent the wrong message: hippie, head shop. Now Lowry 
showed the team new white stickers, which looked bright and pristine. 
Blue nodded, pleased.

Lowry ticked through the marketing box. "We've got T-shirts, hats, 
stickers, magnets, window clings, dispensary bags, posters and a 
brochure display," he said. To reinforce the medicinal aspect of 
dispensaries and Leafly, the Heckler team had printed thousands of 
Leafly-branded bags, just like the ones handed out at the pharmacy 
counter at Walgreens or Rite Aid.

One item on the contents sheet caught Kennedy's eye. "Where we list 
the hat, it says, 'Skull cap,' " he said. " 'Skull cap' is skater. 
It's aggressive. What about 'beanie'? 'Beanie' is happy."

Toward the end of the meeting, Lowry revealed a Leafly ad aimed at a 
mainstream print publication. The ad featured two residents of an 
upscale New York City neighborhood. A dapper businessman exits his 
brownstone. "While beating cancer, Ian used Blue Dream," the copy 
said, referring to a specific type of cannabis. A woman on her 
morning run passes nearby. "Molly prefers Kali Mist to relieve pain." 
The tagline: "What's your strain?"

It looked like a pharmaceutical ad: urban professionals each using a 
specific strain of cannabis to address a specific need - and using it 
like an antidepressant or a statin. Lowry later explained the 
thinking. "In the early '60s, Honda wanted to sell motorcycles to 
Middle America," he said. The problem was the motorcycle's 
reputation. Hoodlums and outlaws rode motorcycles. Think of Brando in 
"The Wild One." "So Honda came out with a campaign: 'You meet the 
nicest people on a Honda.' " The ads featured mothers and daughters, 
wealthy dowagers, even Santa Claus, all riding Hondas. Cannabis, 
Lowry said, is the new motorcycle.

The Privateer team loved it. "This ad could run in The Wall Street 
Journal or an AARP publication," Kennedy said as we walked out into 
the street. "Ultimately we're trying to create reliable, trusted 
products that are attractively packaged. What this industry needs is 
a clean American brand."

Editor: Ilena Silverman
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MAP posted-by: Jay Bergstrom